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The Shareholder Forum

The Shareholder Forum supports investor interests in corporate enterprise value with services that require independence – and that may benefit from the Forum’s network resources and recognition for advocacy of long term investor interests – to assure a definition of relevant issues and fair access to information that can be relied upon by both corporate and investor decision-makers.

The policies that provide a foundation for the Forum’s marketplace functions have been carefully developed and tested to allow any investor to participate in its communications, either anonymously or visibly, without acting in concert. Established originally to accommodate professional fund managers, this independent moderator function has proved to be consistently effective in managing orderly processes of issue definition for rational analysis by fiduciaries who are responsible for informed decisions.

Initiated in 1999 by the New York Society of Security Analysts with lead investor and former corporate investment banker Gary Lutin as guest chairman to address the professional interests of its members, and independently supported by Mr. Lutin since 2001, Forum programs have achieved wide recognition for their effective definition of important issues and orderly exchange of the information and views needed to resolve them. The Forum's ability to convene all key decision-making constituencies and influence leaders has been applied to subjects ranging from corporate control contests to the establishment of consensus marketplace standards for fair disclosure, and has been relied upon by virtually every major U.S. fund manager and the many other investors who have participated in programs that addressed their interests.

Currently important applications of the Forum’s independent position include the support of corporate managers who wish to provide the leadership expected of them by responding to activist challenges with orderly reviews of issues relevant to long term investor interests.

Requests for Shareholder Forum consideration of support may be initiated confidentially by any investor or by the subject company, or by the professional advisors to either.

 

[published June 29, 2001]

Lone Star Steakhouse & Saloon, Inc. (STAR)
Cusip: 542307 Meeting Date: 07/06/2001 Record Date: 05/11/2001


Resolution: 1

Elect one director from one of three classes to serve a term expiring in 2004.

We recommend shareholders WITHHOLD votes from the entire slate.

Board & Committee Composition: Size (% Independent)
Full Board: 5 (60%)
Audit: 3 (100%)
Compensation: 3 (100%)
Nominating: 3 (100%)

Board Structure: Classified

Director Attendance: All directors attended at least 75% of an aggregate of board and committee meetings.

Stock Ownership: All incumbent directors own company stock, and as a group, officers and directors beneficially own 25.5% (or 10% excluding stock options exercisable within the next 60 days) of the company's common stock.

Comment(s): Note that the board has no female members.

ALERT: THIS IS A CONTESTED ELECTION. Mr. Guy Adams, an individual shareholder with respectable credentials, is seeking to unseat Jamie Coulter, the company's chairman and CEO. Mr. Adam's objective is to enhance the independent representation on this board and to bring change and accountability to a board that he believes has supported unacceptable corporate governance practices and a management team that he believes has failed to return sustainable value to shareholders.

Both sides argue credentials and experience, motives and best interests, and both sides claim that the other side has misled shareholders in its characterization of the other. Not surprisingly, the incumbent board and the dissident also disagree in their respective interpretations of the company's financial performance and management's commitment to maximizing shareholder value.

And, like an increasing number of companies faced with similar challenges, management has aggressively opposed Mr. Adam's candidacy as well as his solicitation efforts. Two month's after Mr. Adams filed his solicitation materials, Lone Star sued him seeking to prevent him from soliciting or accepting proxy votes. Among other things, the company alleged that Mr. Adams filed misleading proxy materials. (A federal judge later ruled that Mr. Adams could proceed if he corrected two errors in his filing).

However, in an unexpected move, the company also implicated a highly-regarded institutional investor, claiming that Mr. Adams was a "stalking-horse" for the investment fund and "not a bona fide Lone Star investor." Needless to say, in doing so Lone Star alienated at least a few investor groups who found the move to be arrogant and offensive.

Arguing in favor of his campaign to gain a voice on the company's board, Mr. Adam's criticizes Lone Star's poor operating and financial performance, its unacceptable corporate governance practices, as well as the board's unsupported pay decisions and its recent decision to reinforce its existing armament (which already includes a classified board, a poison pill, and blank-check preferred stock) with change-in-control agreements that have offended more than one of the company's owners.

In our opinion, both the timing and the force of these contracts defy the company's claim to "assure that the company will have [executives'] continued dedication and objectivity, notwithstanding the possibility . . . of a change of control." Among the indefensible provisions are trigger mechanisms and restrictions that could effectively deprive shareholders of their statutorily protected right to elect directors without retribution. And, in addition to increasing the financial rewards to beneficiaries, the contracts minimize the commitments required of the company's officers. For example, the contract with Mr. Coulter (who was already party to an arrangement that presumably served as an effective retention device since Mr. Coulter has served in his current position since January 1992), eliminates all non-compete provisions and allows Mr. Coulter to waive the change-in-control provisions for a party of choice. Given the company's past performance and practices, as well as its recent actions, this level of authority and power is particularly unsettling.

As indicated above, a major source of concern is Lone Star's corporate governance structure, which we agree serves to entrench management, protecting its members (including directors) from sudden or surprise ousters. Of particular concern to Mr. Adams are Lone Star's classified board structure and the company's apparent disregard for shareholders' expressed wishes. For example, at last year's annual meeting, shareholders voted overwhelmingly to end the company's staggered elections of directors. Still, management chose not to follow shareholders' request. Instead, the company has maintained and continues to defend its classified board structure.

Although, in what has been described as a defensive and noncommittal response to Mr. Adam's challenge, the company has recently indicated that it would "strongly consider reforms" to the company's governance structure, including a "declassified board/expanded board." However, the board has also qualified its statement by arguing that it must "keep reasonable protections in place to protect stockholders' long-term interests.”

On the matter of compensation, we also share Mr. Adams concerns and question the merit and the timing of the pay increases given to the company's top two executives (whose business relationship pre-dates their Lone Star association). What's more, the absence of any meaningful information with regard to the board's decision to increase Mr. Coulter's and Mr. White's salaries by 150% and 112%, respectively, sheds more heat than light on this issue. Also adding fuel to the fire is the appearance of cash bonuses in 2000 (no bonuses were paid in the two years prior), which (as best as we can tell) relate vaguely to the company's "performance" and to the attainment of some "level of personal achievement."

In addition, as Mr. Adams correctly points out, shares representing a 24.6% relative reduction in voting power and other ownership rights are underlying outstanding stock options, a level that we believe is unacceptable for this "mature" company. What's more, this calculation does not include any shares that may still be available for future grant under the company's two stock option plans, since that information could not be located in SEC filings. Therefore, there is very likely a downward bias in our dilution calculation.

For companies similarly classified, we expect to see dilution levels at or below 10 percent. When we don't, we seldom support any initiative that could increase shareholders' long-term liabilities or that could facilitate the realization of costs to shareholders.

Over the past four fiscal years, sales have grown at a disappointing annual compounded rate of 4%, but SG&A has grown at an annual compounded rate of 18.9% over the same period. And, while net income increased from $5.4 million (or $0.15 per share) in 1999 to $16.1 million (or $0.61 per share) in 2000, since 1996 net income has actually declined from $60.1 million (or $1.49 per share). Then again, Lone Star has demonstrated some improvements in earnings. Net income in the first quarter of 2001 increased by 16% from $7.1 million (or $0.25 per share) on sales of $139.3 million, to $8.2 million (or $0.34 per shares) on sales of $ $143.8 million. Although it should be noted that these results include an after-tax gain of $898,000 (or $0.04 per shares) from the sale of assets in Australia. And, the company continued its stock buyback program with the purchase of 245,700 shares during the 2001 first quarter. The total number of shares repurchased by the company since it began the stock buyback program in 1997 is 17.2 million at an average price of $9.61 per share.

To its credit, the company also began paying quarterly dividends on its common stock in May 2000. Based on the most recent quarterly dividend, the company's dividend rate is $0.50 per share, representing a current dividend yield of approximately 4 percent. Lone Star's financial position also remains strong with no debt and $39.5 million in cash.

Nonetheless, it is undeniable that Lone Star's long-term shareholders have suffered considerable losses. As of December 26, 2000, five-year total shareholder returns for Lone Star was -26.1%, which was far worse than comparable returns of 8.7% for its peers and 22.6% for its market index.

But despite its stated compensation philosophy to use "stock options to attract and retain qualified employees with the same long-term interests as the company's stockholders," management has fared far better than the company's owners.

Over a period of less than three years (between April 1997 and January 2000), Lone Star repriced an aggregate 14.6 million options shares, including substantially all shares held by executive officers and company directors.

Still, management defends its decisions, claiming that the replacement of these devalued awards was necessary to retain and motivate key personnel. Perhaps so, but life is full of disappointments and risks. And, the reality here is that Lone Star has lost nearly 70% of its value over the last five years under the watch and direction of the very same folks who were made whole by the company's serial repricing programs. Also noteworthy is that the decline in share price was not a market phenomena outside the control of management, as demonstrated by the company's performance vis-a-vis its peers.

Implicitly, if not explicitly, stock options are intended to reward long-term accomplishments, making short-term adjustments wholly inappropriate. Public shareholders, who are acutely aware that stock prices move up and down, have no comparable opportunities to recoup their very real losses. Therefore, to afford this type of protection to optionees is unacceptable. But worse still repricing executive stock options, which are intended to spur superior, sustainable, long-term performance, and stock options held by directors, who are duty bound to protect shareholders' interests.

In its defense, management cites, among other things, improvements in the company's share price over the last six months (which interestingly enough coincides neatly with Mr. Adams February 2001 proxy filing), strong first quarter results, increased comparable store sales, a strong debt-free balance sheet, strong cash flow, and the return of value to shareholders in the form of a $0.50 annual cash dividend - all of which we have noted above.

Nonetheless, it is management's apparent refusal to accept and appreciate the concerns of the company's owners that has influenced us. Several institutional investors and advocacy groups have spoken out against the company's attempt to deprive shareholders of a meaningful choice of candidates for the open board seat, describing the company's action as "shameful" and "fairly telling." We agree.

When it came right down to it, notwithstanding any positive affects of certain of management's decisions and strategies, we ultimately asked and answered two questions:

1) Has the board done its job well?
2) Could Mr. Adam's membership on the board enhance shareholders' long-term interests?

To the first question, we answered no. Not in terms of its compensation decisions, not in terms of its governance practices, and certainly not in terms of fully appreciating its fiduciary role nor respecting the shareholder franchise (including those "activist pension funds" with "unknown political agendas"). Indeed, we believe that management's over-the-top response to Mr. Adam's exercise of his ownership rights lends itself to support the dissident's concerns about the board's commitment to an impartial and high-quality decision-making process, not to mention its good judgment.

To the second question, we answered yes. Mr. Adams is not seeking to gain control of the board or to push an agenda that management describes as different from other shareholders. Quite simply, Mr. Adams is seeking to ameliorate shareholders' rights on a rather basic level - by respecting proper governance practices and by restoring accountability. Furthermore, we are not swayed by management's assertion that Mr. Adam's membership would "disrupt" or "destroy the progress that Lone Star has achieved."

Accordingly, we recommend that shareholders DISCARD the WHITE proxy card, and vote FOR Mr. Adams using the GOLD proxy card.

About Proxy Monitor
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Susan Assadi
Assadi Associates DBA Gitenstein & Assadi Public Relations
9188 E. San Salvador Drive, Suite 103
Scottsdale, AZ 85258
Tel:  480-860-8792
Fax:  480-451-6275
email: susan@assadi.com
http://www.assadi.com
 

 

 

 

 

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