Utah Medical Products (UTMD) 10-K/A2019 FY Annual report (amended)

The Company has adopted a Code of Ethics specifically for its Board of Directors.  The Company also has a Code of Conduct that applies to all of its employees, including its named executive officers, principal financial officer and Board of Directors. The Code of Ethics and Code of Conduct are available on the Company’s website, www.utahmed.com.

The Audit Committee oversees the financial reporting and internal controls processes for UTMD on behalf of the Board of Directors.  The Audit Committee formally met four times during 2019 and once to date in 2020 to review the quarterly financial reports, periodic independent accounting reviews and financial and internal control audits by UTMD’s independent audit firms.  The Committee also met informally as needed during the year.  In accordance with Statement on Auditing Standards No. 61, discussions were held with management and the independent auditors as needed regarding the acceptability and the quality of the accounting principles used in the reports.  These discussions included the clarity of the disclosures, the underlying estimates and assumptions used in the financial reporting and the reasonableness of the significant judgments and management decisions made in developing the financial statements.

The Audit Committee also met with Company management and its independent auditors and discussed issues related to the overall scope and objectives of the audits conducted, the internal controls used by the Company, the openness and honesty of management, auditor verification of information provided by management, quality control procedures used by auditors in performing the independent audit and any possible conflicts of interest. The Committee elicited recommendations for improving UTMD’s internal control procedures. The independent auditors completed a formal review of the scope and effectiveness of the Company’s internal control procedures, and made informal suggestions.

The Audit Committee selects the Company’s independent accountants, approves the scope of audit and related fees and reviews financial reports, audit results, internal accounting procedures, internal controls and other programs to comply with applicable requirements relating to financial accountability. The Audit Committee Chairman on behalf of the Audit Committee reviewed and selected independent auditors for the UK, Ireland, Canada and Australia subsidiaries’ financial audits and tax returns.  In addition, the Audit Committee  discussed with the independent auditors their independence from the Company and its management, including the matters in the written disclosures required by Independence Standards Board Standard No. 1 and The Sarbanes-Oxley Act of 2002.

The Audit Committee of the Board of Directors is composed of all four outside directors, all of whom except one are independent as defined in Nasdaq Stock Market Rule 5605(a)(2) and under Rule 10A-3(b)(1) adopted pursuant to the Securities Exchange Act of 1934.  The exception is Paul Richins, who prior to April 2018 had been an employee member of the board of directors since 1998 and had served as the Principal Financial Officer of UTMD. Under Nasdaq Rule 5605, Mr. Richins is not considered independent until three years after his employment ended.  That notwithstanding, at the Annual Stockholder Meeting in May 2018, Mr. Richins was elected to continue as an outside director. Nasdaq Rule 5605(c)(2)(B) has an exception that allows one non-independent member of the Audit Committee “if the board, under exceptional and limited circumstances, determines that membership on the committee is required by the best interests of the Company and its Shareholders.”  The board of directors made that determination based on Mr. Richins’ deep understanding of the Company’s internal control systems and financial reporting.  Mr. Richins may not serve longer than two years and may not chair the Audit Committee.  The remaining three members of the Audit Committee are independent and comprise a majority of the Board of Directors.  The Audit Committee charter is available at www.utahmed.com.  Ernst G. Hoyer is the Board of Directors’ designated Audit Committee Chairman and Financial Expert consistent with The Sarbanes-Oxley Act of 2002.

The Company’s only equity incentive plan is its 2013 Employees’ and Directors’ Incentive Plan, under which no option awards were issued in 2019.

Named Executive Officers participated in the Profit-Sharing Management Bonus (MB) Plan, generally available to all exempt and key nonexempt employees.  The structure of the performance-based MB Plan is described in the following Compensation Discussion and Analysis.  The 2019 awards under the MB Plan to the named executive officers were recommended by the Compensation and Benefits Committee in early 2020, after the independent audit of financial results had been concluded.  The awards were subsequently approved by the Board of Directors. In early 2020, all UTMD employees, including employees of its subsidiaries, received profit-sharing bonuses based on 2019 performance.  The structure of the MB Plan remains the same for 2020.

The Compensation and Benefits Committee establishes the criteria, and directs the implementation, of all compensation program elements for the CEO.  The CEO’s base salary is set early in each calendar year by the Board of Directors after review of the recommendation of the Compensation and Benefits Committee.  Mr. Cornwell’s base salary in 2020 was set at $156,000, the same as in 2019 and 2018.  However, Mr. Cornwell will contribute 50% of his base salary in 2020 to recompense the cost difference above normal sick benefits of paying employees required to be on quarantine from work due to the corona virus. The annual MB paid to Mr. Cornwell in early 2020 for 2019 performance represented 66% of his total 2019 compensation.  Mr. Cornwell’s 2019 MB was 8% lower than in 2018 because the Company’s consolidated Earnings Before Tax were 8% lower than in 2018.  The MB, which was based by formula on 5% of the Company’s EBT prior to MB accrual, was 8% lower in 2019 than in 2018 for all participants who had met their objectives for the year, except for those who had a change in responsibilities during the year or those who did not receive the full bonus inflating factor due to option awards in the prior year, as further explained below. As in prior years, Mr. Cornwell’s MB was consistent with other participants in the MB Plan, with the exception that he is not eligible for the bonus inflating factor.

The compensation of employees other than the CEO, including other named executive officer(s), is administered by the CEO under the review and ratification of the Compensation and Benefits Committee comprised of all the independent directors. For all other employees, in collaboration with the other executive officer(s), the CEO develops compensation policies, plans and programs that are intended to meet the objectives of the Company’s overall compensation program. The Compensation and Benefits Committee annually reviews and approves the elements of the compensation program recommended by the CEO. In addition, the committee periodically reviews any proposed changes within a calendar year.

Except for Mr. Cornwell, the Company has no employment agreements in the United States.  In Ireland and Canada, UTMD is subject to providing certain statutory advance notice and severance benefits to its employees in the event of redundancy termination.  In the United Kingdom (UK) and Australia (AUS), Femcare has an employment agreement with each of its employees that typically includes a three month termination notice or pay in lieu of notice.

In May 1998, the Company entered into an agreement with the CEO to provide a long term incentive to increase stockholder value.  Per the agreement, the Company is required to pay Mr. Cornwell additional compensation in the event his employment is terminated as a result of a change in control at the election of the Company or by the mutual agreement of Mr. Cornwell and the Company.  Under the agreement, the additional compensation that the Company is required to pay Mr. Cornwell is equal to his last three years’ salary and bonuses.  Based on actual salary plus bonuses for the three years of 2017-2019, the additional compensation would be $1,455,000.

In the event of a change in control, the Company will also pay Mr. Cornwell incentive compensation under the agreement equal to about 1.8% of the enterprise value paid by an acquiring entity that exceeds $14.00 per share.  For example, at the $107.90 per share closing price at the end of 2019, the amount of incentive compensation in the event of an acquisition of UTMD would be $7,042,500.  At the time of the execution of the agreement, the value per UTMD share was $7.75.

Except for statutory notice, or payment in lieu provisions in UK employee contracts, UTMD’s CEO is the only employee with a formal termination benefit agreement, which was last modified in 1998. The Board of Directors does not anticipate the need for any other agreements for the indefinite future.  In the absence of any practical requirement, UTMD has no general policies regarding termination benefits.

The Company is also required to pay all optionees under employee and outside director’s option plans, the appreciation of stock value for awarded options above the option exercise price (“in the money”) in the event of a change of control of the Company.  The number of options outstanding as of December 31, 2019, was 51,689 at an average exercise price of $58.50/ share.  At the year-end 2019 per share closing price of $107.90, the amount of change of control pay due all optionees would be $2,553,385.

At the 2003 Annual Meeting, stockholders approved the 2003 Employees’ and Directors’ Incentive Plan, under which up to 1.2 million shares could have been granted over the ten-year life of the plan. The Board of Directors did not approve an award of outside director options in the three preceding years 2000-2002, or in the ensuing years of 2004-2019, except for a 10,000 share award to Dr. Beeson upon joining the board in 2007 and an ensuing 10,000 share award to Dr. Beeson in 2008.  The 2003 Plan expired in February 2013.

At the 2013 Annual Meeting, stockholders approved the 2013 Employees’ and Directors’ Incentive Plan, under which up to 600,000 shares may be granted over the ten-year life of the plan.  No options have been granted to outside Directors under the 2013 Plan.  In 2014, prior to his retirement as a UTMD employee in 2018, Mr. Richins received a stock option award under which 62 shares remain unexercised as of December 31, 2019.

The median annual total compensation of all employees of the Company in 2019, other than Mr. Cornwell, was $34,030.  Mr. Cornwell’s total annual compensation in 2019 was $474,120. The ratio of these two amounts is 1:14.

To identify the median employee, UTMD compared annual pay, as of December 31, 2019, for all of its employees excluding the CEO, wherever they reside in the world. In addition to the United States, the Company has employees in the United Kingdom, Ireland, Australia and Canada. Employee pay rates in foreign currencies were converted to U.S. Dollars using exchange rates on December 31, 2019.  The median annual pay was identified and that employee’s total annual compensation in 2019 was subsequently calculated using the same methodology as that used for calculating Mr. Cornwell’s compensation as shown in the 2019 Summary Compensation table.

The following table summarizes, as of the end of the most recent fiscal year, compensation plans, including individual compensation arrangements, under which equity securities of the Company are authorized for issuance, aggregated for all compensation plans previously approved by stockholders and for all plans not previously approved by stockholders:

In 2003 and 2013, stockholders approved incentive stock option plans for employees and directors summarized in the table above.  Although the 2003 option plan has expired, 8,512 options awarded prior to expiration of the plan remain unexercised.  The Company currently has no other equity award programs.  The dilutive impact to stockholders of stock option awards is provided in the tables below:

Under the supervision of the Compensation and Benefits Committee, UTMD has developed and implemented compensation policies, plans and programs that seek to enhance the long-term profitability, EPS growth and return on stockholders’ equity (ROE) of the Company, and thus stockholder value, by aligning closely the financial interests of the Company’s senior management and other key employees with those of its stockholders.  The long term key financial performance objectives are a 15% annually compounded rate of increase in EPS and an average ROE prior to payment of cash dividends greater than 20%.  As of the end of 2019, the Company has actually achieved a 14.3% annually compounded rate of increase in EPS and an average annual ROE (prior to payment of stockholder dividends) of 27% over the thirty-three years since 1986, UTMD’s first year of profitability since becoming a publicly-traded company.

At the beginning of each year, the Board of Directors approves an operating plan which sets the standard for the Company’s financial and nonfinancial performance.  The performance each year may vary according to global economic conditions, competitive environment, life cycle of products, new product development, manufacturing costs and other factors.  The Compensation and Benefits Committee then approves compensation criteria set in relation to the Company’s annual operating plan which includes numerous income statement, balance sheet and cash flow measures, in addition to nonfinancial objectives established for each employee participating in the annual MB program.

The Company applies a consistent philosophy to compensation for all employees, including senior management.  The philosophy is based on the premise that the achievements of the Company result from the coordinated efforts of all individual employees working toward common objectives.  The Company strives to achieve those objectives through teamwork that is focused on meeting the needs and expectations of customers and stockholders.

The Company believes that its compensation policies, in particular its profit-sharing MB program and employee stock option awards, align key employee compensation with stockholder interest in creating longer term stockholder value and consistent profitability.  There are no compensation programs or policies that create risks that are reasonably likely to have a material adverse effect on the Company.

There are seven basic objectives for the Company’s compensation program:

UTMD’s management personnel, beginning with the first level of supervision and professional management, and including certain non-management specialists and technical people, together with all direct sales representatives, are eligible participants in the MB Plan.  At the beginning of the year, plan participants were generally awarded participation units in the bonus plan, proportional to base salary and responsibility, based on senior management’s determination of the relative contribution expected from each person toward attaining Company goals.  Each individual’s performance objectives, derived as the applicable contribution needed from that key employee to achieve the Company’s overall business plan for the year, are available for review as needed by the Committee.  As part of the planning process, each eligible employee develops a set of measurable and dated objectives for the ensuing year.  Achieving the Company’s plan sets an expected value per bonus unit.  After the end of the year, each individual participant’s contribution to the Company’s performance is assessed by senior management in order to determine an additional allocation of units for individual contributions, with the accomplishment of the beginning of year objectives as a key component.  In 2019, all employees of the Company participated in the distribution of a $617,000 annual MB Plan payout, not including payroll taxes.  The MB Plan also funded $37,000 in payroll taxes resulting from bonuses, $3,000 in extraordinary bonuses paid contemporaneously to non-executive employees during the year, and $12,300 in non-exempt U.S. employee attendance bonuses.

The Company makes occasional cash awards, in amounts determined on an individual basis, to employees who make extraordinary contributions to the performance of the Company at any time during the year.  These contemporaneous payments are made as frequently as possible to recognize excellent accomplishments when they occur.  The awards are funded from the accrued MB plan described above, and therefore do not otherwise impact the Company’s financial performance. Senior management is not eligible for these awards.

At the 2003 Annual Meeting, stockholders approved the 2003 Employees’ and Directors’ Incentive Plan, under which up to 1.2 million shares could have been granted over the ten-year life of the plan.  During the same period of time that 153,000 (uncancelled) option shares were granted to employees under the 2003 Plan, UTMD repurchased 1.4 million of its shares in the open market.  As of December 31, 2019, 8,512 unexercised option shares remained outstanding under the 2003 Plan.

At the 2013 Annual Meeting, stockholders approved the 2013 Employees’ and Directors’ Incentive Plan, under which up to 600,000 shares may be granted over the ten-year life of the plan.  As of December 31, 2019, 43,177 unexercised option shares were outstanding under the 2013 Plan.

After the first five years of the ten year plan approved by stockholders in 2013, the plan allowed 350,000 shares cumulatively available for grant out of the 600,000 total.  In the first six years of the plan, UTMD awarded 89,400 option shares at an average exercise price of $58.48 per share.  (As an aside, 22,261 option shares of the 89,400 awarded have been cancelled as the result of employees leaving the Company prior to vesting in the right to exercise.) During the same six years, UTMD repurchased 105,207 shares in the open market at an average price including commissions and fees of $58.84/ share.  In other words, UTMD has repurchased more shares at about the same price per share than it has “sold” in the form of option awards under the 2013 plan. In combination with share repurchases, the option plan has been non-dilutive to stockholders while providing a substantial incentive to key employees.

After the conclusion of the annual independent audit and public announcement of financial results, the Board of Directors typically allocates an annual amount of shares for employee options each year at its regularly scheduled Board meeting following the audited close of the prior year’s financial performance.  Allocated shares are usually reserved for awards later in the year to employees, including new or key employees with increased responsibilities. The Compensation and Benefits Committee approves all awards, and the closing price on the date of the approval is the exercise price of the option shares.  According to policy, awards are not made in advance of material news events, or when material non-public information is known.

In December 2018, option awards were granted to 45 U.S., Ireland, UK, Canada and Australia employees to purchase a total of 22,400 shares at an exercise price of $74.64 per share. One thousand three hundred of the 2018 awarded shares have been cancelled as of March 2020.

Employee and director options vest over a four-year period, with a ten-year exercise period as long as the employee remains employed.  Management expects to recommend additional options be awarded on an annual basis to the Company’s key employees based on its belief that sharing ownership of the Company with those who help create its success is the best way to assure growth in stockholder value.  UTMD stockholder value in terms of share price, which ended 2019 at $107.90, plus cash dividends paid to stockholders, has grown 1,780% (an annually compounded growth rate of 15%) in the last 21 years.

The structure and activities of the Compensation and Benefits Committee meet the requirements of SEC Rule 10C-1, as mandated by Section 952 of the Dodd-Frank Act.  In regard to Item 407 of Regulation S-K, in 2019 and to-date in 2020, the company has not retained or obtained the advice of a compensation advisor.

Utilizing the compensation objectives and vehicles outlined previously, the Compensation and Benefits Committee, comprised of three independent outside directors, establishes the annual base salary for the CEO.  All other employees’ salaries are set by the CEO, and reviewed by the Committee for consistency with the Company’s compensation objectives.  The Committee periodically uses surveys of similar companies selected from among the companies with which UTMD’s stock is compared in the Stock Performance Chart, based on variations in industry type, geographic location, size, and profitability as the Committee deems appropriate.  Base salary is fixed at a level somewhat below the competitive amounts paid to executive officers with comparable qualifications, experience and responsibilities at other similarly sized companies engaged in the same or similar businesses.  The annual MB and long-term incentive compensation in the form of stock options were more highly leveraged and tied closely to the Company’s success in achieving significant financial and non-financial goals.

The annual MB for the named executive officers are awarded using the same basis as all employees included in the annual profit-sharing MB Plan, except a bonus inflating factor related to stock option awards is not included for the CEO. The goals for executive officers include financial and non-financial goals.  Financial goals include net sales, gross profit margin, operating margin, EBITDA, EBT, after-tax profits, return on equity and earnings per share.  Non-financial goals include continuing the development of a talented and motivated team of employees, conceiving and implementing programs to maintain competitive advantages and to achieve consistent earnings per share growth, reacting to competitive challenges, developing business initiatives to further support critical mass in a consolidating marketplace, promoting the Company’s participation in socially responsible programs, protecting intellectual property rights, maintaining compliance with regulatory requirements, achieving a high regard for the integrity of the Company and its management, and minimizing issues that represent significant business risk factors such as overly burdensome administrative programs and product liability exposure.  In 2019, UTMD met its beginning of year financial objectives.  Based primarily on the Company’s 8% lower pretax/pre-MB accrual profit, annual management bonuses were 8% lower than in 2018 for the same level of responsibility and contribution of employees regularly participating in the MB plan.

The Committee intends that stock options serve as an important component of executive officers’ total compensation in order to retain critical efforts on behalf of the Company and to focus efforts on enhancing stockholder value.  The Committee believes that past option awards have successfully provided this incentive.  An option for 50,000 shares was awarded the CEO in January 2004, at an exercise price of $25.59 per share.  Except for the 2004 award, no CEO options were awarded during the last twenty-one years.

The Compensation and Benefits Committee has reviewed and discussed the CD&A with UTMD management.  Based on that review, the Committee recommended to the Board of Directors that the CD&A be included in the Company’s annual report on Form 10-K/A.  The Compensation and Benefits Committee charter is available at www.utahmed.com.

The following chart compares annual changes in total executive compensation with changes in non-GAAP earnings per share, stockholder return (year-end share price plus cash dividends paid during the year) and UTMD year-end market capitalization over the last nine years, starting at December 31, 2010:

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The members of the Compensation and Benefits Committee are Ernst G. Hoyer, Barbara A. Payne and James H. Beeson.  No member of the committee is a present or former officer of the Company or any subsidiary.  There are no interlocks.  No member of the Committee, his or her family, or his or her affiliate was a party to any material transactions with the Company or any subsidiary since the beginning of the last completed fiscal year.  No executive officer of the Company serves as an executive officer, director or member of a compensation committee of any other entity, an executive officer or director of which is a member of the Compensation and Benefits Committee of UTMD.

In the previous table, shares owned directly by directors and executive officers are owned beneficially and of record, and such record stockholder has sole voting, investment and dispositive power. Calculations of percentage of shares outstanding assumes the exercise of options to which the percentage relates.  Percentages calculated for totals assume the exercise of options comprising such totals.

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s directors and executive officers, and persons who own more than 10% of a registered class of the Company’s equity securities, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of equity securities of the Company.  Officers, directors and greater than 10% stockholders are required to furnish the Company with copies of all Section 16(a) forms they file.

UTMD’s Board of Directors has determined that a majority of its directors are independent, as that term is defined in NASD Rule 5605(a)(2), which satisfies the independence requirement of NASD Rule 5605(b)(1).  The Board of Directors was not aware of any transactions, relationships or arrangements to be considered in determining that Dr. Payne, Mr. Hoyer and Dr. Beeson were independent under the NASD Rules.