Voce Capital Sends Letter to Obagi Medical Products Board of Directors

  Voce Capital Sends Letter to Obagi Medical Products Board of Directors

   Investor criticizes recent adoption of poison pill and demands immediate
     action to rectify governance deficiencies and to evaluate strategic
                                 alternatives

Business Wire

SAN FRANCISCO -- February 10, 2012

Voce Capital Management LLC (“Voce”) announced today that it has sent a letter
to the Board of Directors of Obagi Medical Products, Inc. (“Obagi”)
(Nasdaq:OMPI) criticizing the Board’s recent adoption of a poison pill and
demanding immediate action to address corporate governance deficiencies and to
evaluate strategic alternatives.

Voce’s letter states that it believes Obagi has spurned recent overtures to
acquire the Company, and further cites pervasive corporate governance
deficiencies that explain the Board’s unwillingness to consider those
proposals. Voce also expresses concern over the Board’s recent decision to
adopt a poison pill, citing it as further evidence of the Board’s
entrenchment.

In the letter to the Board, Voce’s Managing Partner, J. Daniel Plants, said
“We have grown increasingly concerned by the Company’s lack of progress in
broadening its product portfolio and expanding its reach. In our view Obagi
would be much more valuable in the hands of a larger and more skilled
operator, and indeed we believe that interested strategic parties have
approached the Company only to be consistently rebuffed by a Board unwilling
to even entertain discussion of an acquisition proposal.”

Mr. Plants went on to state in the letter:

“To date, we have enjoyed regular and candid dialog with Obagi and have
refrained from publicly questioning or criticizing its leadership. However, we
believe the Company’s deficient corporate governance is a key contributor to
its refusal to consider acquisition offers it has received and explains the
actions the Board has taken to entrench itself. While we would have preferred
to continue these discussions in private, the Board’s decision to adopt a
poison pill – two days before Christmas and in sight of the notice deadline
for shareholder actions at the annual meeting – leads us to conclude that the
Board’s interests have become so misaligned with those of the Obagi
shareholders that public disclosure of these matters is not only warranted but
required.”

Voce’s letter also questions the Obagi Board’s independence, particularly the
undue influence of Stonington Partners and the absence of meaningful stock
ownership by directors. “The Board appears to be preeminently interested in
its self-perpetuation and the maintenance of its insular and clubby nature.”

Specifically, Voce calls upon the Board of Obagi to immediately:

  *commence a review of the Company’s strategic alternatives, including good
    faith consideration of the strong strategic interest in acquiring the
    Company;
  *overhaul the Obagi Board, including the removal of Directors Fitzgibbons
    and Bartholdson and their replacement with proper independent shareholder
    representation; and
  *commit that it will put the poison pill to a vote at the 2012 annual
    meeting, and that it will not adopt another poison pill or any other
    anti-takeover device should the shareholders not ratify the pill at that
    time.

About Voce Capital Management

Voce Capital Management LLC is an employee-owned investment manager and the
adviser to Voce Catalyst Partners LP (the “Fund”). The Fund is a long/short
equity investment partnership which invests in small capitalization companies.

The full text of Voce’s letter follows.

                                                             February 10, 2012

Members of the Board of Directors
Obagi Medical Products, Inc.
3760 Kilroy Airport Way, Suite 500
Long Beach, CA 90806

Attention: Corporate Secretary

Gentlemen:

Voce Capital Management LLC (“VCM”) is the investment advisor to Voce Catalyst
Partners LP (“VCP” and, together with VCM, “Voce”). VCP has been a shareholder
of Obagi Medical Products, Inc. (“Obagi” or the “Company”) continuously since
June 2, 2011. We write in response to the decision by the Obagi Board of
Directors (the “Board”) on December 23, 2011 to adopt a “Preferred Share
Purchase Rights Plan”, more commonly known as a “poison pill”.

We have grown increasingly concerned by the Company’s lack of progress in
broadening its product portfolio and expanding its reach. In our view Obagi
would be much more valuable in the hands of a larger and more skilled
operator, and indeed we believe that interested strategic parties have
approached the Company only to be consistently rebuffed by a Board unwilling
to even entertain discussion of an acquisition proposal.

To date, we have enjoyed regular and candid dialog with Obagi and have
refrained from publicly questioning or criticizing its leadership. However, we
believe the Company’s deficient corporate governance is a key contributor to
its refusal to consider acquisition offers it has received and explains the
actions the Board has taken to entrench itself. While we would have preferred
to continue these discussions in private, the Board’s decision to adopt a
poison pill – two days before Christmas and in sight of the notice deadline
for shareholder actions at the annual meeting – leads us to conclude that the
Board’s interests have become so misaligned with those of the Obagi
shareholders that public disclosure of these matters is not only warranted but
required.

                                    * * *

Since its founding in 1988, Obagi has built a distinctive franchise. Its
flagship Nu-derm® product line is universally acclaimed, and the Obagi brand
commands loyalty from consumers and doctors alike. Obagi has an extremely
valuable physician distribution network and a recurring revenue stream with no
reimbursement risk. As a result, Obagi enjoys premium margins and cash flows.

Obagi has not, however, been able to grow beyond its original success with
meaningful new products, nor has it adequately monetized its distribution
platform. Despite repeated attempts, it has stumbled in efforts to develop new
applications and treatments. After years of discussion about potential
international opportunities, non-US revenues still comprise only about 16% of
the Company’s net sales. And we’ve seen little traction in terms of
in-licensing or acquiring complementary products that could be sold through
Obagi’s network.

Obagi has not posted double digit revenue growth since 2007, and it is
expected to grow only 2% for 2011. While not an abject failure, these results
are hardly cause for celebration given all of the time and capital that has
been invested in trying to grow the Company. We believe the investment
community broadly shares these concerns.

There is no sign that the appointment of Mr. Hummel as CEO has changed any of
this. Perhaps owing to his experience as a “big pharma” executive, Mr. Hummel
initially talked about rejuvenating the Company’s research pipeline. On the
last quarterly call, however, he shifted the Company’s strategic focus to a
new plan to launch a nationwide internet pharmacy. This latest idea was short
on details and presumably would be expensive, complex and time consuming to
implement.

And yet Obagi’s key strengths – its core product line, brand equity, unique
distribution and sound business model – are undoubtedly attractive to
strategic acquirers which are better positioned to monetize these assets. We
believe Obagi would field significant strategic interest from potential buyers
in the following industries: pharmaceutical (aesthetic, specialty and
integrated categories alike); aesthetic energy (lasers); beauty and cosmetics;
and health and wellness. Many of these players are much larger than Obagi and
would pay a significant premium to control this unique property. Moreover,
while the strategic rationales differ by category and by individual acquirer,
there are significant cost and revenue synergy opportunities. Based on our
analysis a purchase price well in excess of Obagi’s 52-week high is not only
achievable but is the likely outcome in the event of a transaction.

Indeed, we believe that potential acquirers have recently approached Obagi
only to be rebuffed by the Company. In our view, the Board’s fiduciary duties
require it to consider in good faith any serious interest in acquiring the
Company, and it appears that the Board has abdicated its responsibility here.
The Board is so adamantly opposed to a sale that it apparently ousted the
previous CEO (Mr. Hummel’s predecessor) over his advocacy of a sale of the
Company.

We believe the only credible alternative for the Board at this juncture is to
undertake a legitimate review of the Company’s strategic alternatives, with
the advice of reputable legal and financial advisors. If the Board truly
believes that its own strategic plans will create the highest value for
shareholders then those plans can be evaluated and quantified and compared
against the results of a thorough process. A competitive process will also
likely elicit more and better offers than those received to date, as some
parties (particularly larger acquirers) will only invest the time in a
potential transaction if it appears that a deal is a legitimate possibility.

                                    * * *

We are also compelled to take issue with the lax corporate governance at
Obagi. How can a company that derives the overwhelming majority of its
revenues selling pharmaceutical products to women through the physician
channel not have a single female or doctor on its Board? Or at least someone
with executive experience in beauty or cosmetics? Moreover, while the Company
touts its efforts to cultivate a trendier image through viral marketing and
social media, and talks of its plans to broaden its appeal to younger
consumers, the average age of the men on the Board is over 60 years old.

The Board’s hiring of Mr. Hummel as CEO – himself a director at the time of
his appointment – is also troubling. Mr. Hummel is concurrently the chief
executive of another company, Cobrek Pharmaceuticals, Inc. (“Cobrek”), based
in suburban Chicago. How can the CEO of a public company also be the CEO of
another company in another city at the same time? Moreover, since Mr. Hummel
has taken over as CEO of Obagi the Company has begun making payments to Cobrek
for unspecified “consulting” services. While the Company has previously
responded to us that these matters have all been disclosed in public filings,
their disclosure does not clear their unseemly air let alone make them
appropriate actions for a publicly-traded corporation.

But the most glaring governance deficiency is that the management and Board of
Obagi own almost none of its common stock. Collectively, the six members of
the Board (including Mr. Hummel) own less than 1% of the Company’s common
stock. To our knowledge, none of the directors have ever purchased a single
share of Obagi stock in the open market, including when it touched multi-year
lows in 2009 and including when the Board thought the stock was a compelling
enough value that it authorized the Company to repurchase shares.

This lack of alignment with shareholder interests is succinctly illustrated by
the continued Board membership of Messrs. Fitzgibbons and Bartholdson. These
gentlemen are both executives of Stonington Partners (“Stonington”), a
leveraged buyout firm. They, along with Mr. Hummel, obtained their Board seats
after the acquisition of Obagi by Stonington but prior to its IPO. While it is
not uncommon for a financial sponsor to retain board representation following
an IPO if it continues to hold a significant ownership position, Stonington
sold all of its remaining Obagi shares (primarily back to the Company) in
2010. To permit these gentlemen to retain their seats after the disposition of
all but a token amount of their ownership suggests that their actions are
primarily motivated by a desire to retain the prestige and perquisites of
sitting on a public Board.

In addition to the direct connection between Messrs. Fitzgibbons and
Bartholdson – who remain business partners at Stonington and have worked
together for many years – the Stonington reach in this boardroom extends even
further. All of the “independent” Obagi directors have sat together on the
boards of other Stonington portfolio companies. Messrs. Fitzgibbons, Badie and
Grant all served together on the board of Merisel Inc., a Stonington
investment. Messrs. Fitzgibbons and Duerden were members of the Dictaphone
board, another Stonington portfolio company, where Mr. Duerden also served as
the CEO – effectively making him a Stonington employee at the time. This same
group of “independent” directors constituted Obagi’s Board at the time Obagi
repurchased Stonington’s shares in 2010.

Far from being an academic exercise in good corporate housekeeping, these
governance failures are at the heart of what precludes serious consideration
of the Company’s strategic alternatives. Quite simply, the Board appears to be
preeminently interested in its self-perpetuation and the maintenance of its
insular and clubby nature. This misalignment has prevented a frank assessment
of the likelihood that the Company’s best option to create shareholder value
is to sell itself to a larger and more skilled operator. We believe this
explains the Board’s hostility to any proposals to acquire Obagi and its
ongoing efforts to entrench itself through actions such as appointing one of
its own in Mr. Hummel as CEO and the adoption of a poison pill.

Unfortunately, this list of Obagi’s governance deficiencies is not exhaustive.
While there are many other steps the Board should take to strengthen itself,
at a minimum we call upon the Obagi Board to immediately remove Messrs.
Fitzgibbons and Bartholdson and replace them with independent directors whose
ownership of common stock in the Company aligns their interests with the
broader Obagi shareholder base.

                                    * * *

Finally, we return to what prompted this letter. While the preceding list of
operating and governance issues had concerned us, the Company’s recent
adoption of a poison pill left us with no choice but to come forward. The
decision by this Board – with its rank governance failures and misplaced
priorities – at this time, while it apparently refuses to even consider offers
that might create meaningful shareholder value – is unacceptable.

It also bears repeating that Company decided to implement the Obagi poison
pill on December 23 – while the majority of the investing world and press were
already home for the holidays. It did not issue a press release nor reflect it
on the investor relations page of its website. It chose to mail notice of this
action to its shareholders on January 10, 2012 – just a short time before the
deadline for the submission of shareholder proposals and nomination of
director candidates for the 2012 annual meeting.

It is clear from the circumstances surrounding the enactment of the Obagi
poison pill that it is not, as Mr. Hummel claimed in his transmittal letter to
shareholders, designed to “guard against abusive tactics to gain control of
the Company” nor to prevent “unfair treatment by an acquirer”. Likewise, it is
disingenuous for Mr. Hummel to defend the poison pill as “intended to
encourage anyone seeking to control or acquire the Company to negotiate with
the Board”, when we believe the Board steadfastly refuses to engage in such
negotiations with anyone who approaches it and has spurned all such overtures.
In this context, the adoption of the poison pill appears to be a desperate
move by the Board to send a signal that Obagi is not for sale at any price and
to stifle further acquisition interest.

We call upon the Board to commit irrevocably to bring the poison pill to a
shareholder vote at the 2012 annual shareholders’ meeting, and further commit
not to adopt another poison pill nor institute any other anti-take-over
devices if the shareholders do not ratify the poison pill at that time.

                                    * * *

As stated at the outset, Voce’s bias would have been to continue expressing
our concerns to Obagi outside of public view. However, the Board’s decision to
institute a poison pill at this time and in this manner has convinced us that
a public airing of these serious issues is necessary. Furthermore, while we
invite the Board’s response to what we have written and would welcome the
opportunity to meet to amplify our concerns, our objective is to see that the
three demands set forth herein are immediately met.

To repeat, we call for:

  *the commencement of a review of the Company’s strategic alternatives,
    including good faith consideration of what we believe to be strong
    strategic interest in acquiring the Company;
  *the complete overhaul of the Obagi Board, including the immediate removal
    of Messrs. Fitzgibbons and Bartholdson and their replacement with proper
    independent shareholder representation; and
  *the Board’s irrevocable commitment that it will put the poison pill to a
    vote at the 2012 annual meeting, and that it will adopt another poison
    pill or any other anti-takeover device should the shareholders not ratify
    the pill at that time.

If these actions are not taken, we reserve the right to take any and all steps
that we believe will unlock value for Obagi’s shareholders.

Respectfully yours,

VOCE CAPITAL MANAGEMENT LLC

By: /s/ J. Daniel Plants

J. Daniel Plants
Managing Partner

Contact:

Voce Capital Management LLC
J. Daniel Plants, 415-489-2601
Managing Partner
 
Press spacebar to pause and continue. Press esc to stop.