EXECUTIVE COMPENSATION = Compensation Discusstion and Analysis 2007

 

The primary metrics we use in structuring our performance-based equity and cash awards include annual sales goals, annual profit goals, return on invested capital (over a three-year period) and revenue growth (over a three-year period). In addition, we use individual management by objectives (“MBOs”) to determine payouts under our annual bonus program. MBOs include qualitative factors which emphasize strong performance, such as product diversification, technology acquisitions and talent management.

 

Our Compensation Process

 

Our Compensation Committee meets as often as necessary to perform its duties. In fiscal 2007, our Compensation Committee met nine (9) times. Although most decisions regarding executive compensation are made in the first quarter of our fiscal year, our management and our Compensation Committee continue to monitor developments during the year. Our Compensation Committee typically meets with Donald Duda, Chief Executive Officer, and, where appropriate, Douglas Koman, Chief Financial Officer. From time to time, our Compensation Committee engages compensation consultants to review the competitiveness and effectiveness of our executive compensation program. In connection with setting fiscal 2007 compensation, both Towers Perrin and The Delves Group were engaged to provide analyses of our executive compensation program as compared to established market benchmarks, as described more fully below.

 

Our Compensation Committee annually reviews tally sheets summarizing our named executive officers’ total compensation, including direct compensation; benefits under equity compensation programs; and perquisites and potential payments on termination of employment, whether on a change in control of Methode or otherwise.

 

Our Chief Executive Officer’s compensation is determined by our Compensation Committee. Management provides relevant survey and other data to the Committee that it may consider for this purpose. Management does not make recommendations to our Compensation Committee regarding compensation elements with respect to Mr. Duda’s compensation. For named executive officers other than Mr. Duda, total compensation packages are developed and recommended by Mr. Duda, in consultation with Mr. Koman, our Chief Financial Officer, and based on guidelines provided by our Compensation Committee. Our Compensation Committee determines whether to approve these recommendations, subject to any further modifications that it may deem appropriate.

 

Market Benchmarking and Positioning

 

We strive to provide compensation opportunities that are competitive with comparable positions at other companies with which we compete for executive talent. As appropriate to further this objective, we review market compensation data and evaluate our executive compensation program as compared to a group of peer companies and various compensation surveys and databases, in each case as provided by our compensation consultants.

 

For compensation decisions affecting fiscal 2007 compensation, our peer group included the following companies: Cobra Electronics Corporation, CTS Corporation, Electro Scientific Industries, Inc. Franklin Electric Co., Inc., Gerber Scientific, Inc., Kemet Corporation, Littelfuse, Inc., Rogers Corporation, Standard Motor Products, Inc., and Stoneridge, Inc. In setting fiscal 2007 compensation, our Compensation Committee also reviewed the following compensation surveys and databases: Watson Wyatt Compensation Calculation (electrical equipment and electronics companies); Watson Wyatt Top Management and Middle Management Databases; Proprietary Cash Compensation Survey (manufacturing companies); and Towers Perrin CDB Executive Compensation and Middle Management and Professional Databases. In identifying appropriate comparisons, our Compensation Committee focuses on revenues, returns on sales, invested capital and growth in sales and profits.

 

As a general policy, we target total direct compensation (that is, base salary, annual and long-term cash incentives and equity-based compensation) for our named executive officers in the 50th to 75th percentile among companies in our peer group and comparable companies within the applicable compensation surveys and databases. In setting compensation for each named executive officer, our Compensation Committee also reviews historical compensation levels, internal equity and consistency, tenure and industry conditions. These and other factors may affect whether total pay for each of our named executive officers falls within the benchmark range. For fiscal 2007 compensation, such other factors included the successful diversification of our products, international expansion and implementation of cost cutting measures. In addition, if we or the relevant business unit performs particularly

well or poorly, total direct compensation for one or more of our named executive officers could be above or below the target levels.

 

Consistent with our pay-for-performance philosophy, our executive compensation program is structured so that a significant amount of each of our named executive officers’ compensation is variable compensation and “at risk” for non-payment if we fail or the executive fails to meet performance targets. The proportion of compensation that is at risk increases with the executive’s level of responsibility. For fiscal 2007, the majority of the named executive officers’ total direct compensation is at risk (on average, 65%). At risk compensation for fiscal 2007 includes the annual bonus and the restricted stock awards, together with the RSA tandem cash awards (described below). As a general policy, we structure the executive compensation program so that approximately 50% to 75% of total direct compensation is in the form of cash.

 

Elements of Compensation

 

Base Salary.  Our Compensation Committee establishes base salaries on an annual basis, taking into account levels of responsibility, prior experience and breadth of knowledge, potential for advancement, recent promotions, past performance, internal equity issues and external pay practices. In general, we target annual base salaries for our named executive officers at the 50th percentile among companies in our peer group and comparable companies within the applicable compensation surveys and databases. For fiscal 2007, our Compensation Committee did not increase the base salary of either Mr. Duda or Mr. Koman. In connection with promotions, Messrs. Reynolds and Glandon were awarded base salary raises of 32% and 45%, respectively.

 

Annual Performance-Based Bonus.  At the beginning of fiscal 2007, our Compensation Committee established individual target awards, expressed as a percentage of base salary, and subject to the achievement of performance goals for all executive officers and management personnel. Bonuses are paid quarterly and are capped at 140% of the established target bonus amount. The awards generally reflect a threshold payment, a target payment and a maximum payment, depending on the level of performance measure achieved. For fiscal 2007, the performance measures for each of the named executive officers include annual net sales and quarterly profit measures compared to budget. For Messrs. Duda, Koman and Kuehnau, the measure is based on our overall consolidated financial results. For Messrs. Reynolds and Glandon, the measure is based exclusively on the financial results of the respective divisions they manage.

 

In addition, the awards use individual MBOs as a performance measure to determine payouts under our annual bonus program. MBOs include qualitative factors which emphasize strong performance, such as product diversification, technology acquisitions and talent management. In general, the most importance is given to quarterly profit measures, followed by the MBOs. Our Compensation Committee believes that using sales and profit measures as a key performance measure focuses the executives on balancing investment and cost control to achieve growth. In setting the measures, our Compensation Committee considered, among other matters, each individual’s and our past performance, the fiscal 2007 operating budget, and general economic conditions. Our Compensation Committee believes that these performance measures are challenging. No amounts are payable unless a specified “threshold” performance level is reached for the applicable period.

 

Discretionary Cash Bonus.  From time to time, our Compensation Committee awards discretionary cash bonuses to the executive officers for exceptional or unusual performance. Historically, such discretionary cash bonuses have been granted in connection with significant involvement in the negotiation, due diligence and integration of an acquired business, the development of a new product line or the recruitment of a significant new customer. In fiscal 2007, Mr. Reynolds received a discretionary bonus of $40,000 and Mr. Glandon received a discretionary bonus of $30,000 in connection with the acquisition of TouchSensor Technologies, L.L.C. (“TST”). None of our other named executive officers received a discretionary bonus in fiscal 2007.

 

Stock Awards.  Our Compensation Committee believes that equity-based compensation is the most effective means of ensuring that our executive officers have a continuing stake in our long-term success. We currently utilize restricted stock awards and restricted stock units as our equity compensation component. Our Compensation Committee believes that these awards serve the following purposes: (i) reward executive officers for long-term stockholder value creation; (ii) provide competitive long-term incentive award opportunities; (iii) retain employees through wealth accumulation opportunities; and (iv) focus executive officers on long-term, sustained performance.

The restricted stock awards and restricted stock unit awards granted to our executive officers in fiscal 2007 are subject to a performance-based vesting condition linked to the revenue growth and return on invested capital achieved during a three-year vesting period. These performance-based awards do not vest unless we achieve a minimum target level of revenue growth and return on invested capital.

 

RSA Tandem Cash Bonus.  In connection with the grant of the fiscal 2007 restricted stock awards, we agreed to pay each executive officer a cash bonus if we exceed our financial targets for revenue growth and return on invested capital, which will be measured as of May 2, 2009. The maximum amount of the tandem cash bonus will equal the product of the closing price of our common stock as of May 2, 2009, and 50% of the number of shares awarded to such executive under the 2007 restricted stock award.

 

Legacy Longevity Bonus Program.  For fiscal 2006 and previous years, our executive officers received long-term incentive awards under the Longevity Contingent Bonus Program (the “Longevity Bonus Program”). The Longevity Bonus Program awards a matching bonus equal to the amount of the current quarterly bonus, which will be considered as earned and payable in three years, provided that the participant is still employed and performance has been satisfactory. If, for any reason other than death, disability, or retirement, the participant terminates his or her employment with us during the three-year period, or his or her performance is not satisfactory, no longevity compensation is payable under this program. Commencing with fiscal 2007, the named executive officers are not eligible to receive future awards under the Longevity Bonus Program. Amounts previously earned by these executives under the Longevity Bonus Program will continue to be paid through fiscal 2009.

 

Other Benefits and Perquisites.  Executive officers are eligible to participate in all of our employee benefit plans, such as medical, dental, vision, group life, disability, and our 401(k) savings plan (with a company contribution), in each case on the same basis as other employees, subject to applicable law. Our executive officers are also provided deferred compensation opportunities through a non-qualified Deferred Compensation Plan. In fiscal 2007, we did not contribute any amounts to the Deferred Compensation Plan on behalf of any of the named executive officers. For a description of the Deferred Compensation Plan, please see the section entitled “Nonqualified Deferred Compensation” below. Dividends are paid with respect to all vested and unvested outstanding restricted stock awards held by our employees. Mr. Duda is also paid an amount equal to the dividend payment with respect to the restricted stock units converted from restricted stock awards (described in more detail below). Mr. Kuehnau participates in our Capital Accumulation Program (which was terminated several years ago), pursuant to which he is entitled to above-market interest accruals on his contributions to such plan. In addition, a few perquisites are provided to the named executive officers. Perquisites include a company car allowance, association dues, limited corporate aircraft usage and provision for an annual physical exam.

 

Change of Control Payments.  We have entered into change of control agreements with our executive officers. These agreements are designed to promote stability and continuity of senior management, both of which are in the best interest of Methode and our stockholders. Our change of control provisions for the named executive officers are summarized below under “Executive Compensation — Potential Payments Upon Termination or Change of Control.”

 

Significant Policies and Procedures

 

Stock Ownership Policy.  Our Compensation Committee considers stock ownership by management to be an important means of linking management’s interests with those of stockholders. We maintain stock ownership guidelines for our executive officers. The amount of stock required to be owned increases with the level of responsibility of each executive. The requirements are subject to a phase-in period in the event of a new hire or a promotion. Our Chief Executive Officer and Chief Financial Officer are expected to own at least 80,000 and 28,000 shares, respectively. All other executive officers are expected to own stock with a value at least equal to their current base salary. Vested restricted stock awards and restricted stock units are included in the calculation of stock ownership for purposes of these guidelines. In valuing restricted stock awards and restricted stock units for this purpose, the policy permits the use of the greater of the grant date fair market value or the current fair market value. Considering the applicable phase-in periods, all of our named executive officers were in compliance with our stock ownership policy for fiscal 2007.

Practices Regarding Grants of Equity Awards.  Our broad-based equity grants are generally made at a scheduled meeting of our Compensation Committee occurring at approximately the same time each year. In addition, our Compensation Committee may choose to make grants of equity awards outside the annual broad-based grant, including in the case of newly hired employees and in connection with promotions.

 

Policy With Respect to Deductibility of Compensation.  Section 162(m) of the Code, as clarified by recent guidance from the Internal Revenue Service, generally denies corporate tax deductions for annual compensation exceeding $1 million paid to certain employees (generally the chief executive officer and the three other most highly compensated executive officers of a public company, but excluding the chief financial officer), unless that compensation qualifies as performance-based compensation under a stockholder approved plan and meets certain other technical requirements. While it is the general intention of our Compensation Committee to maximize the deductibility of executive compensation in structuring our compensation plans and programs, our Compensation Committee has approved, and may continue to approve awards that may not qualify as performance-based compensation under Section 162(m). Our Compensation Committee reserves the flexibility and authority to make decisions that are in the best interest of Methode and our stockholders, even if those decisions do not result in full deductibility under Section 162(m).

 

Resolution of Issues Regarding Section 162(m) and Section 409A of the Internal Revenue Code

 

During fiscal 2007, our Compensation Committee and Donald Duda, our Chief Executive Officer, worked together to address certain issues under Section 162(m) and Section 409A of the Internal Revenue Code related to Mr. Duda’s compensation. The scheduled lapse of the restrictions on Mr. Duda’s 2004, 2005 and 2006 restricted stock awards in April 2007, 2008 and 2009, respectively, would not qualify for an exception under Section 162(m). As such, the value of these awards would be required to be included for purposes of determining whether the $1 million limit has been exceeded in each such fiscal year. Section 409A subjects the recipient of certain forms of non-qualified deferred compensation to an additional 20% tax. Certain payments to be made to Mr. Duda under the 2003 Cash Bonus Agreement described below would be subject to this additional tax.

 

In order to mitigate the Section 162(m) deductibility issue, eliminate the 409A tax consequences to Mr. Duda, and eliminate variable accounting with respect to the 2003 Cash Bonus Agreement, our Compensation Committee approached Mr. Duda regarding the available alternatives. Mr. Duda and our Compensation Committee worked diligently to review and assess the alternatives with the assistance of external legal and compensation advisors. The resolution agreed upon involved multiple steps, including the exercise of stock options and sale of all of the underlying stock by Mr. Duda, the current payment of a portion of the cash bonus to Mr. Duda under the 2003 Cash Bonus Agreement, the amendment of the 2003 Cash Bonus Agreement and Mr. Duda’s 2004, 2005 and 2006 Restricted Stock Award Agreements, and the deferral of certain bonus amounts by Mr. Duda. In fiscal 2007, we were not permitted to deduct $292,507 in compensation paid to Mr. Duda. We currently expect to deduct all compensation payable to Mr. Duda in fiscal 2008.

 

Amended and Restated Restricted Stock Unit Award Agreements.  During fiscal 2007, we entered into Amended and Restated Restricted Stock Unit Award Agreements with Mr. Duda. Pursuant to these agreements, the 2004, 2005 and 2006 restricted stock awards were amended and restated into the form of restricted stock units. Under the terms of the amended restricted stock units, at such time as the value of the award is deductible by us or Mr. Duda’s employment terminates, shares of non-restricted common stock will be delivered to Mr. Duda. The conversion mitigates the Section 162(m) issue because restricted stock units are deductible by us when paid to the executive, in contrast to restricted stock which is deductible upon vesting and, as such, would result in non-deductible compensation. The Amended and Restated Restricted Stock Unit Award Agreements do not amend or modify any other provisions under the 2004, 2005 and 2006 restricted stock awards, including, without limitation, the vesting period or performance criteria.

 

Deferral of 2004, 2005 and 2006 RSA Tandem Cash Bonuses.  In 2004, 2005 and 2006, in connection with the award of restricted stock awards, we agreed to pay Mr. Duda a cash bonus if we met certain financial targets measured as of the end of a three-year period. These cash bonuses do not qualify for an exception under Section 162(m) and will be included for purposes of calculating the $1 million cap in the year paid. Mr. Duda has deferred one hundred percent (100%) of these bonuses pursuant to our Deferred Compensation Plan. The bonuses

are deferred until 2011, 2012 and 2013, respectively. It is currently anticipated that at such time, a substantial portion of Mr. Duda’s annual compensation would qualify for an exception under Section 162(m).

 

Amended Cash Bonus Agreement.  Pursuant to the 2003 Cash Bonus Agreement, Mr. Duda was entitled to two cash bonuses. The amount of the first cash bonus was to be determined by multiplying 100,000 by the value of our common stock in excess of $10.50 (the value of common stock on the date of Mr. Duda’s 2002 stock option grant). The bonus vested in 25% annual increments commencing in June 2003 and ending in June 2006. The amount of the second cash bonus was to be determined by multiplying 150,000 by the value of the common stock in excess of $11.44 (the value of common stock on the date of Mr. Duda’s 2003 stock option grant). The bonus vests in 25% annual increments commencing in July 2004 and ending in July 2007. Under the 2003 Cash Bonus Agreement, Mr. Duda was required to exercise all vested options under the 2002 and the 2003 grants prior to receiving any cash bonuses thereunder. Pursuant to Section 409A, any portion of the cash bonuses which were vested as of January 1, 2005 are grandfathered and not subject to Section 409A. The portions of the cash bonuses that were not vested as of that date are subject to Section 409A and, pursuant to the terms of the Cash Bonus Agreement, would subject Mr. Duda to an additional 20% tax on these bonus amounts.

 

In connection with addressing the issues outlined above, Mr. Duda agreed to elect to receive payment of all cash bonus amounts payable under the 2003 Cash Bonus Agreement that were vested as of January 1, 2005 and not subject to the provisions of Section 409A. In order to make this election, Mr. Duda was required to exercise all vested options under the 2002 and 2003 stock option grants (175,000 shares). The provision of Section 409A prohibited the amendment of the 2003 Cash Bonus Agreement to waive this condition without triggering the 20% additional tax. Mr. Duda exercised these options on April 4 and April 5, 2007, and subsequently sold the underlying 175,000 shares of common stock at a weighted average sale price of $15.32 per share. Also on April 6, 2007, Mr. Duda elected to receive a partial payment under the 2003 Cash Bonus Agreement. We and Mr. Duda agreed that for purposes of this payment and the payments pursuant to the Amended Cash Bonus Agreement described below, the value of our common stock would equal $15.32 per share, the weighted average sales price of the sale of the 175,000 shares. Pursuant to the terms of the Cash Bonus Agreement, these cash bonuses totaled $241,000 [($15.32-$10.50) × 100,000 × 50%] and $145,500 [($15.32-$11.44) × 150,000 × 25%],or $386,500 in the aggregate. These amounts will be included for purposes of determining whether Mr. Duda’s compensation has exceeded the $1 million limit in fiscal-year 2007.

 

We entered into an Amended Cash Bonus Agreement with Mr. Duda. Pursuant to the Amended Cash Bonus Agreement, we will pay Mr. Duda cash bonuses in the amount of $241,000 [($15.32-$10.50) × 100,000 ×50%] and $436,500 [($15.32-$11.44) × 150,000 ×75%], or $677,500 in the aggregate. These cash bonuses are payable on the earliest of the following: (i) May 15, 2009; (ii) the date of Mr. Duda’s termination of employment for any reason; or (iii) Mr. Duda’s death or disability; provided, however, that if, upon the payment date, the payment is not deductible by us under Section 162(m), the payment will be delayed until such time as it is deductible. In such case, the amount may be payable in one or more installments. Mr. Duda is not entitled to any other compensation pursuant to the Amended Cash Bonus Agreement. Amendment of the 2003 Cash Bonus Agreement eliminated variable accounting with respect to the 2003 Cash Bonus Agreement.