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Lamassu Holdings has sent another scorching letter to the board of Ditech Networks Inc (NASDAQ:DITC). In the letter, Lamassu claims that the “decisions of this board have shown a pattern of director entrenchment characterized by prioritizing the interest of its members in the face of poor results at the expense of the shareholders” and has called for shareholders to “receive ample representation on the board.”

We’ve been following DITC (see our archive here) because it is trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has previously offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” Lamassu has now nominated two candidates for election to the board “who are committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” Lloyd I Miller III has also disclosed a 5.9% holding and has come out in support of Mr. Leehealey and Mr. Sansone – the director candidates nominated by Lamassu Holdings for election to the board of directors at the DITC annual meeting – as “candidates who are independent of management and he seeks to encourage greater attention to corporate governance by all members of the Board of Directors.” The stock is up 47.2% from our initial $0.89 to close yesterday at $1.31, giving the company a market capitalization of $34.5M. We last estimated the net cash value at around $32.2M or $1.23 per share and the liquidation value at around $43.4M or $1.65 per share. While the deterioration in value is a concern, Mr. Miller’s support of Lamassu Holding’s director candidates introduces a new element to the position. We’re inclined to hold on to see how the annual meeting plays out.

The press release setting out the text of the open letter from Lamassu Holdings is set out below:

Lamassu Holdings LLC Says Ditech Network’s Board of Directors Benefits at Shareholders’ Expense

Lamassu Holdings LLC files an open letter to the Board of Directors of DITECH NETWORKS, INC. (NASDAQ: DITC)

NEWPORT BEACH, Calif.–(BUSINESS WIRE)–Lamassu Holdings, LLC has sent the following letter to the Board of Directors of Ditech Networks, Inc.

Dear Board of Directors:

The purpose of this letter is to inform you that while you have historically operated with impunity in your role as Directors of Ditech Networks (NASDAQ: DITC – News), going forward your actions will be regarded with a much higher degree of scrutiny. The decisions of this board have shown a pattern of director entrenchment characterized by prioritizing the interest of its members in the face of poor results at the expense of the shareholders. In light of this trend, it is time that the shareholders receive ample representation on the board.

We have taken the time to go through the company’s filing and pull out some of the decisions that were clearly made to benefit the board while adding no value to shareholders. It is worth noting that these decisions were, for the most part, made by the same people who currently serve. We believe these decisions illustrate that, with the exception of Mr. Simpons and Mr. Dramis, all of the currently serving members, including Mr. Harper, Mr. Manoliu, Mr. Sugishita, Mr. Hasler and Mr. Avis, have established a clear pattern of rewarding themselves while shareholders suffer.

In 2003 (see Figure 1), Ditech Networks moved from a policy in which board members were paid in options to one in which they were paid with both cash and options. It is worth noting that during the three years prior to this change, there was a dramatic drop in the equity value of the company. In short, since the options you awarded yourselves were no longer worth anything, you chose to guarantee your compensation regardless of performance.

In 2005, after another very difficult period for shareholders, shown in Figure 2, the Board again rewarded itself with pay raises. Beginning on July 15, 2005, non-employee directors began receiving an annual retainer of $16,000; the chairman of the Audit Committee received an additional annual retainer of $5,000; and the chairmen of the Compensation Committee, the Corporate Governance Committee and the Nominating Committee received additional annual retainers of $2,500.

The final insult is the most recent decision made little more than a year ago. As the table below shows, effective May 1, 2008, the Board raised its salaries and several other fees. Ironically, you even actually raised the amount you get paid for “phoning it in” [“Special (telephonic)” line items below]. To put these pay increases in their full context, at the time you granted these raises for yourselves the stock was hitting all time lows on a daily basis and wouldn’t ultimately level off until it reached well below a dollar. In addition, the fundamentals of the company were never as bad as they had been. As a result of poor decisions and failed strategic maneuvers by the Board of Directors, the company had lost millions and millions of dollars. Despite this backdrop, you rewarded yourselves with additional cash at a time when the company apparently didn’t have enough money to buy back its own stock, despite the record low levels.

(The table above has been modified from the original to fit this space)

Had compensation increases been used to attract new talent to the Board of Directors and resulted in new directors that brought with them a history of sound business decisions and responsible business practices, then the pay raises could be justified. However, the pay raises were not used for this purpose. Instead, in the face of massive shareholder equity losses and a long list of bad investments, the Board increased its pay with no regard for the massive losses the shareholders were experiencing—losses that were painless for the members of the Board due to their low levels of stock ownership. It is clear that under the current leadership, it has been more financially rewarding to be on the Board than to be a shareholder. For this reason and many others Lamassu has moved to replace two of the current board members with its own nominees. It is our hope that this will both give shareholders a direct voice on the Board, as well as bring about a level of fiduciary responsibility that we believe is currently lacking.

Sincerely,

Lamassu Holdings, LLC

[Full Disclosure:  We do not have a holding in DITC. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]