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[published June 29, 2001]
Lone Star Steakhouse & Saloon, Inc. (STAR)
Cusip: 542307 Meeting Date: 07/06/2001 Record
Elect one director from one of three classes to serve a term expiring in
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
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
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
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
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
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
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
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
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
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'
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
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.
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