Activism Adds To The Bottom Line At P&F Industries

In a January 4, 2012 8-K filing, tool and hardware company, P&F Industries (Nasdaq:PFIN), disclosed it has entered into a new 3-year Employment Agreement (“New Agreement”) with current Chairman and CEO Richard Horowitz replacing Horowitz’s prior agreement that expired at the end of 2011 (the “Expired Agreement.”) The improved terms for shareowners in this New Agreement (vs. the Expired Agreement) reflect additional shareholder activist progress towards addressing deficient corporate governance and executive compensation excesses that have existed for years at this small company.

This January 13, 2012 article in the online version of Institutional Investor describes the 1/3 reduction in Mr. Horowitz’ new base salary in the New Agreement, as “unprecedented.” Seeking Alpha recently published an article expressing an investor’s hope that activist involvement at larger tools comparable, Illinois Tool Works, (ITW) would qualitatively increase that company’s share price. However, here, changes in P&F’s CEO’s Employment Agreement, discussed below, have very tangible bottom-line positive impacts.

For example, the $325,000/year in reduced base compensation paid to Mr. Horowitz alone increases P&F’s annual Pre-Tax Income by $0.09/share. Furthermore, assuming for illustration purposes an identical bonus “target”, the new lower 50% of (now lower) base salary vs. the former 90% of base salary bonus could result in an additional $552,000/yr or $0.15/share benefit from reduced bonus calculations in the New Agreement. These are quite meaningful amounts, considering the company’s over $8 million in Tax NOL’s will drop such savings (in this example, $0.24/share) to P&F’s bottom line cash-flow.

Whether using PFIN’s currently depressed P/E multiple of 6.6x, the 13.4x average P/E multiple of the other much larger publicly-traded tool companies of Snap-On (SNA), Stanley Black & Decker (SWK), and Illinois Tool Works, or a 10x multiple (coincidentally, an average of P&F’s depressed P/E multiple and the average of the larger public tool companies’ P/E’s), the potential valuation increase on PFIN’s presently less than $4/share price is sizable, ranging from over 40% to over 80%.

Activist Fight History Leading Up To The Improved CEO Contract

In 2008-2010, P&F encountered a serious liquidity scare from losses from acquisitions made at the peak of the economic cycle. Over the past few years, my firm, Lawndale Capital Management, P&F’s largest independent shareholder, has questioned P&F’s corporate governance in terms of Board independence and senior executive compensation.

In our original February 3, 2010 13D filing (with PFIN at $2.50/share) we disclosed Lawndale’s concerns over the lack of alignment of P&F’s directors with shareowners. It is our belief that qualified independent directors with purchased equity ownership in meaningful quantities will more objectively and aggressively oversee executive’s compensation and their corporate acquisition decisions.

Subsequently, at the invitation of the Chairman of P&F’s Nominating Committee, Lawndale successfully conducted a search for qualified and independent individuals willing to serve on P&F’s Board. At the end of February 2010, Lawndale recommended five of these individuals to PFIN’s Nominating Committee to consider as replacements or additions to P&F’s director slate for its June 2010 Annual Meeting.

While Lawndale’s nominations were submitted long before the company’s deadline for setting its director slate and filing P&F’s Proxy for the June 2010 Annual Meeting, none of them were included as part of the company’s director slate. In addition to not including any of our nominees, this proxy provided further detail on executive compensation that we illustrated in Lawndale’s May 25, 2010 letter to P&F’s Board [pdf file takes a minute to load but the graphics are very illustrative] highlighting CEO Richard Horowitz’ compensation as excessive as well as potential conflicts of interest with certain members of the Board, particularly the Board’s then Compensation Committee. This letter additionally set forth reasons for Lawndale’s vote to “Withhold All” on the re-election of P&F’s director slate at this 2010 meeting.

After leading independent proxy advisory services, Proxy Governance and RiskMetrics (again renamed ISS) also recommended certain “withhold” votes, roughly 30% of the votes cast for PFIN’s nominees were voted “Withhold.” While this percentage is much higher than average for any company, it is more remarkable when considering that upwards of 35% of all of P&F shares are held by Mr. Horowitz, Board members, other affiliated entities, and family members of insiders.

“Rudimentary” Improvements Following The 2010 P&F Annual Meeting

Following this vote and after a face-to-face meeting with myself and a few other concerned shareholders, P&F’s Board took some small steps toward improving the company’s governance as follows:

  • Replaced all members of the Compensation Committee with other legacy directors who are not fellow Glen Oaks Country Club members with Mr. Horowitz;
  • Formed the position of Lead Independent Director;
  • Eliminated an outdated by-law requiring that P&F’s Chairman be the CEO; and 
  • Added Howard Brownstein, one of the highly qualified and independent individuals recommended by Lawndale, to the P&F Board. 

However, in our view, at this point, these changes were rudimentary and more like shifting the deck chairs on a cruise ship. In a September 17, 2010 letter to P&F’s Board, we wrote that, “given the long tenure and social relationships of P&F’s legacy directors with Mr. Horowitz”, the Board still needed to:

  • take additional steps to improve the Board’s independent composition (namely the removal of director Dennis Kalick, who even the P&F Board considered not independent); and
  • Reduce or eliminate the egregious compensation terms provided to Mr. Horowitz under his then current employment contract upon its 2011 expiration, especially via lower “guaranteed” base compensation.

This letter is described further in a September 2010 Seeking Alpha article, entitled “Activist Investor Lawndale Increases P&F Industries Stake While Demanding Action”

Prelude To The 2011 Year-End CEO Contract Renewal Negotiations

With CEO Horowitz’ employment agreement expiring at year-end 2011, we communicated Lawndale’s continuing governance concerns and opposition to a contract renewal on similar or even worse terms (for P&F shareowners) as the expiring Employment Agreement. In a May 25, 2011 13D filing, which included a letter to P&F’s Board, we detailed some of our particular areas of concern and requested further dialogue with P&F’s Board. Other shareholders raised additional concerns about Horowitz’ continued employment on PFIN quarterly earnings conference calls and inPFIN 13D filings.

P&F’s New CEO Agreement – A Large Improvement Vs. Prior Agreement

The recently announced New Agreement differs from the Expired Agreement in several material respects:

  • Mr. Horowitz’s Base Salary was reduced from the Expired Agreement’s minimum $975,000/year to $650,000/year;
  • Mr. Horowitz’ “Target Bonus” has been reduced to 50% of Base Salary vs. 90% of Base in the Expired Agreement and, in addition, PFIN’s Compensation Committee has the right in Year 2 or 3 of the New Agreement to reduce the Target Bonus % (from current 50%) and apply such Target amount into a long-term cash or equity incentive plan;
  • There is a bonus cap in the New Agreement. Mr. Horowitz’ “maximum bonus”, based on exceeding performance targets, is established at 150% of Base Salary vs. no apparent maximum in the Expired Agreement at all;
  • The New Agreement expires in 3-years vs almost 5-years duration of the Expired Agreement;
  • The New Agreement allows terminating Mr. Horowitz “for Cause” based on a vote of a majority of independent directors, whereas the Expired Agreement required a majority vote of P&F’s full board, including non-independent directors.
  • The New Agreement allows someone, other than Mr. Horowitz, to be elected Chairman of P&F’s Board without triggering an onerous and costly “Termination Without Cause or for Good Reason” event. In the Expired Agreement any removal of Mr. Horowitz as Chairman triggered costly Termination/severance provisions.

Room For Further Governance And Compensation Improvement At P&F Industries

While the improved terms of the New Agreement have tangible bottom-line benefits for PFIN shareowners and the P&F Board is better able to replace or demote Mr. Horowitz, if necessary, there is still plenty of room for additional governance and executive compensation reform.

Board composition –

Presently P&F’s board is comprised of nine directors, Mr. Horowitz, his personal tax advisor, three other directors who are long-time close friends and fellow Glen Oaks Country Club members with Mr. Horowitz, three other independent “legacy” directors and the independent shareholder representative, Brownstein. In a December, 12, 2012 8-K filing, P&F announced that Horowitz’ tax advisor, non-independent director Dennis Kalick, would not be standing for re-election at the May 2012 Annual Meeting.

This particular vacancy offers P&F’s Board the opportunity to further increase its independent composition through the addition of another independent nominee from shareholders. Optimally, for a company as small as P&F, one or more of the directors with Glen Oaks Country Club ties to CEO Horowitz should also stand down from re-election. The Board nomination process for any vacancy ought to be completely independent from the CEO, but for taking into account particular skills or experience sets that the CEO feels would be value-added to this company’s boardroom.

Executive Compensation –

While we appreciate Institutional Investor.com’s January 13, 2012 articleand kudo’s regarding “mowing down” CEO Horowitz’ salary by an “unprecedented” amount, the resulting $650,000 base salary still seems a bit high to us. This is especially concerning to us because of P&F’s small size and holding company structure with autonomous operating divisional executives. Our concern similarly applies to the executive compensation provided to P&F’s COO/CFO, Joe Molino, as well. According to P&F’s most recent proxy, Mr. Molino’s total compensation in 2010 was over $417,000, including a base salary of $332,500. Mr. Molino’s Employment is “at will” so compensation reform should now be extended to him as well, further improving P&F’s bottom line.

Regarding the New Agreement, there has not been disclosure on the metrics to be used for determining the CEO’s performance bonus and whether they are aligned with shareholder’s interests. We also haven’t received disclosure on whether the performance thresholds were set at appropriate “reaches” for an industrial goods company in both the tools and residential hardware sectors that are cyclically bottoming off their troughs right now.

Conclusion

After a serious liquidity scare from a money-losing acquisition, tool and hardware company, P&F Industries has reestablished profitability, while at the bottom of its economic cycle. This bodes well for increased profits in the future. Historically, more of the company’s cash flowed to Chairman and CEO Richard Horowitz than to the company’s bottom line. As a result of activism by my firm, Lawndale Capital Management, and other courageous P&F shareholders, improvements in both corporate governance and a new, greatly reduced and restructured CEO Employment Agreement has the potential for shareholders to enjoy a greater share of P&F’s rebound.

Disclosure: I am long PFIN.

Additional disclosure: At time of writing, author and/or funds author manages hold a long position in this issuer and is a 13D filer. Author and the funds may buy or sell securities of this issuer at any time.




About the Author

AndrewShapiro
Andrew Shapiro is Founder, President and Portfolio Manager of Lawndale Capital Management, an investment advisor that has managed activist hedge funds focused on small- and micro-cap companies for over 18 years. Mr. Shapiro’s proactive ownership approach has been effective in directly creating and unlocking shareholder value in Lawndale’s portfolio companies and has contributed to Lawndale’s activist funds often being ranked among the top event-driven and small-cap value funds in peer databases for long-term performance. In addition to leading Lawndale, Mr. Shapiro has also served as a Director or Observer on portfolio company boards and debt and equity bankruptcy committees. Mr. Shapiro is a member of the National Association of Corporate Directors (NACD) and Lawndale has been a long-time Sustaining Member of the Council of Institutional Investors (CII). Mr. Shapiro has more than two decades of portfolio management and analytically varied experience from a number of "buy-side" positions, employing a rare combination of credit, legal and equity analytic and workout skills. Prior to founding the Lawndale organization in 1992, Mr. Shapiro managed the workout and restructuring of large portfolios of high-yield bonds, distressed equities and risk arbitrage securities for the Belzberg family's entity, First City Capital. Before joining First City, Mr. Shapiro was involved in numerous highly leveraged corporate acquisition and recapitalization transactions for both Manufacturers Hanover Trust and the Spectrum Group, a private equity firm. Mr. Shapiro received his JD degree from the UCLA School of Law where he was an Olin Fellow, an MBA from UCLA's Anderson Graduate School of Management where he was a Venture Capital Fellow and a BS in Business Administration from UC Berkeley's Haas School of Business, where he has taught finance courses and frequently guest lectures. Mr. Shapiro is often quoted on matters of corporate governance, fiduciary duty and activist investing and has been the subject of several articles, including a Business Week article in 2000 calling him “The Gary Cooper of Governance”. He is also a frequent speaker on corporate governance and activist investing issues at a broad range of prestigious forums that include the Council of Institutional Investors, National Association of Corporate Directors, American Society of Corporate Secretaries, SEC Advisory Committee on Small Public Companies, and the Director’s education programs of Stanford Law School, UCLA Anderson Grad. School of Mgmt., the Wisconsin Business School and Yale’s Millstein Center for Corporate Governance, among others. Mr. Shapiro started Lawndale’s funds in 1993 with only $188,000 under management and through performance and added capital has grown the firm’s managed assets substantially. In many of its investments, the firm plays a constructive relational role by actively working with Boards and management teams to help them achieve their strategic and operating goals. In other investments, Lawndale is a direct value-unlocking catalyst, utilizing a range of tools that include aggressively promoting improvements in a company's governance and operational structures, asserting shareowner’s legal rights and taking active roles in restructuring and buyout proposal negotiations.