On Nov. 4, Bill Mann
wrote a letter
to Robert Stikeman, chairman of
Motley Fool Hidden Gems
November 28, 2005
Dear Mr. Mann:
Thank you for your letter of November 4, 2005, the contents of which we have considered carefully. I appreciate both your feedback about CryptoLogic's compensation policies and the spirit behind your comments -- that is, engaging in a dialogue to maximize the value of CryptoLogic for all shareholders over the long term, the very goal to which both Management and our Board of Directors are fully committed.
You suggest that neither Management nor the Board should take comfort in the proposals of compensation specialists. We use consultants to determine whether our compensation practices are within the range of our peers. Towers Perrin, an internationally recognized compensation specialist that has served three-quarters of the world's 500 largest companies and Fortune 1000 US companies, was retained to provide competitive analysis and recommendations to CryptoLogic's 2005 compensation policies. As indicated in my fax of November 10, I will now address each of your comments in the order appearing in your letter.
1. Comparative Competitive Compensation:
We do not agree that peer companies should have little bearing on how compensation is determined for senior management. To attract superior management in a competitive human resources environment, we must pay competitively to our peers, and this reality runs through all levels of management. As a software supplier headquartered in Canada and with offices in the UK and Cyprus -- and with more than 60% of our workforce in research and development -- we compete with all technology companies for high-quality talent, including recruiting human resources from our peers, and are in turn exposed to their competitive bids for our capable executives. We would ignore our competitors at our own peril.
2. Performance Measures:
We believe shareholders experience increased share value if the earnings per share and trading prices rise. This is why we tie both of these factors into the compensation plan of the company. CryptoLogic is a widely held and liquid company. Consequently, our share price represents a more realistic measure of how the market values the company than book value alone.
We agree that Management should not be wholly compensated for riding industry waves that raise entire sectors' share prices, so a portion of Management's performance is measured on share price, combined with the company's performance over several years as opposed to general market indicators. We believe it is oversimplified to suggest that the share price value not be considered in assessing Management's performance, because shareholders want to ensure their interests are aligned with those of Management.
You suggest that the use of book value would be more appropriate. However, this measure is exposed to the same "subjectivity under GAAP" which concerns you, since book value is determined by a similar process as it relates to accounting inputs under GAAP used to calculate earnings per share. Since any measure of earnings or book value is subject to judgement, we have selected the combination of the share price and earnings per share -- and in the case of the LTIP [long-term incentive plan], based on cumulative EPS targets with growth requirements -- as the best factors that would align with shareholders' interests in improving the value of the company. In any event, we believe that share price and earnings per share are driven by the underlying value of the company.
3. LTIP Disclosure:
The advance disclosure of the LTIP in the April 2005 circular was intended to advise investors of a new plan that the company was adopting. In the 2006 circular, following the first completed year of the LTIP, the full parameters of the final plan will be provided as required by securities laws, including the amount of awards made, the nature of the targets, and additional features of the plan such as payouts, which are to be made in cash and the expensing of awards at vesting.
4. Stock Options:
The statement "moving away from options" speaks to the company reducing its reliance on stock options and adopting alternative forms of long-term incentives to maintain the company's competitive position in attracting and retaining exceptional talent. It should be noted that despite a more than doubling in book value and tripling in share price since the CEO's permanent appointment in January 2003, no additional grants of options have been made to the CEO and his base salary has remained the same, and that fewer options have been awarded to Management in recent years.
5. Comparable Companies:
The companies that CryptoLogic considers to be "comparable" are those companies from whom it recruits its executive talent or with whom it competes in the process of recruiting key personnel in the open marketplace. As we addressed in point 1 above, we compete for high-quality, highly skilled, and specialized talent in the broader North American and overseas labour markets, with all technology companies as well as peer companies within the Internet gaming market.
With regard to the 50% to 75% range, we need to ensure CryptoLogic is able to offer competitive compensation, have the flexibility to recruit and retain key personnel, particularly in highly specialized skill areas, and have the leverage to reward for superior performance.
We want to deliver the best products and services to our customers and their players. This requires the best talent available.
6. Share Buyback:
Contrary to your remarks, CryptoLogic's share buybacks are not made simply to counter the dilutive effect of options. The buyback is implemented, as stated in the notice to the Toronto Stock Exchange, when the directors believe that the trading price of the company's stock is significantly below what they believe to be its true value.
7. Insider Ownership:
In a young and growing company, we continue to look at ways to broaden share ownership within our organization. Most of our directors and senior management and many of our employees own stock.
In 2005, CryptoLogic implemented a policy to encourage equity ownership by directors, officers, and employees. At the executive level, specific guidelines were established to encourage senior management to achieve a certain level of share ownership over a three-year time period, based on a multiple of his/her salary. The newly adopted LTIP, which allows for payout in shares purchased in the open market, also provides a potential vehicle to assist management in increasing its share ownership. In the second quarter this year, CryptoLogic introduced the company's first employee share purchase plan, which many of our employees are now signing up for.
CryptoLogic has delivered increasing returns through revenue and earnings growth, cash generation, and a strong balance sheet even during volatile times and increasing competition for the global online gaming industry. It is CryptoLogic's record of consistent performance and financial strength that have enabled our company to create value for shareholders through investing significantly in our business, recently increasing our quarterly cash dividend, buying back shares, and actively pursuing potential growth opportunities.
Under the leadership of our CEO and the current management team, CryptoLogic's revenue, earnings, earnings per share, and book value have more than doubled since December 31, 2002 (the CEO's permanent appointment was in January 2003). Over this same time period, CryptoLogic's share price has increased 220%.
CryptoLogic's accomplishments are attributed to its greatest asset -- its people, who are key to ensuring the company's competitive advantage and market leadership. In today's fast-changing environment, CryptoLogic remains committed to fostering a corporate culture that is market-competitive and performance-driven, which is aimed at delivering superior long term returns to all shareholders.
I trust the above remarks respond to the questions that you raised in your letter, and provide you with a better understanding of our perspective. We would be happy to continue this dialogue with further discussions should you so wish.
Chairman of the Board