AGM commentary on resolutions - board paper

OK - while Pinto was busy posting in the last few days I was preparing the commentary in a paper which I have now sent to the board.

I am sorry but I cannot  upload a word document so have had to copy and past it.  I have excluded appendices  and also a couple of extracts from a report that i had included as images.  It is too difficult to include them here.

It sets out in far more detail than Pinto's posts the rationale that we have for voting against the resolutions.

I hope this helps people who are interested

Introduction
I have recently voted on the Alexium International remuneration proposals and, having voted against them, thought that I would like to explain to you the reasons for my decision, since it was not based on a superficial assessment of the proposals but a reasonably in-depth assessment of matters as I saw them.

I have set out below my assessment of relevant factors and in doing so hope that I may contribute to some reflection and thinking at Board level that will lead to decisions that work for the benefit of all shareholders.
In making the comments I wish to reinforce that they are NOT a reflection on the progress the company has made towards successful commercialisation, or on its potential.  It is not a reflection on the capability, energy, intellect and drive of its CEO either.  It is instead an attempt at applying a rigorous analysis to the data in front of me rather than forward projection of what might be.

I understand that Alexium has put in place a remuneration plan that is consistent with that which might be found among other ASX 300 companies. However the issue I want to address is not the generic characteristics of the plan but the quanta that result from its application.

I draw for my guidance a rather long period working with some of these matters within the private sector and an intimate understanding of how effective cultures can be fostered, as well as AICD remuneration guidelines.
These latter are quoted in appendix 1 though they will hardly be a surprise to you

Executive Summary
Key matters raised in this document are:

Overall performance and remuneration for CEO and Executive Chairman
While growth of the business has been exceptional during 2015/16 total remuneration including bonuses should properly reflect the remuneration of the company in terms of market cap, return, stage of growth, revenue etc.   When such a comparison is done it is hard to see the bonus payment for 2016 and the remuneration recommendations as other than a reward for effort rather than performance.  While that may seem harsh good practice keeps emotion out of the equation.

The role of the Executive Chairman
This role was introduced in 2012 when circumstances were different, with a different CEO.  I have raised a query about whether this role continues to be necessary, as well as the implications for the company in respect of additional costs.   In an Australian context it is an unusual role, particularly where an effective CEO is in place.  The advisory firm “Ownership Matters” also red flags this role.

Board composition and residency
It is disappointing that Alexium has not taken steps to appoint a female to the Board.  I believe there may also be a need to reassure shareholders that residency requirements are met – with two directors being resident in Australia.

Overall company performance

1. Criteria

I have used three key criteria for assessing overall company performance

• Share price
• Financial performance
• Growth

Share price

• At the time the resolutions were forwarded to shareholders last year the share price was $1.00
• At the date of the last AGM the price was $0.87
• At the date of issuing the notice this year $0.59
• Currently - $0.60
• For the ASX 300 as a whole as at 10/11 there has been a 4.26% return on share price
• For Alexium that was a return of -29.17%

Financial performance

My assessment of remuneration was made on the basis of the data available in the end of year 2016 report.  This represents the most recent audited results AND were the only figures available at the date on which the notice of AGM was issued.

It is normal practice for base salaries to be derived from such data with performance incentives providing the mechanism to factor in growth potential.
Data utilised includes:

• Actual Revenue
• Revenue to target
• Margins

While there were no formal targets published for the end of the financial year 2016, shareholder newsletters and a review of the initial Moelis report published in April 2016 could reasonably be seen to have created a set of expectations.  (The latter indicates that the financial tables were based in part on company data.)  (See Appendix 2 for relevant extracts)

The company did not achieve the expectations that would have been established in the market in terms of total revenue or margins, and although growth was impressive given the stage of the company’s development, and the low base.

For me, however, the questions should not be – how impressive is the progress but:

• What remuneration levels might be appropriate for this stage of development of the business?
• Are there incentives in place that will appropriately reward performance commensurate with the level of achievement over a year?

Growth
There is no doubt that the business has made impressive strides in terms of revenue generation, and has exceeded the norm in terms of commercialisation ramp up – assuming one counts from the date the current CEO was in place, or from the time the focus shifted to fire retardants.

If one considers progress from the date of listing however progress is rather closer to average.
Despite this, I am of the opinion that until there is evidence of the current pipeline customers being converted, and having regard to the results at the end of fy16, as shareholders we are currently going somewhat on faith.
In my view the remuneration should be better constructed to reflect the current state in terms of returns with adequate capacity to reward the stellar performance expected in 2017.

Adoption of remuneration report
I note that adopting the remuneration report would result in the payment of bonuses to both Mr Rezos and Mr Clark.  These bonuses were not included in the remuneration plans approved by shareholders last year and are being sought in retrospect.

Expectations for company performance may have been set high through reports and announcements but it is not good practice to seek approval after the event for performance that left many shareholders disappointed to the extent it did not match expectations, and shareholders experienced a substantial reduction in the value of their shares over the 12 month period.

I cannot support such a payment for the reasons outlined above.

Executive chairman remuneration
I note that the Mr Rezos became executive chairman in 2012, at the time when Mr Susta was the CEO.  While I can review the company history and see why that move may have been considered necessary at that time, it was not until approximately 1 year after Mr Clark had become the CEO (i.e. 2014) that we started to see any progress in the company from the point of view of strategy, execution and sales.   My thoughts are therefore that it has been the appointment of Nicholas Clark that has made the difference rather than the presence of an Executive Chairman.
I am surprised that there has been no review of the Executive chairman role, and while I do not have facts it is my guess that it is now an unnecessary role.  I respectfully request the Board to consider the role and the remuneration with the following in mind:

• Whether it is consistent with ensuring proper division between governance and executive roles and even if this exists;
• Whether it remains necessary to provide the strategic support and guidance that was necessary at the time it was introduced
• Whether the costs associated with the role are justified by the level of effort and input that occurs in practice

I note also that the Alexium International constitution includes the following reference
THE ROLE OF THE CHAIRMAN
(a) The Chairman is responsible for the leadership of the Board, ensuring it is effective, setting the agenda of the Board, conducting the Board meetings, ensuring then approving that an accurate record of the minutes of board meetings is held by the Company and conducting the shareholder meetings.
(b) Where practical, the Chairman should be a non-executive Director. If a Chairman ceases to be an independent Director then the Board will consider appointing a lead independent Director.
(c) Where practical, the Chief Executive Officer/Managing Director should not be the Chairman of the Company during his term as Chief Executive Officer/Managing Director or in the future.
(d) The Chairman must be able to commit the time to discharge the role effectively.
(e) The Chairman should facilitate the effective contribution of all Directors and promote constructive and respectful relations between Board members and management.
(f) In the event that the Chairman is absent from a meeting of the Board then the Board shall appoint a Chairman for that meeting in an Acting capacity

An email from Mr Rezos that was shared with retail investors in September 2016 noted that the factors that may have impacted on the AJX share price, including:

Lack of an Australian Retail Broking House appointed to highlight Alexium to the retail sector;
We did not immediately replace Baker Young as retail broker and that is something we should have addressed earlier. Strong announcements were not being picked up by new retail clients of other brokers but simply by our existing shareholders and insto’s.

Institutional Broker as sole coverage;
Institutional brokers contact their clients and issue research updates only on material news as opposed to much more regular contact that occurs between retail brokers and their clients. We have a number of institutional holders who have taken a position with a view to significantly increasing that position when we meet our revenue projections. Fidelity, one of the world’s largest funds has expressly stated that position to us. That means we need to expand our Insto base more widely pending the additional buying on achieving our numbers.

Moelis have a $1.20 price target.  (now dropped to a 12 month target of $1.00)

Lack of an Australian based Investor Relations resource;
It is evident that we need at least a part time resource on the ground in Sydney or Melbourne given our US base and my London base.

These are matters which I think it would have been reasonable to expect an effective Executive Chairman to address with the CEO and yet to the best of my knowledge they remain unresolved. Whatever we may think of the quality of the latest Moelis report (and I don’t think much of it at all) it is out there and has effectively devalued the company.

I understand that the Chairman has a substantial interest in the company as both founder and is the largest shareholder through direct and indirect interests.  However given that this is a public company I would urge the board to review this role with confidence and courage.

The consequence of retaining this role (unusual in Australia in particular) for a company that has moved beyond its early development days and is now well into successful commercialisation and has a highly effective CEO, is to impose additional costs on the business.

I also observe from publically available records that Mr Rezos has the following interests in other companies:

• Chair – Resources and Energy Group
• Director – department 13
• Executive Chair – Alexium international
• Viaticus capital
• Director – Iluka Resources which includes additional responsibilities as Director of Metalysis

He resigned as company secretary on 20 October 2015 from a company Born Int, incorporated on 29 October 2013 that appears to have been associated with family interests.  I understand he is also working on another venture called WhiteHawk Cyber Security.

This is a substantial workload spread among the different companies and yet you have asked us to approve 2017 remuneration for the chairman that in total, including all remuneration elements, is $1,032,500.  This sets the potential remuneration for the Executive chairman at approximately 64% of the remuneration for the CEO.

We all know how hard Mr Clark works for the company and while I am not querying whether Mr Rezos works hard on our behalf I do question whether he adds value to that level.  Further I would ask, if this is the case, are there gaps in the capability of capacity of the CEO that need to be addressed and if so – can they be addressed through appointment of an employee at less cost to the business?

It is my belief that the value Mr Rezos adds from having been founder will be realised when the company is fully commercialised and successful and remuneration as an Executive Chairman should not be used as a mechanism to ensure a financial return beyond the role of chairman.

Recommendation:
That the board:

• Review the need for an Executive Chairman role and
• Put in place remuneration that more accurately reflects the level of effort and value that is added by the incumbent, and that is more consistent with other companies of similar size, market cap and known potential, and
• If there are gaps in the capacity or capability of the CEO address these through the appointment of an employee reporting to the CEO

CEO remuneration
Many of the comments made above in relation to the overall performance of the business and the Executive chairman remuneration apply to the CEO remuneration as well.

The Alexium remuneration report /description of remuneration policy provides no detail of the comparators used other than reference to the ASX300.

In addition the current market cap of Alexium only barely makes the ASX 300, and this situation has been the case for the bulk of this year.  Therefore if averages of CEO remuneration for ASX 300 companies has been used that is, in my view, too broad brush to be helpful.

While a report from “Ownership matters” uses a benchmark group from the same sector of the ASX it is noted that for the large part this sector includes mining related companies.  I regard these as poor comparators for a range of reasons.

I therefore undertook a review of remuneration paid to CEOs in range of ASX300 companies, considering different factors:

• Same sector
• Market cap – regardless of sector
• Shareholder return last 12 months regardless of sector
• Revenue/profit/loss regardless of sector
• Geographic spread of operations
• Stage of development – early phase commercialisation

A list of reviewed companies is attached as Appendix 3.  While it is difficult to be precise, and there is a reasonable level of variation across companies, in general it is my view that the remuneration for the CEO is approximately 25-30% higher than I’d expect even were there not an Executive Chairman.

I have even greater queries about the rate given the existence of the Executive Chairman role.  Apart from a couple of notable exceptions other comparators have the more traditional structure of a non-executive chairman and a CEO who is on the Board. In the couple which have an executive chairman the remuneration reflects a dual CEO/chairman role, or the CEO receives comparatively lower remuneration.   

My sense of this is also influenced by the current costs associated with the business – the CEO remuneration is a substantial chunk as it is and the costs associated with the two roles is a substantial impost.

I admit freely to finding it difficult, on a personal level, to say that I believe the remuneration recommended for the CEO is inappropriate for the current state of the company.  I have written many short pieces over the last year in which I outline why I believe that this business is extraordinary with a CEO who matches many of the best I have had the privilege to work with and there are not many I would talk of in those terms.  However there is and must be a difference between how one feels about a person and the way they are rewarded.

In fact it is this ability to recognise how personal interest and emotion can interfere with sound decision making that make a difference in whether a company builds a culture that is productive, healthy and ethical that can become a source of competitive advantage in its own right. Few companies achieve that but it must start at Board level.

As an aside I have not adequately tested whether there is sufficient stretch in the structure of the remuneration in terms of at risk rewards or way the performance criteria are to be applied to ensure that if in fact company performance for year 2017 is stellar the remuneration will deliver in a way that compensates for a more conservative base salary.


Other matters
I have recently reviewed the report completed by the advisory service “Ownership Matters”.  While they recommended adoption of the remuneration report and individual resolutions they also made cautionary comments.  Since I share many of these concerns I have referred to them below, rather than focus only on my opinions.  Where relevant I have included extracts from that report for ease of reference.

Executive Chairman
I believe that this supports the position I outlined earlier in this paper.

Board composition
It is disappointing that Alexium has not sought to take a lead in ensuring its board composition reflects gender diversity.

I would like to be reassured that the residency requirements for board composition of an ASX listed company are being met.
A public company must have at least three directors (not counting alternate directors). At least two of the directors must live in Australia.

Resolutions 11 and 12 long and short term incentives for G Rezos
Both these resolutions are based on the presumption that Mr Rezos is an executive. I do not support that proposition.

Remuneration
The paper from Ownership Matters includes the following cautionary notes  (for this post I have not included the extracts but essentially they deal with the quanta and the risks/concerns associated with the resolutions.  

In general I concur with these assessments.  However I would suggest that given the likely growth trajectory of the business during the year ending 2017 it may have been more beneficial to construct the CEOs remuneration in a way that lowers the base and therefore fixed cost, and increases the amount of at risk pay to ensure that stellar performance can be appropriately recognised.  I am not convinced that the current mix is either appropriate or beneficial.

While TSR is a mechanism for linking pay to performance and return to shareholders it also carries well known risks particularly with regard to the comparator group. Inadequate disclosure of these comparators is of concern.  I am not able to understand why an AJX representative might have suggested using the ASX materials 200 group

A study by Cornell University in October 2015 indicated
Estimates of TSR plans on firm performance (Tables 8 through 10) indicate that there is no strong evidence of a positive impact of TSR plans on firm performance. Moreover, we find that point estimates of TSR plans on 1/3/5 year TSR measures are often negative while only occasionally being statistically significant.
(TSR, Executive Compensation, and Firm Performance∗ A Brief Prepared by the Institute for Compensation Studies ILR School, Cornell University Hassan Enayati, Kevin Hallock, and Linda Barrington October 1, 2015)

I have also reviewed a report published by the Australian Council of Superannuation Investors “Board Composition and Non-executive Director Pay in ASX200 Companies: November 2016”   This would suggest that even if the Executive Chairman did not receive benefits more consistent with those of an employee/executive, his base pay would place him among the better remunerated non-Executive Directors in the ASX 100-200.

Uses of shares and options for Directors
The cautionary notes in the Ownership Matters paper include the following:
(again not included in this post but the comments deal with the use of options to reward non executive directors)

Page 15 – Employee share plan

There is the following reference on page 15 relating to the employee share plan.  You will note that it states … each of the directors being…….. and Aaron Kresch. The plain meaning of  this paragraph  suggests that Aaron (whose name is actually spelt Krech in other documentation) is a director.   I am assuming this is incorrect. Even if this were a poorly worded attempt to use an example of an executive or employee  (not what the words actually say) it is a strange choice of example, and of course would not be required as part of the resolution.

Page 17  - performance rights plan
The same problematic wording also appears on page 17 of the document

cheers

1. parsifal