MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH (68581)
ALAN SCHULMAN (128661)
JAMES A. CAPUTO (120485)
TRAVIS E. DOWNS, III (148274)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
Attorneys for Plaintiffs
[Additional counsel appear on signature page.]
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
WALTER W. HEAD, III, GREGORY SELMANSON,
DOMINIC CASTALDO, LEILA WALDMAN, and
JOHN VELONIS, JR., On Behalf of Themselves
and All Others Similarly Situated,
Plaintiffs,
vs.
NETMANAGE, INC., ZVI ALON, WALTER AMARAL,
UZIA GALIL, AMATZIA BEN-ARTZI, ROBERT WILLIAMS,
RICHARD KORETZ, JOHN BOSCH and DAN GEISLER,
Defendants.
_________________________________________
No. C-97-4385-CRB
CLASS ACTION
SECOND AMENDED COMPLAINT FOR VIOLATIONS OF
THE SECURITIES EXCHANGE ACT OF 1934
Plaintiffs Demand A Trial By Jury
1. This is a class action on behalf of purchasers of NetManage, Inc. ("NetManage" or the "Company"), stock between 7/25/95 and 1/11/96 (the "Class Period"), against NetManage and certain of its top officers and directors.(1) In 94, 90% of NetManage's revenues came from the sale of non-proprietary TCP/IP (transmission control protocol/Internet protocol) based applications software to run on the Microsoft Windows computer operating system. TCP/IP protocols are the rules that govern the interconnectivity of computer networks -- the intercommunications' "plumbing" or "translator" -- enabling one type of PC to communicate with a different type of computer also equipped with TCP/IP. NetManage's TCP/IP software products enabled a standard Windows PC, or a network of Windows-based computers, to communicate with non-Windows systems, including mainframe computers, mini-computers and workstations.
2. TCP/IP was an open, non-proprietary system which any company could use or utilize to create software products. In early 95 Microsoft publicly announced that its new Win95 operating system would include and utilize TCP/IP. So that software developers would be able to develop Windows-compatible products to run on Win95 in time for the introduction of Win95 later in 95, Microsoft provided "Beta" versions of Win95 to software developers (including NetManage) in late 94. These "Beta" versions of Win95 contained an embedded TCP/IP "stack."
3. NetManage's TCP/IP core product line was marketed under the name Chameleon and allowed corporations to communicate and share information between work groups and such functions as file and printer sharing, electronic mail and messaging, Internet and group collaboration. Because NetManage's Chameleon products utilized TCP/ICP, they had no patent protection. NetManage also marketed ECCO, a personal information manager software product allowing users to schedule meetings, collaborate on projects and share calendars, phone books, etc. Most of NetManage's revenues came from its sales of TCP/IP Windows products to large corporate accounts, i.e., the Fortune 1000, via NetManage's own internal Telesales efforts and through Value Added Resellers ("VARs") who took NetManage's Chameleon product and incorporated it into customized products. During 94-95, NetManage was attempting to grow its business and diversify away from its dependence on TCP/IP Windows products by acquiring other software companies and technologies. For instance, ECCO was a non-Windows product NetManage acquired from Arabesque Software in 94. By late 95, NetManage was actively seeking additional acquisitions and had identified AGE Logic, Inc. ("AGE") and Syzygy Communications Inc. ("Syzygy") as acquisition candidates.
4. During most of 94, NetManage's stock was a very mediocre performer and, by 12/94, was selling at just $12-$13, only slightly higher than the $10-$11 range it sold for in 3/94. But, in late 12/94 when NetManage announced it would report much better than expected 4thQ 94 EPS, its stock quickly jumped to $22-1/2. After NetManage's stock soared higher, between 1/26/95-5/24/95, NetManage's insiders sold several hundred thousand shares of their NetManage stock on the open market at artificially inflated prices as high as $21-1/4.
5. However, between 5/25/95 and 5/31/95, NetManage stock declined sharply, falling from 19-5/8 to $13 -- a 33% decline in just a few days, due to investors' concerns (i) over NetManage's 1stQ 95 results -- which had reported lower EPS than NetManage's 4thQ 94 EPS, causing concern that NetManage's EPS growth could not be maintained; and (ii) that the upcoming 95 release of Microsoft's Win95 would contain features and capabilities that would supplant NetManage's TCP/IP products and hurt NetManage's EPS growth. This decline also greatly reduced the value of NetManage's insiders' NetManage stock holdings and options, made it much more expensive for NetManage to use its stock as currency for acquisitions and adversely impacted NetManage's insiders' ongoing scheme to unload their NetManage shares at very high prices to maximize their insider selling proceeds.
6. The Defendants were alarmed by this sharp decline in NetManage's stock. In reaction they stopped selling off their NetManage stock in late 5/95. However, they were determined to overcome investors' concerns and re-inflate NetManage's stock. To inflate NetManage stock back up to much higher levels, Defendants began to flood the market with positive announcements. They stated that NetManage was "successfully" pursuing a major international expansion in Europe and Japan, had expanded NetManage's product distribution channels in the U.S. to allow its products to be sold at retail and was enjoying "continued success" in expanding the distribution of its products in the retail market, which would lead to dramatic increases in NetManage's 95-96 EPS. They represented that NetManage's new ECCO product was a "big success," and that its core Chameleon connectivity products were enjoying continuing "strong sales." As a result, NetManage was the "leader in TCP/IP applications software" -- the "fastest growing public software company in the United States." NetManage also assured investors that the introduction of Win95 would not only not hurt NetManage but would be "a great advantage" for NetManage and would greatly increase the market and demand for NetManage's TCP/IP Windows products. After Win95 was introduced, Defendants represented that Win95 had not had any negative impact on NetManage's business, that NetManage had "strengthened our strategic relationship with Microsoft" and had entered into an important software development partnership with Microsoft -- the largest and most successful software company in the world, and "the fact that Microsoft is licensing our technology demonstrates that we have proven leadership in TCP/IP for Windows" and "is an endorsement of NetManage's strategy to provide a complete range of Internet and TCP/IP-based applications." Finally, overcoming investor concerns that NetManage's growth was slowing, NetManage reported very strong revenue and EPS growth in the 2ndQ and 3rdQ of 95 -- stating that these results fairly presented NetManage's results in conformity with Generally Accepted Accounting Principles ("GAAP") -- and were due to the strong ongoing demand for NetManage's products, the success of NetManage's international expansion and showed that the introduction of Win95 had not hurt NetManage's business -- forecasting that NetManage would achieve 95 EPS of $.68-$.71, 96 EPS of $1.00-$1.05, 97 EPS of $1.50+ and a 3-5 year secular EPS growth rate of 40%-50%.
7. These positive assurances, strong EPS and forecasts of continuing EPS growth drove NetManage's stock to a Class Period high of $34 by early 12/95 -- a 162% increase over its 5/95 low of $13. As NetManage's stock moved back up to artificially inflated levels, NetManage's insiders resumed their insider "bailout," starting to sell again on 7/27/95 -- just two days after NetManage reported its very strong -- but false -- 2ndQ EPS -- unloading over 900,000 shares of the NetManage stock they owned for $17.7 million in illegal insider trading proceeds over the next few months, just before NetManage's stock collapsed back to $10 per share. In addition, Defendants took advantage of NetManage's inflated stock price to have NetManage acquire two companies in 10/95-11/95 -- AGE and Syzygy, when NetManage's stock was trading at $19-$20 -- issuing 1.44 million shares of NetManage stock -- just half the number of shares of NetManage stock NetManage would have had to issue for those acquisitions had its stock not been re-inflated during the Class Period. This not only enabled NetManage to acquire AGE and Syzygy on favorable, non-dilutive terms, but also limited the dilutive impact of those acquisitions on Alon's controlling 22% ownership position of NetManage.
8. NetManage's positive statements and strong financial results during the Class Period were false and/or misleading. In truth, demand for NetManage's Chameleon TCP/IP connectivity products was stagnant or falling. NetManage's Telesales group -- which was not adequately trained in interconnectivity technology -- was unable to sustain growing sales of Chameleon in the increasingly competitive environment. NetManage's VARs were increasingly refusing to sell NetManage's products in retaliation for NetManage's Telesales group directly competing with the VARs to sell Chameleon products to Fortune 1000 companies the VARs had already approached or solicited. Consumer interest in NetManage's new ECCO personal management system product was only lukewarm and sales of that product through NetManage's new retail distribution channel were slow. NetManage's analysis of the Win95 Beta versions and its discussions with NetManage's existing corporate customers revealed that the introduction of Win95 was going to have a negative effect on demand for and sales of all NetManage's TCP/IP Windows products, as Win95 not only had an embedded TCP/IP stack, but also contained several TCP/IP applications which directly competed with Chameleon, and would be available to PC users for free with Win95. As Win95 was about to be introduced and then after Win95 was introduced, Defendants immediately learned from internal sales reports detailed at ¶¶23, 26-27 and 31 that sales of NetManage's TCP/IP Windows products were being very adversely impacted. At the same time, Netscape Communications, Inc.'s ("Netscape") Navigator network browser and accompanying applications software, which was broadly released and in some instances free of charge, cut into NetManage's Internet and intranet markets. Also, the agreement with Microsoft neither demonstrated NetManage's proven leadership in TCP/IP for Windows nor endorsed NetManage's strategy as the agreement contained no commitments for Microsoft to do anything for NetManage and NetManage knew that it was extremely unlikely that this arrangement would ever generate any revenue for NetManage. Finally NetManage's international expansion was a failure, generating very weak sales, especially in Japan, but continuing to burden NetManage with high expenses, which was hurting NetManage's profitability. To cover up these negative conditions and declining trends in NetManage's core business, Defendants falsified NetManage's 2ndQ and 3rdQ 95 financial statements by inflating its revenues and EPS via the manipulative transactions and devices detailed in ¶¶99-109.
9. It was also false and misleading for Defendants to continuously describe NetManage as the "leader in TCP/IP software applications" and the "fastest growing software company." There were several other companies that provided TCP/IP software applications products which were at least as good as NetManage's products and provided equal or better price/performance, including Attachmate, Hummingbird, Wall Data and FTP Software. Also, Win95 not only used TCP/IP technology and had a TCP/IP interface, but also contained several interconnectivity applications which performed many of the functions of NetManage's Chameleon and ECCO products for free. Thus, no one company, and certainly not NetManage, was the "leader" in TCP/IP software applications. Nor was NetManage the "fastest growing software company" as, in fact, during 95, Intuit, 3DO, Avant!, Platinum Technology, Quarterdeck, Geoworks, Security Dynamics, PeopleSoft, Avid Technology, Business Objects, Parametric Technology, Remedy, Mercury Interactive, Media 100 and WonderWare were faster-growing software companies, even accepting NetManage's 94-95 revenues and EPS as reported as accurate, which they were not. It was also misleading to describe NetManage as the "fastest growing software company," as NetManage's purported fast growth, at least during the Class Period, was being achieved by falsifying its revenues and EPS, as detailed at ¶¶99-109, to make its growth look much stronger and faster than it really was, and Defendants knew that NetManage's growth was actually slowing due to the diminished demand for and slowing sales of its Chameleon and ECCO products and the introduction and success of Win95 with its TCP/IP and applications programs.
10. In 12/95, NetManage's outside auditors began their annual audit of NetManage. They discovered that NetManage was trying to recognize revenue on millions of dollars worth of product shipments which included contingencies and commitments which made revenue recognition improper under GAAP and told NetManage they would not permit recognition of these revenues. In 12/95, NetManage's stock began to fall as rumors circulated that its 4thQ 95 results would be lower than earlier forecast -- which rumors Alon and Amaral denied. Then, in early 1/96, NetManage's stock fell further, as two other software companies reported very disappointing 4thQ results, increasing investors' concerns about NetManage's 4thQ results. Again, NetManage falsely assured investors and analysts that it had in fact had a good 4thQ 95, it would still achieve 4thQ 95 EPS of $.19-$.21. But then, on 1/12/96, NetManage revealed its 4thQ 95 EPS would decline from 3rdQ 95 levels (and even 4thQ 94 levels) and be far below the levels forecasted during the Class Period principally because NetManage was not able to recognize revenues on millions of dollars of software products it had shipped, due to accounting restrictions. NetManage's stock fell by over 33% in one day -- to just $10 on 1/12/96 on volume of over 11.6 million shares -- the largest one-day stock volume in NetManage's history as a public company! This decline took NetManage's stock back below where it sold at the beginning of the Class Period and far below the stock's all-time high of $34 just a month earlier. Subsequently, except for the 2ndQ 96 when NetManage again artificially inflated its stock from $9-3/4 to $18-7/8,(2) so key NetManage insiders could garner additional illegal insider trading proceeds and the persons who had sold AGE and Syzygy to NetManage could sell off hundreds of thousands of their NetManage shares at inflated prices, rather than sue NetManage and its top executives -- as they had threatened to do, NetManage has reported horrible financial results -- plunging revenues and minimal EPS, followed by large losses. NetManage largely abandoned its existing TCP/IP product line, closed its Japan sales office and curtailed its other international operations, seen numerous top executives resign including Amaral, Peter Shaw (Senior Vice-President of Worldwide Marketing), Joseph L'Italien (Director of International Sales), Michelle A. Shannon (Director or Channel Sales and Marketing), Kurt Ziegler (Vice-President of Marketing), Robert Lawton (Vice-President of Emerging Technology), Carl W. Peede (Senior Vice-President of Worldwide Marketing after Peter Shaw), Charles Kimmel (Director of Worldwide Operations) and Robert Williams (Vice-President of Corporate Marketing and Business Development), fired more than 200 persons -- over 30% of its employees -- and was left struggling for survival -- an unsuccessful company, unable to achieve ongoing profitable growth. NetManage's stock price plunged to $7-5/8 by 7/96 and ultimately to $2-1/4 in 12/97, and has not recovered!
11. The charts below sets forth NetManage's inflated financial result during 95 and NetManage's substantial financial decline following the end of the Class Period:
NETMANAGE INC.
Quarterly Results
(in thousands, except EPS)
1994*
03/31 06/30 09/30 12/31 Year
Revenues $13,179 $13,849 $18,888 $25,550 $ 71,446
Net income 4,094 3,604 3,930 6,187 17,815
EPS $.10 $.09 $.09 $.15 $.43
1995*
03/31 06/30 09/30 12/31 Year
Revenues $26,936 $32,034 $35,250 $31,226 $125,446
Net income 5,345 6,121 7,561 3,270 22,297
EPS $.12 $.14 $.18 $.08 $.52
1996
03/31 06/30 09/30 12/31 Year
Revenues $33,022 $26,775 $25,426 $19,373 $104,596
Net income 5,020 1,635 241 783** 7,679**
EPS $.12 $.04 $.01 $.02** $.18**
1997
03/31 06/30 09/30 12/31 Year
Revenues $16,379 $12,701 $13,556 $18,888 $ 61,524
Net income (2,739) (4,548) (10,901)** 2,900 (15,288)**
EPS ($.06) ($.10) ($.25)** $.07** ($.34)**
* 1994 results and 1stQ to 3rdQ 95 results are restated to include results of AGE, which was accounted for under the "pooling of interests" method.
** Excluding estimated effects of charges for in process research and development.
12. The following graphs show the price of NetManage's stock during the Class Period with Defendants' insider sales and stock issuances and also that when compared to an index of similar software companies, the price action of NetManage shares was due to company-specific events and not to market forces.
3. Taking advantage of NetManage's inflated stock price during the Class Period, the Individual Defendants engaged in manipulative and deceptive devices in selling substantial amounts of their NetManage stock at inflated prices, profiting from their participation in the scheme:
DEFENDANT SHARES SOLD PROCEEDS
Alon 240,000 $4,727,225
Ben-Artzi 284,500 5,608,200
Bosch 9,667 172,846
Galil 92,500 1,892,100
Geisler 65,250 1,235,838
Koretz 186,182 3,496,959
Williams 37,400 694,350
TOTAL: 915,499 $17,733,767
In addition, NetManage "saved" at least 1.4 million shares in the AGE and Syzygy acquisitions by making those acquisitions by issuing NetManage stock when its price was artificially inflated to about $19-$20.
14. Jurisdiction exists pursuant to the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §78aa. Defendants used the instrumentalities of interstate commerce. The claims arise under §§10(b) and 20(a) of the 1934 Act and SEC Rule 10b-5 promulgated thereunder.
15. Venue is proper here pursuant to §27 of the 1934 Act. Many of the acts giving rise to the violations complained of occurred in this District.
16. (a) Walter W. Head, III purchased 70 shares of NetManage stock on 10/2/95 @ $24-1/2 per share.
(b) Gregory Selmanson purchased 300 shares of NetManage stock on 12/28/95 @ $23-3/4 per share.
(c) Dominic Castaldo purchased 2,000 shares of NetManage stock on 1/5/96 @ $16-1/4 per share.
(d) Leila Waldman purchased 500 shares of NetManage stock on 12/5/95 @ $31-3/8 per share.
(e) John Velonis, Jr. purchased 200 shares of NetManage stock on 12/5/95 @ $32-3/4 per share and 200 shares on 12/15/95 @ $23-1/2 per share.
(f) Each plaintiff suffered damage due to his or her stock purchase of NetManage stock.
17. NetManage, headquartered in Cupertino, CA, markets TCP/IP-based intranet applications and Internet connectivity software. During the Class Period, NetManage's stock traded in an efficient market on the NASDAQ National Market System.
18. (a) Zvi Alon founded NetManage and is its Chairman, President and CEO. As of 1/1/95, Alon owned 8.9 million shares of NetManage stock, 22% of its 40.9 million outstanding shares. Based on non-public information, Alon sold 240,000 shares of the NetManage stock he actually owned for $4.7 million in illegal insider trading proceeds during the Class Period.
(b) Walter Amaral was Senior Vice President, Finance and Chief Financial Officer ("CFO") of NetManage from 4/94 until he resigned in 8/97. During the Class Period, Amaral actually owned no NetManage stock and had no vested NetManage stock options and thus could not and did not sell NetManage stock.
(c) Uzia Galil has been a director of NetManage since 12/91 and a member of its Audit Committee. Galil is also the Chairman of Elron Electronic Industries, Ltd. ("Elron"), a company which owned 1.1 million shares of NetManage stock. Galil is the father-in-law of Alon. Based on non-public information, Galil sold 92,500 shares of the NetManage stock he actually owned for $1.9 million in illegal insider trading proceeds during the Class Period.
(d) John Bosch has been a director of NetManage since 12/91 and a member of its Audit Committee. Based on non-public information, Bosch sold 9,667 shares of the NetManage stock he actually owned for $172,846 in illegal insider trading proceeds during the Class Period.
(e) Amatzia Ben-Artzi has been Vice President, Business Development of NetManage since 9/92. Based on non-public information, Ben-Artzi sold 284,500 shares of the NetManage stock he actually owned for $5.6 million in illegal insider trading proceeds during the Class Period.
(f) Robert Williams was Vice President, Marketing of NetManage. Based on non-public information, Williams sold 37,400 shares of the NetManage stock he actually owned for $694,350 in illegal insider trading proceeds during the Class Period.
(g) Richard Koretz was Vice President, North American Sales of NetManage until mid-95 and remained an employee of NetManage with those responsibilities until 12/95. Based on non-public information, Koretz sold 186,182 shares of the NetManage stock he actually owned for $3.5 million in illegal insider trading proceeds during the Class Period.
(h) Dan Geisler was Vice President, International Marketing of NetManage after 2/95. He was Vice President, OEM and International Sales from 12/92 until 2/95. Based on non-public information, Geisler sold 65,250 shares of the NetManage stock he actually owned for $1.2 million in illegal insider trading proceeds during the Class Period.
19. Defendants Alon, Amaral and Galil, by reason of their positions as Chairman/CEO, director and CFO of NetManage, and director of NetManage, respectively, and their NetManage stock ownership, were controlling persons of NetManage and had the power and influence to cause NetManage to engage in the conduct complained of. NetManage controlled each of its officers and employees. These controlling persons are liable under §20(a) of the 1934 Act.
20. The Individual Defendants, because of their positions with NetManage and the small size of NetManage's Board and the small, tight-knit nature of NetManage's management team, were each involved in the drafting and preparation of NetManage's annual and quarterly reports, financial statements and press releases. Specifically, Alon, Amaral and Williams undertook the final preparation and review of corporate documents, such as press releases, based on information provided by, inter alia, the Individual Defendants. This collaborative process evidences Defendants' joint responsibility for the resulting statements. For example, statements attributed to Alon in the Company's 1/12/96 press releases were in fact written by Amaral. Each Defendant was also provided with copies of NetManage's financial statements, SEC reports and corporate public releases, alleged herein to be false or misleading, prior to their issuance and had the ability and opportunity to prevent their issuance or cause them to be corrected. Further, because of their respective positions and access to material, adverse, non-public information, each of these Defendants actually knew the positive statements being made were false or misleading when made and that the adverse facts specified herein were being concealed. The NetManage corporate statements pleaded at ¶¶46, 49, 53, 61-62, 64, 69-70, 77-78, 81, 83-85 and 96 were the result of Defendants' collective work and, as such, are "group-published" information, for which each defendant is legally responsible.
21. The Individual Defendants, because of their positions with NetManage, the very small size of NetManage's Board and the small nature of NetManage's management team, were each involved in the day-to-day management of NetManage's business. Alon, Amaral, Ben-Artzi, Williams, Koretz and Geisler were the top operating officers and managers of NetManage during the Class Period. They had constant contact with each other, as these individuals ran NetManage's business on a daily basis as "hands-on managers." They communicated with each other to discuss and deal with the most important issues facing NetManage's business, i.e., the impact of Win95 on NetManage's business, the features and capabilities of the Beta version of Win95 that had been provided to NetManage by Microsoft, the competing applications software from Netscape and its impact on NetManage's sales and marketing, the ongoing sales of NetManage's core products, especially its existing Chameleon suite of products and its Swift and ECCO products, NetManage's financial results, NetManage's attempted international expansion, its expanded domestic distribution channels to stimulate retail sales of its products and NetManage's attempt to expand and diversify its business away from dependence on Windows-compatible products, by way of acquisitions, using NetManage's stock.
22. Defendants Bosch and Galil were each directors and members of the Audit Committee of NetManage. Bosch and Galil were much more intimately and actively involved in the day-to-day management of NetManage than would ordinarily have been the case with outside directors. NetManage had a very small Board of Directors which consisted only of five persons, including Bosch, Galil and Alon. Thus, NetManage's Board was very small and operated as a cohesive group. In addition, because NetManage's business was small, these directors (Bosch and Galil) were in a position to and in fact did oversee NetManage's operations on an ongoing basis. As such, Bosch and Galil were intimately familiar with the details of the status of the new Win95 product and its impact on NetManage's business due to NetManage's receipt and analysis of Beta versions of Win95 in late 94 or early 95, the impact of Netscape's browser and applications software on NetManage's business, the status of demand for and sales of NetManage's Chameleon and ECCO products, NetManage's attempted international expansion and its new domestic distribution channels. As members of the Audit Committee, they also participated in the decision which was made to mis-account for the shipments of product to NetManage's distributors, resellers and certain end users, and NetManage's Japanese distributor, by having NetManage improperly recognize millions in revenue during 95, to generate inflated, phony net income and EPS.
23. Because of the importance of the price of NetManage's stock to the Individual Defendants, they each received daily reports on the trading in NetManage's stock. These "trading reports" also reported NetManage's domestic and international orders, revenue and average sales price on a daily, monthly, quarterly and year-to-date basis as compared to NetManage's 95 plan/budget.
24. Because of their top executive and Board positions with NetManage and involvement in the day-to-day management of its business, Defendants Alon, Amaral, Ben-Artzi, Williams, Koretz, Bosch, Galil and Geisler each actually knew the adverse non-public information about softening demand for the Company's products, including Ch ameleon and ECCO, the falsifying of NetManage's 2ndQ and 3rdQ 95 financial results, the adverse impact of Win95 and Netscape's software products on NetManage's business and NetManage's poor future revenue and EPS prospects from internal corporate documents, ¶¶23, 26-28, 31, and conversations with other corporate officers and employees and their attendance at weekly management and Board meetings.
25. Because vastly increased sales of NetManage's Chameleon and ECCO products, both internationally and domestically, at profitable prices was indispensable to NetManage meeting its internally budgeted and public 95, 96, 97 EPS forecasts, each of the Individual Defendants focused on and constantly monitored each of the key factors affecting NetManage's business.
26. In order to monitor NetManage's performance, NetManage's top executives received monthly financial reports, including internal corporate reports known variously as "Trading Reports," "Monthly Sales Analysis by Product and Time," "Monthly Sales Analysis by Revenues and Units," "Revenue Trend Analysis Reports," "Build Schedules" and "Domestic/International Resell Reports." NetManage's finance department prepared these reports under the guidance of Alon and Amaral. NetManage's executives also received and reviewed other written and oral reports from members of management, including Defendants Williams (Vice President/Marketing), Miller (Executive Vice President/Corporate Strategic Marketing) and Geisler (Vice President/OEM and International Sales). In order to effectively manage NetManage's business and monitor its revenues, NetManage's management information system and Telesales departments were capable of generating reports on a daily basis showing sales revenue and cost of goods sold by customer, product, office and order size, as well as overall corporate revenue, expenses, cash balances, etc. Through the Company's "Bookings Reports," which showed overall bookings by sales category (end user, reseller, OEM, channel), by office (domestic, Japan, Asia Pacific, United Kingdom, France, Germany, Israel), and by order size, Defendants closely monitored NetManage's sales revenues. For example, the "International Bookings Report" evidenced a marked downturn in Asian orders, and consequently sales revenues from those offices. Through this information system and review process, the Individual Defendants, who were NetManage's top managers, knew the corporation's daily performance and were thus aware, virtually immediately, of any significant problems with sales revenue or expenses associated with any NetManage product, customer or office.
27. NetManage's finance department also generated "Monthly Budget Reports" for the Company's "Corporate," "Retail Channel Sales," "Manufacturing" and "Marketing" functions which provided detailed data respecting overall corporate revenue, net income and EPS, as well as sales by product, customer and office -- all presented so as to compare performance for that month, that quarter and the year-to-date with the 95 plan/budget. The Monthly Budget Reports include a report prepared immediately after the monthly close and distributed to top management within 48 to 72 hours, which provides summary, sales, expense and income data. These reports also include a monthly financial statement package that provided even more detailed information, including graphic comparisons of actual performance to forecasted performance and a narrative explanation of material variances of actual results compared to forecasted or budgeted results, which is completed within 10 days after the monthly close and immediately provided to members of top management.
28. In order to try to manage NetManage's business, NetManage's top executives held a weekly staff meeting, run by Alon and Amaral and attended by NetManage's Vice Presidents including Ben-Artzi, Williams, Koretz and Geisler. At this weekly staff meeting these executives reviewed the current state of NetManage business, the problems confronting it and made "action items" and "to do lists" to confront these problems. The results of these meetings were reflected in an "ECCO file," and were reported to Bosch and Galil who also received the notes of the meetings via the "ECCO file."
29. At NetManage's weekly executive staff meetings each of the materially adverse facts impacting NetManage's business was discussed, including the weakening sales of Chameleon, the poor sales of ECCO, NetManage's weak international sales and continuing high expenses of NetManage's international expansion, the problems with NetManage's VARs, the inability by NetManage's Telesales group to successfully sell Chameleon in the increasingly competitive environment, the reaction of NetManage's Fortune 1000 customers to the proposed and actual introduction of Win95 and that this would hurt NetManage's Chameleon sales very badly, and NetManage's conduct in boosting its reported revenues and sales in the 2ndQ and 3rdQ 95 by shipping products to distributors and customers and recording revenue while, in fact, material contingencies and commitments of NetManage continued to exist which made revenue recognition improper.
30. NetManage desperately needed to generate additional revenue in the 2ndQ and 3rdQ of 95 in order to demonstrate to investors that its strong revenue and EPS growth was intact. However, demand for its core Chameleon products was softening and customer reaction to its ECCO products was lukewarm at best and therefore the rate of growth in revenue from those products was not sufficient to enable NetManage to achieve strong revenue and EPS growth. Worse yet, based on NetManage's analysis of the Beta version of Win95 in late 94 or early 95 and NetManage's insider discussions with major customers, Defendants knew that Win95 would hurt sales of NetManage's products. They were similarly aware of the negative impact Netscape's browser and applications software had on NetManage's product sales and marketing programs. Thus, in order to keep its apparent record of revenue and EPS growth intact until it could try to supplement its revenues and EPS by way of acquisition of other companies or the development of other products, NetManage's insiders decided to falsify NetManage's financial results as detailed in ¶¶99-109.
31. Over 70% of NetManage's sales were generated by its own in-house Telesales group who concentrated on selling Chameleon to Fortune 1000 companies. NetManage created daily reports on the sales generated by its in-house Telesales group (as well as weekly and monthly reports), and thus NetManage's top executives knew the status of NetManage's Chameleon sales -- which generated 90% of NetManage's revenues -- on a current basis.
32. While NetManage's Telesales group had been successful in selling NetManage's Chameleon product in 94 when competition was sparse and pricing was firm, by mid-95 NetManage's Telesales group was having a very difficult time selling Chameleon due to the emergence of competitive products and the emergence of Win95 which contained not only a TCP/IP embedded stack but application software as well. NetManage's Telesales group was comprised mostly by persons without technical training -- often ex or retired police officers -- who were not able to sell Chameleon successfully in this increasingly competitive environment beginning in mid-95.
33. NetManage also sold its Chameleon products through VARs who incorporated Chameleon into other custom designed products and resold them, mostly to Fortune 1000 companies. This accounted for 15-20% of NetManage's sales. However, NetManage made a deliberate practice of having its Telesales group target Fortune 1000 companies it knew its VARs had already solicited and were trying to sell to and to then offer "low ball" prices to them to undercut the VAR and get the sale for NetManage directly.
34. NetManage's practice of directly competing with its VARs made the VARs, including Egghead, Inc., Comp U.S.A. Stores, L.P., Computer City, Inc., Micro Warehouse, Inc., P.C. Connections and Ameritech Corp., furious and by 7/95 resulted in many VARs refusing to push NetManage's Chameleon products in favor of competing products which were hurting NetManage's sales growth.
35. NetManage's Board and top management were also focused on the impact of Win95 on NetManage's products. This was a matter of constant attention and frequent discussions among NetManage's corporate Board and top managers. As a result, these individuals were kept apprised of the current status of the development of Win95, including the features of the Beta versions of Win95 provided to NetManage by Microsoft and the reaction of NetManage's customer base to this product and the new TCP/IP features and applications software it would contain.
36. In addition to having actual knowledge of the falsity of their statements, each of the Defendants had the motive and the opportunity to perpetrate the fraudulent scheme and course of business described herein. Defendants' motive to engage in this misconduct included a desire to inflate the price of NetManage's stock to: (i) permit NetManage insiders to resume selling off large amounts of their NetManage stock but only at higher inflated prices to maximize their insider trading proceeds; (ii) cover up and conceal NetManage's deteriorating business and prospects to protect and enhance their executive positions and the substantial compensation and prestige they obtained thereby; and (iii) inflate the price of NetManage stock so NetManage could make needed acquisitions of other companies more cheaply and thereby reduce the number of shares necessary to effect such acquisitions. During the Class Period, while the Defendants were issuing false and misleading statements about NetManage, the NetManage insiders named as Defendants sold over 915,000 shares of their NetManage stock for proceeds of $17.7 million, thereby personally profiting from the artificial inflation in NetManage's stock price.
37. Also during 94-95, NetManage was operating in an industry in which smaller niche companies like NetManage were at a competitive disadvantage, and to survive, NetManage was attempting to grow rapidly and diversify NetManage's product base. Because NetManage wanted to conserve its cash to fund ongoing operations, it had to use stock for acquisitions, especially sizable acquisitions. However, the problem with using NetManage stock to pay for acquisitions was its poor performance, i.e., low price, during most of 94, when NetManage stock traded between $10-$13. This put tremendous pressure on NetManage's executives to present NetManage's business in a very favorable light to the investment community to inflate NetManage's stock to higher levels, thereby greatly increasing its value for use as consideration in acquisitions. A rising per-share price would not only induce stockholders of other companies (like AGE and Syzygy) to approve an acquisition by NetManage but also the higher NetManage's stock price rose, the fewer shares NetManage would have to issue to complete any such acquisition, making the acquisition much less dilutive to NetManage, and its EPS, but also benefiting controlling stockholder, Alon, who owned 22% of NetManage's outstanding stock, by reducing the number of shares of its stock NetManage needed time to issue to complete acquisition.
38. The AGE and Syzygy acquisitions were large for a company of NetManage's size. The Syzygy deal was worth $8.6 million and cost NetManage 444,000 shares. The AGE deal was worth $22 million and cost NetManage 1 million shares. These two acquisitions could have been very dilutive to NetManage's EPS and Alon's ownership position in NetManage if NetManage's stock were selling at lower per-share prices. By way of example, using a $10 per share price -- about the price NetManage's stock fell to at the end of the Class Period -- NetManage would have had to issue at least 3 million shares of its stock to complete these two acquisitions, which would have doubled the dilutive impact of the acquisition on NetManage and Alon.
39. Alon had a personal motive to make the acquisitions of Syzygy and AGE as non-dilutive as possible. He owned approximately 22% of NetManage's outstanding shares. Had NetManage stock been selling for lower prices at the time of the Syzygy and AGE acquisitions, Alon's ownership percentage would have been cut much more than it was. Instead, because NetManage's stock was artificially inflated, Alon was able to avoid material dilution of his 22% ownership position of NetManage as a result of these acquisitions -- retaining control of "his" Company.
40. Each of the Defendants is liable as a primary violator, for making false and misleading statements and for engaging in deceptive and manipulative acts in selling NetManage stock without disclosing the adverse information they knew while participating in a fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of NetManage stock during the Class Period. All of the Defendants pursued a fraudulent scheme and course of business to inflate NetManage stock by making false and misleading statements and concealing material adverse information. The fraudulent scheme and course of business was designed to and did: (i) deceive the investing public, including plaintiffs and other Class members; (ii) artificially inflate the price of NetManage stock during the Class Period; (iii) cause plaintiffs and other members of the Class to purchase NetManage stock at inflated prices; and (iv) increase the value of options to purchase NetManage stock owned by certain of the Defendants, as well as their own NetManage shareholdings and permit them to sell off their holdings at artificially inflated levels to profit from the scheme.
41. Defendants' fraudulent scheme was very successful -- for them. By artificially inflating NetManage's stock, they were able to acquire Syzygy and AGE for far fewer shares -- about 50% fewer -- than would have been necessary had NetManage's stock sold at its true value. Also, the NetManage insiders named as Defendants sold 915,499 shares of NetManage stock for over $17.7 million in illegal insider-trading proceeds -- more than twice what they would have received had they sold their stock after the stock plummeted to $10, or before they reinflated the stock from its low of $13 before the beginning of the Class Period.
42. Between 5/25/95-5/31/95, NetManage stock declined sharply to as low as $13, due, in part, to investors' concerns (i) over NetManage's 1stQ 95 results -- which had reported lower EPS than NetManage's 4thQ 94 EPS, which investors feared meant NetManage's rapid growth rate was slowing and could not be maintained; and (ii) that the upcoming 95 release of Microsoft's Win95 would contain features and capabilities that would supplant NetManage's products and hurt NetManage's sales and EPS growth.
43. In the months prior to the Class Period, Defendants had been selling off their shares to take advantage of the huge upsurge in NetManage stock in late 12/94. However, Defendants ceased their insider selling as NetManage stock plunged on 5/25/95, falling to $13 by 5/31/95. The Individual Defendants wanted to continue their insider "bail-out," but only at much higher per share prices. Defendants were also desperately trying to grow NetManage while diversifying its product base. However, the only way NetManage could do this quickly was by making acquisitions of other companies by using NetManage's stock. To limit the number of shares issued in acquisitions and thus reduce the dilutive impact of any acquisition, Defendants wanted to re-inflate NetManage's stock back up to a much higher level.
44. Then in 5/95, NetManage learned that several large mutual fund shareholders of NetManage were going to sell off large blocks of NetManage shares, which would place even greater pressure on NetManage stock. In late 5/95, several large funds, including Putman Investments, did unload their NetManage shares causing NetManage stock volume to explode to over one million shares per day, compared to average daily volume of about 300,000 shares, as NetManage stock fell to just $13. NetManage was so concerned over trying to keep its stock price up that it even helped find buyers for the stock -- including the large Putman block -- with Amaral stating: "I'm fortunate they were able to find a buyer."
45. In order to halt the decline of NetManage stock and push it back up to higher, artificially inflated levels, Defendants commenced a public relations campaign of positive announcements.
46. On 6/20/95, NetManage issued several announcements about a new sales and marketing channel program and product upgrades. These releases were very significant, as they indicated that NetManage was going to broaden significantly its product distribution beyond direct sales to corporate accounts to include the retail markets, which would increase its sales. One 6/20/95 release was headlined and stated:
NETMANAGE LAUNCHES NEW CHANNEL SALES & MARKETING DIRECTIONS TO PROVIDE GLOBAL INFORMATION ACCESS . . . .
NetManage, the leader in TCP/IP applications for Windows, announced today . . . the company's sales and marketing channel program . . . .
The availability of NetManage's products through the channel is part of the company's aggressive effort to provide end-users with manageable and integrated working environments and successful support programs. . . .
"With the growth of the company and the phenomenon of the Internet as a business tool, business professionals are requiring that our products be available through the channel," said Zvi Alon, President and CEO of NetManage.
* * *
Nationwide channel partners that have signed up with NetManage to distribute Internet Chameleon and ECCO include Ingram Micro and Merisel effective immediately.
A second 6/20/95 release stated:
NetManage, the leader in TCP/IP applications for Windows, today announced a major new release of Internet Chameleon designed for the mobile professional who requires high-performance Internet tools for doing business on the Internet. . . . Significant to the release of Internet Chameleon is the product's availability via key NetManage partners that were named in a separate announcement made today. . . . "We are excited that our channel partners are working with us to bring NetManage's latest Internet technology to the street as fast as we release it," said Zvi Alon, President and CEO of NetManage.
A third 6/20/95 NetManage release was headlined and stated:
NETMANAGE AND INGRAM MICRO SIGN CONTRACT TO DELIVER GLOBAL INFORMATION ACCESS SALES AND MARKETING PROGRAMS TO THE CHANNEL
NetManage, the leader in TCP/IP applications for Windows, announced today NetManage and Ingram Micro Inc. signed a contract to bring the most robust Internet application products and well-rounded channel programs to the market today.
* * *
"NetManage is excited about Ingram Micro distributing our Internet products and know this relationship will be successful based on NetManage's success in developing award winning customer driven Internet products and Ingram Micro's leadership in selling to the reseller channel.
47. On 6/20/95, Alon spoke with Robertson Stephens analyst Powers about these new developments. On 6/21/95, Robertson Stephens issued a report on NetManage, written by Powers, which repeated the information given him by Alon. The report stated:
* * *
48. The 7/3/95 edition of Computer Retail Week contained an article about NetManage. The article was headlined and stated:
NETMANAGE TO ENTER RETAIL CHANNEL THIS MONTH
NetManage . . . plans to enter the retail channel on July 5 with consumer versions of its Internet Chameleon and ECCO Pro 3.0.
The company has also recently added to its distributor base, which includes Merisel, with the signing this month of an agreement with Ingram Micro.
NetManage's foray into the retail channel is being supported by intensive in-store publicity and several promotions . . . . "For the first three months of the promotion, we will have a special pricing in place. The titles will be selling at a much-discounted point to the end user and the reps," said Michelle Shannon, NetManage's director of channel sales and marketing.
49. On 7/11/95, NetManage announced a new TCP/IP product which would be compatible with the Apple Macintosh product line. The release was headlined and stated:
NETMANAGE TO BRING WINSOCK TO APPLE COMPUTER'S OPEN TRANSPORT
Apple Computer, Inc. today welcomed the leading Windows TCP/IP developer -- NetManage Inc. to the Macintosh platform, in conjunction with the announcement by NetManage of its intent to bring the Window Sockets 1.1 APIs to the Mac OS.
WinSock has emerged as the Application Programming Interface (API) of choice for accessing TCP/IP services on personal computers running the Windows environment. . . . [W]ith Window Sockets APIs, this proposed new developer tool will enable cross platform programming between the Mac OS and Windows, Windows/NT and Windows '95.
* * *
Zvi Alon, President and CEO of NetManage commented, "We are pleased to bring our TCP/IP developer tools to the Mac OS. With our proven track record on the Windows platform and Apple's support, we believe Windows developers with applications built on WinSock 1.0/1.1 will now more easily be able to port to the Mac OS, and take advantage of Open Transport/TCP."
* * *
NetManage Inc. is the leading supplier of TCP/IP applications for Windows.
50. On 7/12/95, Oppenheimer issued a report on NetManage, written by Yuen, which was based on and repeated information given him by Alon and Amaral. The report forecast 95 and 96 EPS of $.68 and $1.00, respectively, with the following 95 and 96 quarterly EPS for NetManage:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14A $.16E $.17E $.21E $.68E
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.21E $.24E $.26E $.29E $1.00E
The report also stated:
NetManage is well-positioned to benefit from the growing acceptance to TCP/IP . . . [which is] growing in use and should be nearly ubiquitous once Windows 95 begins shipping.
Fears over the potential impact from Microsoft's decision to include a TCP/IP protocol stack in the Windows 95 operating system have been greatly overdone . . . . While Microsoft's move poses an acute threat to NetManage's TCP/IP protocol stack sales, this area only constitutes roughly 5% of the company's business. Furthermore, we feel that the Windows 95 inclusion of TCP/IP may actually benefit NetManage, in that it helps speed the deployment of this standard protocol which NetManage's core applications utilize.
51. On 7/12/95, Robertson Stephens issued a report on NetManage, written by Powers, which was based on and repeated information given him by Alon and Amaral. The report forecast a three-year secular growth rate of 50% and the following 95 and 96 EPS for NetManage:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14A $.17 $.18 $.20 $.70
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.22 $.24 $.26 $.28 $1.00
The report also stated:
Yesterday, NetManage announced support of the Apple Macintosh operating system by creating developer tools which are compliant with WinSock, the de facto applications programming interface standard for TCP/IP on Windows PC's. Thus, the job of porting PC communications applications to the Macintosh will be dramatically simplified.
* * *
We believe that NetManage will follow this tools announcement with an announcement of a "Macintosh Chameleon" suite of networking applications. We think that this announcement, which we expect before year end, would be positive for a number of reasons:
The announcement of a Mac version would expand NETM's served available market.
NETM's competitive position in mixed Mac and Windows enterprises will be strengthened.
And finally, NETM's strategy of providing a networking environment for the home Internet user that is the same as the office environment will be enhanced, since many PC users are Windows in the office and Macintosh at home.
52. By 7/95, Alon and Amaral were telling securities analysts, including Powers of Robertson Stephens and Yuen of Oppenheimer that because of the success of NetManage's enhanced Chameleon product and its new ECCO product, its growing overseas sales and its enhanced domestic distribution channels, NetManage would earn $.68-$.70 in 95 and $1.00 in 96, with the following quarterly EPS:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14A $.16-17 $.17-.18 $.19-.20 $.68.70
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.21 $.24 $.26 $.79 $1.00
By late 7/95, Defendants had re-inflated NetManage stock back up to $18-$19, just as NetManage was to report its much anticipated 2ndQ 95 results, ended on 6/30/95, which results would allow investors to determine if NetManage had been able to regain its rapid revenue and EPS growth after the disappointing 1stQ 95.
53. On 7/25/95, NetManage announced its 2ndQ 95 results -- strong increases over the 1stQ95 -- revenues of $30.2 million, net income of $6.8 million and EPS of $.16, in line with what it had been forecasting to analysts. The release also stated:
"We are pleased with NetManage's financial performance during this quarter and our continued success in expanding our sales and support capabilities to include a new domestic channel program and the opening of our Tokyo based office," said Zvi Alon, President and CEO of NetManage.
54. On 7/25/95, NetManage held a conference call for analysts, money and portfolio managers, institutional investors and large NetManage shareholders. During the call, Alon (the CEO) and Amaral (the CFO) made presentations and answered questions. During the call -- and in follow-up conversations with participants, including analysts Yuen (Oppenheimer), Prince (Smith Barney) and Powers (Robertson Stephens) on 7/25-26/95 -- Alon and Amaral disseminated information to the market by stating:
55. On 7/25/95, Oppenheimer issued a report on NetManage, written by Yuen, which repeated information given Yuen in the conference call and follow-up conversations with Alon and/or Amaral on 7/25/95. The report forecast 95 and 96 EPS for NetManage:
1stQ 2ndQ 3rdQ 4thQ Year
1995 $.14A $.16E $.17E $.21E $.68E
1stQ 2ndQ 3rdQ 4thQ Year
1996 $.21E $.24E $.26E $.29E $1.00E
The report also stated:
56. On 8/15/95, The Reuter Business Report published a story about the impact of Microsoft's Win95 operating system on software firms. Alon was quoted as stating that the release of Win95 incorporating TCP/IP is a "`great advantage for NetManage because it is a huge endorsement of what we have been pushing for a long time.'"
57. On 8/17/95, Smith Barney issued a report on NetManage, written by Prince, initiating coverage on NetManage. Because this was Prince's first report on NetManage, he interviewed Alon and Amaral in depth about NetManage to get the information from them which he used to write the report. Alon and Amaral were the source of the information in this report and they reviewed it before it was issued and assured Prince the report was accurate. The report forecast a five-year EPS growth rate of 40%-50% and the following 95 and 96 EPS for NetManage:
1stQ 2ndQ 3rdQ 4thQ Year
1995 $.14A $.16A $.17E $.23E $.70E
1stQ 2ndQ 3rdQ 4thQ Year
1996 $.22E $.24E $.26E $.32E $1.05E
The report also stated:
As the market moves to an ever wider adoption of TCP/IP, as evidenced by Microsoft Corp.'s decision to include the communications protocol in Windows NT, Windows for Workgroups and Windows 95, the opportunity to sell TCP/ IP-enabled applications will be huge. NetManage has been positioning itself to be the leading supplier of TCP/IP-enabled applications while conceding the distribution of the protocol to the operating system vendors such as Microsoft. NetManage already ships more than 40 applications in the box with its Chameleon TCP/IP solution and will continue to increase that number over time. We expect NetManage to have one of the richest product offerings supporting TCP/IP among software vendors.
* * *
NetManage has been expanding its distribution to include more retail oriented markets primarily for its Internet Chameleon and its ECCO personal information manager products. We expect the company to add products to this channel while not compromising its high margin telesales and major account business. With the upcoming release of Windows 95, the TCP/IP protocol is positioned to increasingly become a retail product. We believe that the investments that NetManage has made in international infrastructure are only beginning to pay off. We expect the international markets in Europe and the Far East to exhibit very strong growth over the next few years. With the company essentially finished with adding new offices, the sequential growth in sales and marketing expenses will start to slow. Accordingly, we believe that there will be a reversal in operating margin trends back to the mid 30% range by the end of 1996. . . .
In addition, NetManage's shares have been impacted in the past from fears that Microsoft will be entering the market with the release of Windows 95. We also feel that investors should consider the possibility that Microsoft will become a threat sometime in the future; but, for now, Microsoft is not a competitive concern.
58. Each of the positive statements about NetManage's business during 7/25/95-8/17/95, as set forth in ¶¶53-57, were false and also misleading in failing to disclose the following true facts:
(a) Sales of NetManage's Chameleon and ECCO products were below NetManage's internal expectations, derived from the 95 plan/budget, because of weaker than anticipated demand and lower than expected price levels, due to intensive price competition which was adversely impacting NetManage's profitability;
(b) NetManage's direct Telesales group was inadequately trained in TCP/IP interconnectivity technology and was not able to successfully sell NetManage's Chameleon products in the increasing competitive environment that emerged in mid-95;
(c) Several of NetManage's VARs were downplaying NetManage's Chameleon products in favor of competing products -- or even refusing to sell Chameleon at all -- in retaliation again NetManage's practice of having its Telesales group directly compete with the VARs by targeting Fortune 1000 companies that NetManage knew had already been approached by or solicited by VARs;
(d) NetManage had learned from internal management discussions and discussions with its corporate account managers that the introduction of Win95 with its own embedded TCP/IP protocol and the rapid acceptance and popularity of Netscape's browser and software applications would adversely impact market demand for and acceptance of NetManage's products, thereby reducing NetManage's future EPS growth;
(e) NetManage falsified its 2ndQ 95 results by recognizing revenues in the 2ndQ 95 in violation of GAAP on shipments to distributors, resellers and certain corporate customers which were contingent on resale or contained other contingent terms, such as customization requirements, new version upgrade provisions, etc., as detailed at ¶¶99-109;
(f) NetManage falsified its 2ndQ 95 results by recognizing revenues in the 2ndQ 95 in violation of GAAP on shipments to distributors and resellers where NetManage had no reasonable basis to estimate future returns, particularly with respect to new and newly upgraded products, which NetManage had only recently begun shipping, as detailed at ¶¶99-109;
(g) NetManage falsified its 2ndQ 95 results by recognizing revenues in the 2ndQ 95 in violation of GAAP on shipments to distributors, resellers and certain end user customers without adequately providing a reserve for returns or price protection that could reasonably be expected in connection with those sales, as detailed at ¶¶99-109;
(h) Defendants knew that by the end of the 2ndQ 95 there was already an excess of NetManage's products in the reseller and distribution channels, that NetManage was competing directly with its reseller and distribution sales channels and that sales recorded in the 2ndQ 95 were improper and contingent on resale or other contingencies occurring;
(i) Future demand for many of NetManage's products would be hurt by the excess levels of product already held by distributors, who had accepted delivery of more product than they expected to or could sell because NetManage agreed that they could return the product if it could not be sold;
(j) NetManage's international expansion was a failure which was severely hurting NetManage's profit margins, as NetManage was incurring large expenses to establish and support foreign sales offices (including Japan) to create large foreign production, but was achieving very slow sales there, thus resulting in losses from its international operations;
(k) NetManage's Japan sales office was a complete failure and virtually all the "sales" recorded as revenue on shipments to and from NetManage's Japan sales office were phony, as delivery was not even made at the time NetManage recognized the revenue and because those customers had been promised by NetManage that they could return the product or exchange it if they did not sell that product;
(l) The substantial price discounts provided on Chameleon and ECCO products that were shipped to NetManage's distributors and resellers were not temporary and were not just for three months but rather were permanent price cuts due to competitive pressures; and
(m) Defendants knew that their forecasts of strong EPS growth to $.68-$.71 in 95 and $1.00-$1.05 per share in 96, respectively, as well as for 30%-50% secular 3-5 year EPS growth, were false as the above adverse facts and conditions contradicted these projections and made it impossible for NetManage to achieve them.
59. It was also misleading to describe NetManage as the "leader in TCP/IP software applications" during this time period. There were several other companies that provided TCP/IP software applications products which were at least as good as NetManage's products and provided equal or better price/performance, including Attachmate, Hummingbird, Wall Data and FTP Software. Also, Win95 not only used TCP/IP technology and had a TCP/IP interface, but also contained several applications which performed many of the functions of NetManage's Chameleon and ECCO products for free. Thus, no one company, and certainly not NetManage was the "leader" in TCP/IP software applications. It was also false to describe NetManage as the "fastest growing software company" as, in fact, Intuit, 3DO, Avant!, Platinum Technology, Quarterdeck, Geoworks, Security Dynamics, PeopleSoft, Avid Technology, Business Objects, Parametric Technology, Remedy, Mercury Interactive, Media 100 and WonderWare were faster-growing software companies, even accepting NetManage's reported 94-95 to date revenues and EPS as reported as accurate. It was misleading to describe NetManage as the "fastest-growing software company," as NetManage's purported fast growth, at least during the Class Period, was being achieved by falsifying its revenues and EPS to make its growth look much better than it really was, and Defendants knew that NetManage's growth was actually slowing dramatically, due to the diminished demand for and slowing sales of its Chameleon and ECCO products and the introduction and success of Win95 with TCP/IP applications and Netscape's browser and applications software
60. As NetManage's stock moved higher, the Individual Defendants resumed their insider bailout, as the stock was now at a sufficiently artificially inflated level to assure them the level of insider trading profits on their sales they wanted to get. In 8/95, Win95 was formally introduced. Between 7/27/95-9/1/95, the Individual Defendants sold off about 592,500 of their NetManage shares for over $10.7 million in illegal insider trading proceeds.
61. On 9/19/95, NetManage issued a release stating:
NETMANAGE REVOLUTIONIZES THE CORPORATE INTERNET WITH CHAMELEON ENTERPRISE; THE INDUSTRY'S FIRST FRONT OFFICE AND BACK OFFICE INTERNET SOLUTION
NetManage Inc., the leader in TCP/IP for Windows applications, introduced today Chameleon Enterprise, a set of three core technologies that revolutionizes the way people in corporate environments utilize their internal network.
* * *
Chameleon Enterprise debuts in the latest releases of the Chameleon product family for Windows, Windows 95 and Windows NT.
"Chameleon Enterprise allows corporations to address the growing trend of using Internet technology to facilitate communication, sharing and collaboration. Web and Internet technology has evolved to be a platform for internal business solutions. With Chameleon Enterprise, NetManage is introducing a strategy and a set of products that will make the Web and the Internet a fundamental component of corporate workgroup computing strategies," said Zvi Alon, President and CEO of NetManage.
* * *
NetManage Inc., the fastest-growing software company in the United States . . . .
62. On 9/22/95, NetManage issued a release that again represented that NetManage was "the leader in TCP/IP applications for Windows" and "the fastest growing software company in the United States."
63. On 10/6/95, Smith Barney issued a report on NetManage, written by Prince. This report was based on and repeated information provided Prince by Alon and/or Amaral in communications shortly prior to 10/6/95. Alon and Amaral reviewed this report before it was issued and assured Prince it as correct. The report forecast a 5-year EPS growth rate of 40% and the following 95 and 96 EPS for NetManage:
1stQ 2ndQ 3rdQ 4thQ Year
1995 EPS $.14A $.16A $.17E $.23E $.70E
1stQ 2ndQ 3rdQ 4thQ Year
1996 EPS $.22E $.24E $.26E $.32E $1.05E
The report also stated:
We believe that the recent weakness in NetManage's stock over the past week represents an excellent buying opportunity. Short and long term growth prospects for the company remain strong, for both the Windows-based TCP/IP products as well as for the new ECCO product in the retail channel. We have spoken with company management and nothing has changed, from their perspective, to explain the recent price decline.
64. On 10/18/95, NetManage issued a release announcing its acquisition of Syzygy for 440,000 shares of NetManage stock. The release stated:
NetManage, the leader in TCP/IP applications for Windows, announced today that it has acquired Syzygy Communications, Inc. . . .
* * *
NetManage Inc., the fastest growing public software company in the United States . . . .
65. On 10/18/95, subsequent to the announcement of the Syzygy acquisition, Alon and Amaral spoke to analysts, including Yuen (Oppenheimer), Powers (Robertson Stephens) and Prince (Smith Barney), to discuss NetManage's business and its prospects. During these conversations, Alon and Amaral disseminated information to the market by stating:
66. On 10/18/95, Oppenheimer issued a report on NetManage, written by Yuen. This report was based on and repeated information provided Yuen by Alon and/or Amaral in conversations on 10/18/95. The report forecast the same quarterly and annual 95 and 96 EPS as the 7/27/95 Oppenheimer report and stated:
The introduction of Windows 95 did not have the material negative impact on the TCP/IP applications market that many had feared. In fact, the TCP/IP applications business for NETM, as well as its competitors, remains strong. Expansion costs for the company's international sales offices should start to decrease this quarter, which should lead the operating margins to begin trending upwards.
67. On 10/18/95, Robertson Stephens issued a report on NetManage, written by Powers. This report was based on and repeated information provided Powers by Alon and/or Amaral in conversations on 10/18/95. The report forecast a 3-year secular growth rate of 50% and the following 95-96 EPS for NetManage:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14 $.17 $.17 $.19 $.67
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.19 $.25 $.26 $.30 $1.00
68. On 10/19/95, Smith Barney, issued a new report on NetManage, written by Prince, forecasting a 5-year EPS growth rate 40%, 3rdQ and 4thQ 95 EPS of $.17 and $.23 and 95 and 96 EPS of $.70 and $1.05, respectively for NetManage. This report was based on and repeated information provided Prince of Smith Barney by Alon and/or Amaral in communications on 10/18/95.
69. On 10/23/95, NetManage issued a release again representing that NetManage was "the leader in TCP/IP Applications for Windows" and "the fastest growing public software company in the United States."
70. On 10/24/95, NetManage reported better than expected 3rdQ 95 results -- revenues of $32.7 million, net income of $7.4 million and EPS of $.18. The release stated:
"We are very pleased that our investment in expanded products and services has enabled NetManage to continue with positive growth," said Zvi Alon, President and CEO of NetManage. "We have continued our leadership in TCP/IP applications for Windows by shipping our third generation version for Windows NT. . . . We have also strengthened our strategic relationship with Microsoft by jointly announcing a set of programming interfaces for Internet security."
NetManage, Inc., the fastest growing public software company in the United States . . . .
71. On 10/24/95, NetManage held a conference call for analysts, money and portfolio managers, institutional investors and large NetManage shareholders. During the call -- and in follow-up conversations with participants (including Prince of Smith Barney, Yuen of Oppenheimer and Powers of Robertson Stephens) -- Alon and Amaral disseminated information to the market by stating:
72. On 10/25/95, Oppenheimer issued a report on NetManage, written by Yuen, which was based on and repeated information provided Yuen in the 10/24/95 conference call and a follow-up conversation with Alon and/or Amaral on 10/24/95. The report forecast the following 94 and 96 EPS for NetManage:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14A $.16A $.18A $.21E $.68E
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.21E $.24E $.26E $.29E $1.00E
The report also stated:
The company noted that its business continues to be robust, and with healthy industry demand for internetworking software applications and the company's market position remaining strong, we expect the trend to continue.
* * *
Importantly, we believe this quarter's strong results indicate that the introduction of Windows 95 has not had the detrimental effect on the TCP/IP communications software market (either by diminishing the need for such communications software or, to a smaller degree, creating purchasing delays) that many in the investment community had feared.
Margins for Q3 were in line with expectations. Gross margins of 90.4% bounced back from last quarter's 89.1% level, which were impacted slightly by the cost of upgrading users to the new version of Chameleon. Going forward, we expect gross margins to be in the 88%-90% range. . . .
Going forward, we expect operating margins to continue rising as the international expansion costs begin to taper down and as the company further leverages its resources. For the fourth quarter 1995, we are looking for operating margins of 34.2%, resulting in full 1995 operating margins of 32.6%. For 1996, we are estimating operating margins to grow to 34.6%.
73. On 10/25/95, Robertson Stephens issued a report on NetManage, written by Powers, which was based on and repeated information provided Powers in the 10/24/95 conference call and a follow-up conversation with Alon and/or Amaral on 10/24/95. The report forecast a 40% 3-year secular growth rate for NetManage and the following 95 and 96 EPS for NetManage:
1995 1stQ 2ndQ 3rdQ 4thQ Year
$.14 $.17 $.18 $.19 $.68
1996 1stQ 2ndQ 3rdQ 4thQ Year
$.19 $.25 $.27 $.30 $1.01
The release also stated:
* * *
NetManage continues its leadership position in a rich market opportunity of internetworking software for the enterprise. We expect significant players in this complex and evolving market to grow their capabilities and market opportunities, as NetManage has, through both internal development, acquisition and partnerships. In recently announced partnerships with Microsoft, Cylink, NetCom, and PSI, NetManage continues to strengthen its position as a premier internetworking software provider.
74. On 10/31/95, Smith Barney issued a report on NetManage, written by Prince, which was based on and repeated information provided Prince in the 10/24/95 conference call and follow-up conversations with Alon and/or Amaral on 10/25/95. The report forecast a 5-year EPS growth rate of 40% and the following 95, 96 and 97 EPS for NetManage:
1stQ 2ndQ 3rdQ 4thQ Year
1995 $.14A $.16A $.18A $.23E $.71E
1stQ 2ndQ 3rdQ 4thQ Year
1996 $.22E $.24E $.26E $.32E $1.05E
1stQ 2ndQ 3rdQ 4thQ Year
1997 $.30E $.36E $.39E $.45E $1.50E
The report also stated:
EPS were . . . slightly ahead of our (and Street consensus) estimate of . . . . Operating margins improved from 2Q95, earlier and better than we anticipated. After expanding its international facilities over the last four quarters, NetManage has begun to reap its benefits: International sales grew at more than twice the rate of domestic sales, and have come to represent 30% of total sales vs. 21% in 1994. NetManage also has begun to roll out a new generation of its Chameleon product as part of its new enterprise strategy. Looking forward, we remain confident with regard to our 4Q95 estimates and beyond. . . .
* * *
Product Breakdown: . . . We are seeing the direct benefit of new product introductions, although no new product accounts for 10% of total sales at this point. The rising star, in our opinion, among NETM's new products is the ECCO personal information manager product line, which we estimate contributed $2 million in revenues for the quarter. Investors should note that this is the first full quarter that ECCO 3.0 has been selling through the retail channel. There seems to be strong consumer demand for ECCO -- management indicated that inventory in the channel remains at low levels.
* * *
Balance Sheet: NetManage's balance sheet continues to strengthen. . . . The growth in accounts receivable primarily relates to the delay in shipping Japanese versions of Chameleon from August to September because the company ran out of inventory. Days Sales Outstanding (DSO), as a result, reached 58 compared with 50 in 2Q95. We expect some improvement in the 4Q95.
75. Each of the positive statements about NetManage's business during 9/19/95-10/31/95, as set forth in ¶¶61-74, were false and also misleading as they failed to disclose, inter alia, the following true facts:
(a) Sales of NetManage's Chameleon and ECCO products were below NetManage's internal expectations, derived from the 95 plan/budget, because of weaker than anticipated demand and lower than expected price levels, due to intensive price competition which was adversely impacting NetManage's profitability;
(b) NetManage's direct Telesales group was inadequately trained in TCP/IP interconnectivity technology and was not able to successfully sell NetManage's Chameleon products in the increasingly competitive environment that emerged in mid-95;
(c) Several of NetManage's VARs were deemphasizing and even refusing to sell NetManage's Chameleon products in favor of competing products -- in retaliation again of NetManage's practice of having its Telesales group directly compete with the VARs by targeting Fortune 1000 companies that NetManage had learned had been approached by or solicited by VARs;
(d) NetManage had learned from internal management discussions and discussions with its corporate account managers that the introduction of Win95 with its own embedded TCP/IP protocol and the rapid acceptance and popularity of Netscape's browser and software applications had adversely and materially reduced market demand for and acceptance of NetManage's products, and was having a very negative impact on NetManage's EPS;
(e) NetManage falsified its 3rdQ 95 results by recognizing revenues in the 3rdQ 95 in violation of GAAP on shipments to distributors, resellers and certain corporate customers which were contingent on resale or contained other contingent terms, such as customization requirements, new version upgrade provisions, etc., as detailed at ¶¶99-109;
(f) NetManage falsified its 3rdQ 95 results by recognizing revenues in the 3rdQ 95 in violation of GAAP on shipments to distributors and resellers where NetManage had no reasonable basis to estimate future returns, particularly with respect to new and newly upgraded products, which NetManage had only recently begun shipping, as detailed at ¶¶99-109;
(g) NetManage falsified its 3rdQ 95 results by recognizing revenues in the 3rdQ 95 in violation of GAAP on shipments to distributors, resellers and certain end user customers without adequately providing a reserve for returns or price protection that could reasonably be expected in connection with those sales, as detailed at ¶¶99-109;
(h) Defendants knew that by the end of the 3rdQ 95 there was already an excess of NetManage's products in the reseller and distribution channels, that NetManage was competing directly with its reseller and distribution sales channels and that sales recorded in the 3rdQ 95 were improper and contingent on resale or other contingencies occurring;
(i) The reason NetManage's DSOs had increased was due to poor sales of its products in the domestic channel and internationally and reflected NetManage's granting extended payment terms to distributors to try to move product and because, at least with respect to certain Japanese customers, NetManage had not even shipped the product to the customers as of 9/30/95;
(j) Future demand for many of NetManage's products would be hurt by the excess levels of product already held by distributors, who had accepted delivery of more product than they expected to or could sell because NetManage agreed that they could return the product if it could not be sold;
(k) NetManage's international expansion was a failure which was severely hurting NetManage's profit margins, as NetManage was incurring large expenses to establish and support foreign sales offices (including Japan) to create large foreign production, but was achieving very slow sales there, thus resulting in losses from its international operations;
(l) NetManage's Japan sales office was a complete failure and virtually all the "sales" recorded as revenue on shipments to and from NetManage's Japan sales office were phony, as delivery was not even made at the time NetManage recognized the revenue and because those customers had been promised by NetManage that they could return the product or exchange it if they did not sell that product;
(m) The substantial price discounts provided on Chameleon and ECCO products that were shipped to NetManage's distributors and resellers were not temporary and were not just for three months but rather were permanent price cuts due to competitive pressures; and
(n) Defendants knew that their forecasts of strong EPS growth to $.68-$.71 in 95 and $1.00-$1.05 per share in 96, respectively, as well as for 30%-50% 3-5 secular year EPS growth, were false as the above adverse facts and conditions contradicted these projections and made it impossible for NetManage to achieve them.
76. It was also misleading to describe NetManage as the "leader in TCP/IP software applications" during this time period. There were several other companies that provided TCP/IP software applications products which were at least as good as NetM anage's products and provided equal or better price/performance, including Attachmate, Hummingbird, Wall Data and FTP Software. Also, Win95 not only used TCP/IP technology and had a TCP/IP interface, but also contained several applications which performed many of the functions of NetManage's Chameleon and ECCO products for free. Thus, no one company, and certainly not NetManage was the "leader" in TCP/IP software applications. It was misleading to describe NetManage as the "fastest growing software company," as NetManage's purported fast growth, at least during the Class Period, was being achieved by falsifying its revenues and EPS to make its growth look much better than it really was, and Defendants knew that NetManage's growth was actually slowing dramatically, due to the diminished demand for and slowing sales of its Chameleon and ECCO products and the introduction and success of Win95 with TCP/IP applications and Netscape's browser and applications software.
77. On 10/30/95, 11/6/95 and 11/14/95, NetManage issued releases representing that NetManage was "the leader in TCP/IP applications for Windows and Internet Productivity software" and "the fastest growing public software company in the United States."
78. On 11/20/95, NetManage announced it was acquiring AGE Logic for NetManage stock. The release stated:
NetManage, Inc., the leader in TCP/IP for Windows applications and Internet connectivity software, announced today that it has signed a definitive agreement to acquire AGE Logic, Inc. of San Diego, Calif.
* * *
NetManage, Inc., the fastest growing public software company in the United States . . . .
79. On 11/20/95, subsequent to the announcement of the AGE acquisition, Alon and Amaral spoke to securities analysts, including Yuen (Oppenheimer), Powers (Robertson Stephens) and Prince (Smith Barney), to discuss NetManage's business and its prospects. During these conversations, Alon and Amaral disseminated information to the market by stating:
80. On 11/20/95, Smith Barney issued a report on NetManage, written by Prince, which was based on and repeated information given Prince by Alon and Amaral on 11/20/95 in conversations with Prince. The report forecast the following 95-97 EPS for NetManage:
1stQ 2ndQ 3rdQ 4thQ Year
1995 EPS $.14A $.16A $.18A $.23E $.71E
1stQ 2ndQ 3rdQ 4thQ Year
1996 EPS $.22E $.24E $.26E $.32E $1.05E
1stQ 2ndQ 3rdQ 4thQ Year
1997 EPS $.30E $.36E $.39E $.45E $1.50E
81. On 11/28/95, NetManage issued a release representing that NetManage was "the leading supplier of TCP/IP for Windows applications" and "the fastest growing public software company in the United States."
82. As NetManage stock continued to trade at artificially inflated levels during 10/95-11/95, the Individual Defendants sold off another 322,000 shares of their NetManage stock pocketing another $6.6 million in illegal insider trading proceeds.
83. On 12/1/95, NetManage issued a release announcing it had finalized the AGE acquisition for one million shares of NetManage stock. The release represented that NetManage was "the leader in TCP/IP for Windows applications and Internet connectivity software" and "the fastest growing public software company in the United States."
84. On 12/4/95, NetManage issued a release announcing a major new partnership with Microsoft -- the largest and most successful software company in the world. The release stated:
NetManage, Inc., the leading supplier of TCP/IP for Windows and Internet connectivity software announced today that it has signed a software licensing and joint development agreement with Microsoft Corporation . . . .
The two companies will be working together on OLE controls supporting Internet protocols which is scheduled to be released by Microsoft next year.
"We are very pleased to have entered into this relationship with Microsoft," said Zvi Alon, president and CEO of NetManage, Inc. "The fact that Microsoft is licensing our technology demonstrates that we have proven leadership in TCP/IP for Windows and Internet technologies, and are able to utilize these technologies to develop customized business solutions for the internal corporate network, or 'intranet.' The agreement with Microsoft combines the strength of two industry leaders to provide a solid Internet product offering, and is an endorsement of NetManages' strategy to provide a complete range of Internet and TCP/IP-based applications for both developers and end users."
* * *
NetManage is the fastest growing public software company in the United States.
85. On 12/4/95, NetManage issued two more releases, which each represented that NetManage was the "the leading supplier of TCP/IP for Windows applications" and "the fastest growing public software company in the United States." On 12/5/95, NetManage issued two other releases, which each described NetManage as the "the leading supplier of TCP/IP for Windows applications" and "the fastest growing public software company in the United States."
86. On 12/4/95, subsequent to the announcement of its new Microsoft partnership, NetManage held a conference call for securities analysts, money and portfolio managers, institutional investors, large NetManage shareholders, brokers and stock traders to discuss NetManage's new Microsoft relationship, business and its prospects. During the call -- and in follow-up conversations with participants -- Alon and Amaral disseminated information to the market by stating:
87. On 12/4/95, Robertson Stephens issued a report on NetManage, written by Powers, which was based on and repeated information provided Powers in the 12/4/95 conference call and follow-up conversations with Alon and Amaral. The report forecast 95 and 96 EPS of $.68 and $1.01, respectively, a 40% 3-year secular growth rate and 4thQ 95 EPS of $.19. The report also stated:
NETMANAGE MAKES SEVERAL ANNOUNCEMENTS ON ITS INTERNET EFFORTS:
Enters Joint Agreement With Microsoft In Development For Internet Protocols -- Releases First SMTP Messaging Solution For Intranets
1. Microsoft and NetManage have an emerging partnership that makes NETM increasingly strategic to MSFT's Internet plans. NETM has licensed technology to MSFT that the two companies will build into important MSFT OLE (Object Linking and Embedding) applications and development tools (Visual Basic, Visual C++, etc.). In other words NETM is helping define how Microsoft clients and servers work over the Internet. MSFT/NETM thus become one important team in the Internet software wars, where NSCP/Sun with Java are another major competitive team and IBM/Lotus/NOVL are a third major competitor. We believe that Windows applications will continue to be important over the Internet, and that it will be strategically very significant for NetManage to be a close partner in this effort. While we do not believe that there is any significant near term revenue impact, we do expect the NetManage sales pitch to corporate customers to benefit from the clear positive working relationship that the company has with Microsoft. We expect that the strength of the relationship will be clearer to investors after the Microsoft Internet announcements expected this Thursday.
* * *
IMPACT
3. Improving confidence in the long term growth prospects for the company.
88. On 12/4/95, Smith Barney issued a report on NetManage, written by Prince, which was based on and repeated information provided Prince in the 12/4/95 conference call and follow-up conversations with Alon and Amaral. The report forecast 95 and 96 EPS of $.71 and $1.05, respectively, a 5-year 40% EPS growth rate and 4thQ 95 EPS of $.23 for NetManage. The report also stated:
NetManage announced today . . . that it has signed a deal with Microsoft whereby Microsoft will incorporate certain NetManage technology into future products that Microsoft is developing for the Internet. This is a strong statement of support by Microsoft for NetManage's technology in that Microsoft did not chose to develop its own or go to someone else.
89. On 12/6/95, Oppenheimer issued a report on NetManage, written by Yuen, which was based on and repeated information provided Yuen in the 12/4/95 conference call and follow-up conversations with Alon and Amaral. The report forecast 95 and 96 EPS of $.68 and $1.00, respectively, and 4thQ 95 EPS of $.21 for NetManage. The report also stated:
Monday (12/4/95), NetManage signed a licensing and joint development agreement with Microsoft. . . .
Although the licensing revenue contribution to NetManage is likely to be minimal, we view the agreement very positively as it will help increase the number of existing -- and future -- Internet-enabled applications and spur industry awareness for NetManage's technology and products aimed at internal Internet (a.k.a. ("Intranet") users.
* * *
Despite a growing list of competitors, we believe NetManage is well-positioned in the emerging Intranet market due to its strong TCP/IP client products (Chameleon), a growing family of server tools, its corporate focus (90%+ of its revenues come from corporate and government entities), a large, rapidly expanding installed base and its increasing capabilities to provide other corporate communications software (i.e., X Windows and terminal emulation).
90. After the Microsoft and other announcements on 12/4-5/95, NetManage's stock soared from $22-1/2 to an all-time high of $34.
91. Each of the positive statements about NetManage's business during 10/30/95-12/5/95, as set forth in ¶¶77-90, were false and also misleading as they failed to disclose the following true facts:
(a) Sales of NetManage's Chameleon and ECCO products were all below NetManage's internal expectations, derived from the 95 budget/plan, because of weaker than anticipated demand and lower than expected price levels, due to intensive price competition which was adversely impacting NetManage's profitability;
(b) NetManage's direct Telesales group was inadequately trained in TCP/IP interconnectivity technology and was not able to successfully sell NetManage's Chameleon products in the increasingly competitive environment that emerged in mid-95;
(c) Several of NetManage's VARs were deemphasizing or even refusing to sell NetManage's Chameleon products in favor of competing products -- in retaliation again of NetManage's practice of having its Telesales group directly compete with the VAR's by targeting Fortune 1000 companies that NetManage had learned had been approached by or solicited by VARs;
(d) There was an excess of NetManage's products in the reseller and distribution channels, that NetManage was competing directly with its reseller and distribution sales channels and that sales recorded in the 3rdQ 95 were improper and conditioned on resale or other contingencies occurring;
(e) Future demand for many of NetManage's products would be hurt by the excess levels of product already held by distributors, who had accepted delivery of more product than they expected to or could sell because NetManage agreed that they could return the product if it could not be sold and, in fact, domestic and international distributors had informed NetManage that they would be returning large amounts of product, as opposed to ordering more product;
(f) NetManage had learned from internal management discussions and discussions with its corporate account managers that the introduction of Win95 with its own embedded TCP/IP interface and the rapid acceptance and popularity of Netscape's browser and applications software had adversely and materially reduced market demand for and acceptance of NetManage's products, thereby hurting NetManage's EPS;
(g) Microsoft never actually licensed NetManage's technology and the agreement with Microsoft neither demonstrated NetManage's proven leadership in TCP/IP for Windows nor endorsed NetManage's strategy, as the agreement contained no commitment for Microsoft to do anything for NetManage and NetManage knew that it was extremely unlikely that this arrangement would ever generate any revenue for NetManage;
(h) NetManage's international expansion was a failure which was severely hurting NetManage's profit margins, as NetManage was incurring large expenses to establish and support foreign sales offices (including Japan) to create large foreign production, but was achieving very slow sales there, thus resulting in losses from its international operations;
(i) NetManage's Japan sales office was a complete failure and virtually all the "sales" recorded as revenue on shipments to and from NetManage's Japan sales office were phony, as delivery was not even made at the time NetManage recognized the revenue and because those customers had been promised by NetManage that they could return the product or exchange it if they did not sell that product;
(j) The substantial price discounts provided on Chameleon and ECCO products that were shipped to NetManage's domestic and foreign distributors were not temporary and were not just for three months but rather were permanent price cuts due to competitive pressures; and
(k) Defendants knew that their forecasts of strong EPS growth to $.68-$.71 in 95 and $1.00-$1.05 per share in 96, respectively, as well as for 30%-50% 3-5 year secular EPS growth, were false as the above adverse facts and conditions contradicted these projections and made it impossible for NetManage to achieve them.
92. It was also misleading to describe NetManage as the leading supplier of TCP/IP for Windows application "and Internet connectivity software." There were several other companies that provided TCP/IP software applications products which were at least as good as NetManage's products and provided equal or better price/performance, including Attachmate, Hummingbird, Wall Data and FTP Software. Also, Win95 not only used TCP/IP technology and had a TCP/IP protocol, but also contained several applications which performed many of the functions of NetManage's Chameleon and ECCO products for free. Thus, no one company, and certainly not NetManage was the "leader" in TCP/IP software applications. It was also false to describe NetManage as the "fastest growing software company" as, in fact, Intuit, 3DO, Avant!, Platinum Technology, Quarterdeck, Geoworks, Security Dynamics, PeopleSoft, Avid Technology, Business Objects, Parametric Technology, Remedy, Mercury Interactive, Media 100 and WonderWare were faster-growing software companies, even accepting NetManage's reported 94-95 to date revenues and EPS as reported as accurate. It was also misleading to describe NetManage as the "fastest growing software company," as NetManage's purported fast growth, at least during the Class Period, was being achieved by falsifying its revenues and EPS, as detailed at ¶¶99-109, to make its growth look much stronger and faster than it really was, and Defendants knew that NetManage's growth was actually slowing, due to the diminished demand for and slowing sales of its Chameleon and ECCO products and the introduction and success of Win95 with its TCP/IP applications programs and Netscape's browser and applications software.
93. During mid-12/95 NetManage's outside auditors began their year end 95 audit work on NetManage's 95 financial statements. NetManage's 2ndQ and 3rdQ 95 results had not been audited by Arthur Andersen and as set forth in ¶¶99-109, NetManage had falsified those results by improperly recognizing revenue and inflating its reported EPS. However, by 12/31/95, Arthur Andersen had discovered irregularities in NetManage's proposed year end 95 results, including the proposed recognition of millions in revenue on shipments of products to NetManage's domestic and international resellers, where NetManage retained significant and as yet uncompleted obligations with regard to those shipments, including rights to return unsold product and extensive price protection rights. As a result, Arthur Andersen refused to permit this improper revenue recognition and so informed Alon and Amaral.
94. During the last half of 12/95, NetManage's stock declined, falling to $23-1/4 by 12/29/95, as rumors circulated that NetManage's 4thQ 95 EPS might be below forecasted levels. NetManage's management denied these rumors. On 1/4/96, NetManage's stock fell sharply from $22-5/8 on 1/3/96 to as low as $14 on 1/4/96, as two other software companies -- Firefox Communications and FTP Software -- reported 4thQ 95 EPS shortfalls, analysts cut their EPS forecasts for those companies going forward and their stocks collapsed. Alon and Amaral both communicated with Prince of Smith Barney, Yuen of Oppenheimer and Powers of Robertson Stephens to assure them that FTP's and Firefox's problems were company-specific and that NetManage's 4thQ was good, demand remained strong and NetManage still expected 4thQ 95 EPS of $.19-$.21, with 96 and 97 EPS of $1.00-$1.05 and $1.50+, respectively, i.e., NetManage's growth rates and prospects were unchanged. Smith Barney, Oppenheimer and Robertson Stephens repeated this information in reports issued by them on 1/4-5/96 and NetManage's stock rallied back up to $17-5/8.
95. The assurances given Prince, Barney and Yuen in 12/95 were false as in fact NetManage had not had a strong 4thQ 95 but had encountered continuing weak sales of its Chameleon and ECCO products and had in fact had a horrible 4thQ 95, with plunging EPS well below the levels forecast by and for NetManage -- which results were due to serious and persistent Company-specific problems that would result in NetManage achieving very poor results going forward in 96-97, well below the levels being forecast by and for NetManage.
96. However, on 1/12/96, faced with Arthur Andersen's refusal to allow it to falsify its 4thQ 95 results, NetManage revealed that its 4thQ 95 EPS would be substantially lower than $.15 and would decline from 4thQ 94 levels. NetManage stated this shortfall was because it could not record revenues on millions in product shipments that had occurred because of continuing obligations to these customers. NetManage's stock collapsed from $15-3/8 on 1/11/96 to $10 on 1/12/96 -- a decline of 33% on volume of 11.6 million shares -- the largest one-day stock volume in NetManage's history as a public company. One analyst stated "our confidence in the quality of information flow from management has been significantly reduced," while analysts reduced the 96-97 EPS forecasts for NetManage. NetManage later reported 4thQ 95 EPS of just $.08 -- a decline from the $.18 EPS reported in the 3rdQ 95, a decline from the $.15 EPS reported in the 4thQ 95 -- and well below the EPS of $.19-$.23 forecasted by and for NetManage during the Class Period. Subsequently, except for the 1stQ 96 when NetManage and certain of its insiders again artificially inflated NetManage's stock from $9-3/4 to $18-7/8, so key NetManage insiders could garner additional illegal insider trading proceeds and the persons who had sold AGE and Syzygy to NetManage could sell off approximately one million of the NetManage shares they got in this acquisition, NetManage has reported horrible financial results -- plunging revenues, minimal EPS followed by large losses -- largely abandoned its existing product line, abandoned its Japan sales office, fired over 200 persons and was left struggling for survival -- a wholly unsuccessful company, unable to achieve ongoing profitable growth. NetManage's stock price (except for the temporary re-inflation to $18-7/8 in 5/96) plunged to even lower levels, falling to $7-5/8 by 7/96 and ultimately to $2-1/4 in 12/97, from which it has not recovered.
97. NetManage's strong financial performance during the Class Period and its financial decline in the 4thQ 95-97 is set forth below:
NETMANAGE INC.
Quarterly Results
(in thousands, except EPS)
1994*
03/31 06/30 09/30 12/31 Year
Revenues $13,179 $13,849 $18,888 $25,550 $ 71,446
Net income 4,094 3,604 3,930 6,187 17,815
EPS $.10 $.09 $.09 $.15 $.43
1995*
03/31 06/30 09/30 12/31 Year
Revenues $26,936 $32,034 $35,250 $31,226 $125,446
Net income 5,345 6,121 7,561 3,270 22,297
EPS $.12 $.14 $.18 $.08 $.52
1996
03/31 06/30 09/30 12/31 Year
Revenues $33,022 $26,775 $25,426 $19,373 $104,596
Net income 5,020 1,635 241 783** 7,679**
EPS $.12 $.04 $.01 $.02** $.18**
1997
03/31 06/30 09/30 12/31 Year
Revenues $16,379 $12,701 $13,556 $18,888 $ 61,524
Net income (2,739) (4,548) (10,901)** 2,900 (15,288)**
EPS ($.06) ($.10) ($.25)** $.07** ($.34)**
* 1994 results and 1stQ to 3rdQ 95 results are restated to include results of AGE, which was accounted for under the "pooling of interests" method.
** Excluding estimated effects of charges for in process research and development.
98. The two charts below further graphically demonstrate this financial decline:
99. In order to overstate its revenues, gross profit, net income and EPS in the 2ndQ and 3rdQ 95, the Defendants caused NetManage to improperly recognize revenue on shipments of products to resellers (including Bradlees, Inc., Computer City, Inc., CompUSA Stores L.P., Egghead Software Services, Inc., Micro Warehouse, Inc., PC Connections and Ameritech Corp.) and directly or indirectly to customers (including ABB, ADC Telecommunications, Inc., AT&T, British Telecom, Canon USA, Inc., Chipcom Corp., Dun & Bradstreet, EDS, Ericsson GE Mobile Communications, Hitachi, Honeywell, Hughes LAN Systems, Lucent, NatWest Bank, Pepsi-Cola, Reuters, RevCo O.S., Inc., Rohm Electronics, Shell, SHL Systemhouse, Inc., Siemens, Software Publishing Co., Sony, Sprint Corp., Synoptics Communication, Syntex, Inc., Unisys Corp. and Xerox Corp.), where NetManage granted the right to return unsold merchandise as well as other contingent contract terms, such as customization commitments, upgrade obligations (through programs such as "ESP" or Early Ship Program), acceptance contingencies and other significant ongoing vendor obligations. These contingencies were still unresolved at the time NetManage recognized revenue associated with these shipments. Further, NetManage improperly recognized revenue on purported "sales" to Japanese customers, including Forval, Sumitomo and NetOne, which were not delivered until after the end of the quarter in which the revenue was recognized. The Company's false reporting caused NetManage's financial statements for the 2ndQ and 3rdQ 95 to be presented in violation of GAAP and SEC rules.
100. GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with the SEC, which are not prepared in compliance with GAAP, are presumed to be misleading and inaccurate, despite footnotes or other disclosures.
101. GAAP, as set forth in FASB Statement of Accounting Standard ("SFAS") No. 48 (Revenue Recognition When the Right of Return Exists), requires that when an entity grants its customers the right of return, certain conditions must be met before revenue recognition, including the following:
b. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product.
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e. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.
f. The amount of future returns can be reasonably estimated.
102. GAAP, as set forth in Statement of Position ("SOP") 91-1 (software revenue recognition) imposes additional requirements on entities that license software, including that prior to revenue recognition three tests must be met: (i) delivery has occurred; (ii) other remaining vendor obligations are no longer significant; and (iii) collectibility is probable. SOP 91-1 requires that where "other vendor obligations remaining after delivery are significant, revenue should not be recognized, because the earnings process is not substantially completed." SOP 91-1, ¶68. Moreover, an important concept in SOP 91-1 states: "If, after delivery, there is significant uncertainty about customer acceptance of the software, license revenue should not be recognized until the uncertainty becomes insignificant." SOP 91-1, ¶36.
103. In the 2ndQ 95 ended 6/30/95, NetManage reported revenue of $30.2 million, an increase of 17% over the 1stQ 95, and net income per share of $.16. In the 3rdQ 95, NetManage reported revenues of $32.7 million, an 8% increase over the 2ndQ 95, and EPS of $.18. Reporting these increased results was indispensable to NetManage indicated to the investment community that its strong growth was intact and that Win95 had not adversely impacted NetManage's business. In turn, these strong results gave credibility to NetManage's forecasts of strong growth going forward in the 4thQ95, all of 95, 96 and 97, as well which would support NetManage's stock price at high levels and allow NetManage's insiders to sell off their NetManage shares and allow NetManage to use its inflated stock to make acquisition of other companies.
104. The results reported for the 2ndQ and 3rdQ 95 and the statements accompanying those results in the reports on Form 10-Q for those quarters were false and misleading as the Company had materially overstated its revenues associated with shipments and licenses granted to resellers, distributors and certain end user customers, which included the right of return, significant vendor obligations such as customization and other acceptance contingencies, and the financial statements did not fairly present NetManage's financial information in accordance with GAAP. These distributors, resellers and end user customers required that NetManage provide them with the right to return unsold merchandise, customization, updating and other acceptance privileges, and price protection on their unsold inventories, prior to accepting any shipments of NetManage products. These customers' right to return unsold merchandise and NetManage's other obligations with respect to these licenses effectively made the sales contingent on resale or acceptance and necessitated that NetManage defer recognition of such revenue until the product had been sold through to end users. If NetManage had not improperly reported this revenue, its 2ndQ and 3rdQ 95 revenues would have been approximately $2 million lower and EPS approximately $0.03 lower than that reported in each quarter.
105. NetManage also improperly recognized revenue on purported "sales" to Japanese customers where delivery did not occur until after quarter end in direct violation of GAAP, as set forth in SOP 91-1. The Japanese customers included Forval, Sumitomo and NetOne. The revenue from such late shipments which NetManage improperly recognized exceeded $1.2 million in the 3rdQ 95, further inflating a 3rdQ 95 revenues and EPS.
106. During mid-12/95 NetManage's outside auditors began their year end 95 audit work on NetManage's 95 financial statements. NetManage's 2ndQ and 3rdQ 95 results had not been audited by Arthur Andersen and as set forth above NetManage had falsified those results by improperly recognizing revenue and inflating its requested EPS. However, by 12/31/95, Arthur Andersen had begun audit procedures and discovered serious irregularities in NetManage's proposed year end