Wednesday, August 29, 2007

Lawndale Raises Stake in Sparton (SPA), Requests Board Form Committee To Explore Strategic Alternatives

An interesting 13D on micro-cap company Sparton Corp. (NYSE: SPA), filed a few weeks ago, has been brought to our attention recently.

In the 10th amendment to an original 13D filled in February of 2003, Lawndale Capital disclosed that they raised their stake in the company to 9.1% and issued a letter to the Board of Directors expressing concern over the company's continued operational deterioration and the Board's apparent inaction and failure to provide management oversight and accountability.

In the letter, Lawndale Capital's President Andrew Shapiro requested that the company "Immediately form a special committee of independent board members, who, with the advice of a reputable financial advisor, explore strategic alternatives to maximize value for all shareholders, including, but not limited to, significant restructuring, management changes and/or sale of the Company or one or more of its divisions in order to maximize value for all shareholders", among other things.

A Copy of the Letter:

Dear Sparton Board Members,

Lawndale Capital Management, LLC and its affiliates have increased their ownership of Sparton Corp. ("Sparton" or the "Company") to 890,086 shares, constituting 9.1% of the Company, and remains Sparton's largest independent shareholder. We have become increasingly troubled by the Board's inaction and acquiescence to Sparton's perennially underperforming management team-a team that has presided over a decades-long decline in both the Company's book and stock values.

The Company's poor governance mechanisms, including a staggered board (which has now been eliminated from a majority of Fortune 500 companies), the improper stripping of cumulative voting rights and the over allocation by the employee pension to Sparton stock has entrenched the Board and management. As a result, we believe both the Board and management have been insulated from the problems faced by the Company's shareholders, and have failed to take the necessary actions to improve Sparton's business. Sparton's Board needs fresh perspective from qualified and energetic new Board members willing to explore all strategic options to maximize shareholder value and provide necessary oversight and accountability of a management team that has underperformed for years.

The consequences of Sparton's poor governance can be seen in the Company's dismal operating results. In spite of years of worldwide economic expansion, Sparton's management has an extended record of value destruction through ongoing operational mediocrity and recurring "non-recurring" losses. As the Board seems so oblivious to such troubling results, and we don't want to be accused of short-term focus, let us succinctly summarize a whole decade of mismanagement and underperformance.

- Book Value per share has fallen from $10.90 in 1997 to $9.21 in 2007, reflecting a decade's worth of poor operating results and mediocre re-allocation of shareholder capital. Mr. Hockenbrocht has presided over Sparton as a senior executive throughout this time period.

- Executives and directors, demonstrating their own lack of confidence in the Company and its management, routinely and consistently sell their equity holdings in the Company. As a result, while Mr. Hockenbrocht has been President at Sparton since 1978 and received numerous equity grants designed to "encourage management to remain dedicated to maximize long-term shareowner value", he owns less than 1% of Sparton's stock and habitually sells stock below book value upon exercising his options. Sparton's independent directors show a similar lack of confidence in the Company. On average, these directors, excluding the recently appointed Mr. Schrank, own just over 3,500 shares each after sitting on Sparton's board for an average of more than 13 years.

- For years, management has entrenched itself by over-allocating the Sparton employee pension plan (over 25% of plan assets per the 2006 Annual Report) to Sparton stock so that Mr. Hockenbrocht might vote its stock as he sees fit, including voting in 2004 to reduce board accountability through removing shareholders' cumulative voting rights. As a result, while Mr. Hockenbrocht personally sells Sparton stock, he maintains more than a quarter of the Company's employee pension fund assets in Sparton stock, whose votes he alone controls. This reckless over-allocation of Sparton employees' retirement assets to Company stock imprudently jeopardizes employees' retirement funds and flies in the face of lessons learned earlier this decade at companies like Enron and WorldCom. How can the same senior executive who continually disposes of his personal shares below book value consider such a large allocation of employees' retirement funds to Sparton stock prudent? Why should employees' retirement be jeopardized so that Mr. Hockenbrocht can garner enough votes to entrench a lackluster operating team?

- Sparton's operating metrics have struggled despite global prosperity and increased profits at competing firms. Internal growth initiatives designed to offset losses in the core business have failed. While continuing to lose money more than two years since it began operations, the Vietnam facility remains behind budget and underutilized.

- Through the end of July, Sparton's stock is down 29% from a decade ago and down 48% from twenty years ago. The S&P 500 has risen 79% and 619%, respectively.

A decade's worth of shareholder capital abuse reflected in decreased book value and stock market value speaks for itself and, even by Sparton's antiquated standards of corporate governance, justifies action. These depressing results have occurred on this Board's watch. It is inexplicable to us why you have been willing to acquiesce to an arrogant, underperforming management team with little economic stake in the Company. Long-term investors are appalled that senior management has not been held accountable after so many years of deterioration at our Company. How much value must be destroyed before you take belated action? Have the members of the Board forgotten their fiduciary obligations to shareowners? What tangible goals, if any, will management be held accountable to?

In recent months, we have constructively reached out to your Nominating and Corporate Governance Committee offering access to our extensive network of qualified director candidates. When informed, in February, that Sparton's criteria for selecting directors might be modified at an upcoming Board meeting, we immediately requested that Sparton provide us with its revised criteria so that we might provide fitting candidates willing to go through the interview process. Unfortunately, highlighting the Board's disregard for modern governance standards, this simple request from your largest independent shareholder was met with stonewalling, obfuscation and circuitous nonsense. The Board has subsequently named Mr. Schrank to fill a director vacancy. While we find Mr. Schrank's background encouraging, given Sparton's history we do not understand why his appointment was hidden from the Company's shareholders until after it was announced, or why we have not been allowed to meaningfully participate in the process of providing candidates for the Sparton Board.

In light of the perpetual deterioration in Sparton's operating results and on behalf of the Company's long-suffering shareholders, Lawndale makes the following requests of Sparton's Board:

- Immediately form a special committee of independent board members, who, with the advice of a reputable financial advisor, explore strategic alternatives to maximize value for all shareholders - including, but not limited to, significant restructuring, management changes and/or sale of the Company or one or more of its divisions in order to maximize value for all shareholders.

- Immediately hire an outside pension consultant to review Sparton's defined pension benefit plan asset allocation to the Company stock, which, at over 25% of plan assets, recklessly endangers employees' retirement assets.

- Enable employees owning shares in Sparton's employee 401(k) plan to vote their shares anonymously from management scrutiny

- Immediately begin the necessary action to modify Sparton's Charter to eliminate the Company's staggered board, so that all directors may be elected on an annual basis, which is consistent with best governance practices and the policies in place at a majority of the Fortune 500.

- Establish and enforce share ownership requirements for both management and the Board, mandating minimum stock holding requirements relative to salary and amend equity compensation policies to require a minimum holding period for shares obtained from options exercise.

We continue to make ourselves available to management, shareowners and board members to discuss ways to improve the Company's governance and performance in an effort to maximize shareholder value.

Yours Sincerely,

Andrew E. Shapiro


Lawndale Capital Management, LLC

Labels: , , ,


Post a Comment

<< Home