Investor Group Urges Kellwood to Reconsider Sale

CtW Investment Group Letter:

December 18, 2007

Harvey A. Weinberg
Chair, Corporate Governance Committee and Presiding Director
Board of Directors
Kellwood Company
600 Kellwood Parkway
Chesterfield, Missouri 63017

Dear Mr. Weinberg:

The failure of Kellwood's independent directors to open a constructive dialogue with Sun Capital regarding its interest in acquiring Kellwood suggests the board may be more interested in protecting management than maximizing value for shareholders. By granting golden parachutes to executives soon after Sun disclosed its 8.0 percent ownership, and by retaining an “independent” financial advisor with extensive ties to Kellwood, the board has exacerbated this concern.

We therefore write to urge the Kellwood board to immediately name a special committee of independent directors to explore strategic alternatives, including a possible sale of the company. While we consider Sun's current offer inadequate, Sun is a qualified buyer, has made a serious offer and has said it is open to alternatives. Kellwood has lost 50 percent of its market value in the past year. A sale to Sun or another buyer could enable shareholders to realize value without bearing the execution risk of Kellwood's long-term plan, a compelling option given the plan's optimistic 25 percent annual EPS growth assumption and Kellwood's poor historical performance.

As you know, we previously raised concerns with regard to the Kellwood board's responsiveness to shareholders in a June 29, 2007 letter to you. In your September 24 reply, you disclose that the board subsequently removed director Jerry M. Hunter from key committees and will seek shareholder authorization to declassify the board. Given the board's failure to engage Sun, these steps now appear to be too little and too late, respectively.

Sun's all cash offer may be opportunistically timed, coming 11 days after Kellwood reported a $66 million quarterly loss that sent its shares to a seven-year low, but it nonetheless represents a 38 percent premium to its closing share price on September 18, the last trading day before Kellwood disclosed the offer, and a 29 percent premium to yesterday's close. It also translates to an enterprise value multiple of 7.3x EBITDA, in line with Kellwood's peer group average, but insufficient to compensate shareholders for the upside potential of Kellwood's reconfigured brand portfolio.

By establishing a special committee of independent directors to retain a genuinely independent investment bank, to explore Sun's interest in Kellwood and to seek competing bids, the board can address investor concerns regarding its independence from management at an especially critical moment for Kellwood and its shareholders. We further detail these concerns below.

1. Kellwood's board has been unresponsive to shareholder concerns, twice reseating a director who failed to receive majority support from interested shareholders.

At Kellwood's 2005 annual meeting, shareholders withheld 51 percent of their votes from outside director Jerry M. Hunter after the company disclosed that Mr. Hunter's law firm provided legal services to Kellwood while Mr. Hunter served as the Kellwood board's Presiding Director and Chairman of its Corporate Governance Committee. Despite the majority withhold vote, the board reseated Mr. Hunter in 2005 and re-nominated him for election at the end of his two-year term in 2007, by which time the board had adopted a majority vote policy for director elections.

It appears that Mr. Hunter again would have failed to win re-election in 2007 if uninstructed broker votes had not been included in the “FOR” column, as detailed in our June 29 letter — excluding such “phantom votes,” an estimated 54 percent of votes cast were withheld from Mr. Hunter. The board nevertheless reseated Mr. Hunter once again.

We understand from your September 24 letter the board recently removed Mr. Hunter from key committees and repositioned the legal work done by his firm. Given that he failed to receive majority support from interested shareholders in his last two director elections, we fail to see how these actions “demonstrate Kellwood's responsiveness to its shareholders and its unwavering commitment to good corporate governance,” as you assert in your letter.

2. Kellwood's charter and bylaws limit board accountability and provide a fortress against hostile takeovers; plans to declassify the board will not take effect by the 2008 director election.

Among the provisions that entrench management and the board are a poison pill, a staggered board and supermajority requirements to amend key provisions of the governing documents. While Kellwood states that its takeover defenses are intended “to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover,” Sun's recent filings lead us to believe that it is the Kellwood board that appears to be refusing to enter into meaningful discussions.

In an overwhelming demonstration of shareholder opposition to Kellwood's entrenching governance provisions, Kellwood shareholders cast 88 percent of their votes in favor of CalPERS' board declassification proposal at the company's 2007 annual meeting. While your September 14 letter discloses the board's decision to respect the vote, the need to obtain shareholder authorization to amend the charter means that the entire board will not stand for election at the 2008 shareholder meeting.

3. The board's granting of golden parachutes to executives following the disclosure of Sun's ownership raises conflict of interest concerns and creates another barrier to would-be acquirers.

On July 17, 2007, 39 days after Sun Capital filed a 13D disclosing that it had acquired an 8.0 percent ownership in Kellwood, Kellwood entered into Change of Control Agreements with four senior executives: Patrick J. Burns, Vice President and Chief Strategy and Marketing Officer, Samuel W. Duggan II, Vice President Investor Relations and Treasurer, J. David LaRocca, Jr., Vice President Human Resources, and Michael M. Saunders, Vice President and Chief Information Officer. The agreements, which contain provisions similar those in longstanding Change of Control Agreements covering each of Kellwood's five named executive officers, provide lump sum payments in the event of termination of employment following a change in control.

We believe it is unusual for a company to provide change-in-control payments to non-key executives, particularly since the purpose of such arrangements is to make management open to pursuing mergers or acquisitions that benefit shareholders even if it puts their own jobs at risk. This rationale has little relevance for these four executives.

4. Conflicts of interest compromise the independence of Kellwood's financial advisor.

In rejecting Sun's offer, Kellwood disclosed that the board “conducted a detailed review of the Company's strategy for enhancing shareholder value,” and this review “included consultation with the Company's independent financial advisor — Banc of America Securities LLC.” It is not clear from the press release whether the board engaged Banc of America Securities to review the fairness of the Sun offer. If so, we request that you immediately disclose that review to shareholders. What is clear, however, is that Banc of America Securities is not independent given its extensive, long-term business relationships with Kellwood.

Kellwood has maintained a business relationship with Banc of America Securities and its affiliates, most notably Bank of America, since at least December 1994, when Bank of America acted as Issuing Bank and Agent on Kellwood's $70 million long-term credit facility. Since then, Banc of America Securities and its affiliates have acted as:

— Joint underwriter for Kellwood's September 1997 shelf registration of $300 million in equity, preferred stock and debt securities.

— Joint placement agent for Kellwood's June 2004 private placement of $200 million in convertible senior debentures due 2034.

— Joint arranger and facility agent for Kellwood subsidiary Smart Shirts' Asian credit agreement, a $50,000,000 Term and Revolving Credit Facility Agreement dated December 2005.

— Joint lead arranger and agent for Kellwood's $400 million revolving credit facility dated April 2006.

— Financial advisor to Kellwood in connection with its September 2006 acquisition of CRL Group.

Clearly Banc of America Securities and its affiliates derive substantial income from their relationships with Kellwood management, relationships that could be jeopardized by a change in control.

5. Summary

In our view, evaluating a potential change in control is the most critical measure of a board's fitness and independence given the enormous value at stake and potential for conflicts of interest between management and shareholders. The Kellwood board's failure to establish an independent process to review Sun's offer and its opportunely-timed granting of golden parachutes to executives reinforce our concern that the board may be more interested in protecting management than maximizing shareholder value. These circumstances warrant a special committee of independent directors to engage Sun and explore strategic alternatives.

The CtW Investment Group works with pension funds sponsored by unions affiliated with Change to Win, a federation of unions representing nearly 6 million members, to enhance long-term shareholder returns through active ownership. These funds, together with public pension funds in which members of CtW unions participate, are substantial long-term Kellwood shareholders.

We look forward to a timely response, including disclosure of the creation and composition of the requested special committee and the name of its investment bank.

Sincerely,
William Patterson
Executive Director
cc: Kellwood board of directors