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MILBERG WEISS BERSHAD |
WOLF POPPER LLP |
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
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ALBERT J. COPPERSTONE and JOSEPH |
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No. C-97-3495-SBA CLASS ACTION COMPLAINT FOR VIOLATION Plaintiffs Demand A |
1. This is a class action on behalf of purchasers of the common stock of TCSI Corporation ("TCSI" or the "Company"), between Oct. 11, 1995 and Sept. 25, 1996 (the "Class Period"), seeking to remedy violations of the federal securities laws by TCSI and certain TCSI insiders. These defendants pursued a fraudulent scheme and course of business that artificially inflated TCSI's stock to as high as $29-3/4 per share(1) based on representations that TCSI was enjoying very strong demand for its products that was generating large contracts, resulting in TCSI achieving substantial sequential revenue and earnings gains, which would continue throughout 1996 and 1997. As TCSI's stock soared upward from $8-1/2 per share on Oct. 10, 1995, TCSI and the individual defendants sold approximately six million shares of TCSI stock to the public at artificially inflated prices, pocketing over $105 million. In March 1996, TCSI completed a huge secondary public offering of TCSI stock in which TCSI and its founder and long-time Chairman (Harvey E. Wagner ("Wagner")) sold 1.5 million and 3.675 million shares of TCSI stock, respectively, at $18-5/8 per share, pocketing $26.6 million and $65.1 million, respectively. During the Class Period TCSI's insiders (including Wagner) also sold approximately 800,000 more shares of their TCSI stock into the open market at prices as high as $26 per share, pocketing an additional $15 million. By way of these sales, Wagner unloaded 81% of his TCSI holdings, three other top officers of TCSI sold 100% of their holdings, and two other insiders sold 78%-79% of their holdings. Then, in mid-Sept. 1996, after defendants had completed their stock selling spree, TCSI shocked the market by admitting its revenues were declining and it would suffer a loss for the third quarter! TCSI then reported revenues of just $9 million for the third quarter -- a 55% decline from its second quarter revenues -- and a huge third quarter loss of $6.5 million or $.31 per share which wiped out all the profits TCSI had previously reported during 1996 and revealed it was changing its revenue recognition policy for software licenses. Upon these revelations, TCSI's stock collapsed to just $5-3/4 per share from its Class Period high of $29-3/4 per share just three months earlier -- a stunning 81% collapse. Subsequently, TCSI has continued to report revenues of only $9-$10 million per quarter and operating losses. Roger Strauch, TCSI's Chairman and Chief Executive Officer ("CEO"), resigned and its stock price has never recovered.
2. TCSI was formed in 1987 as a division of Teknekron Corporation which was then owned and controlled by Wagner, its Chairman and CEO, to sell object-oriented software, primarily to companies in the telecommunications industries. TCSI was later spun off of Teknekron and taken public in a 1991 stock offering underwritten by PaineWebber Inc. and Smith Barney Inc. During 1993, 1994 and 1995, TCSI reported consistent net income and earnings per share ("EPS") growth on a quarterly and annual basis, as shown below:
| YEARS ENDED | 1993 | 1994 | 1995 |
| Revenue | $32.1 million | $40.3 million | $55.4 million |
| Net Income | $ 2.6 million | $ 5.4 million | $ 8.1 million |
| Earnings Per Share | $ 0.15 | $ 0.30 | $ 0.42 |
| Quarter Ended(2) | Mar 31, 1994 | Jun 30, 1994 | Sept 30, 1994 | Dec 31, 1994 | Mar 31, 1995 | Jun 30, 1995 | Sept 30, 1995 | Dec 31, 1995 |
| Revenues: | ||||||||
| Services | $7,997 | $8,020 | $8,393 | $10,462 | $10,446 | $10,026 | $11,813 | $11,505 |
| Software licensing fees | 992 | 1,454 | 2,099 | 889 | 2,266 | 3,345 | 2,267 | 3,694 |
| Total Revenues | $8,989 | $9,474 | $10,492 | $11,351 | $ 12,712 | $ 13,371 | $14,080 | $ 15,199 |
| Net income | $1,133 | $1,305 | $1,423 | $1,569 | $1,764 | $1,876 | $2,101 | $2,329 |
| Earnings per share | $ .06 | $ .07 | $ .08 | $ .09 | $ .09 | $ .10 | $ .11 | $ .12 |
3. However, by the fall of 1995, TCSI's insiders realized that TCSI's business had peaked, that new competitors (including Objective Systems Integrators) and competitive products were making significant in-roads into TCSI's business, and thus TCSI's competitive position was eroding, the strength of demand for TCSI's products was diminishing and TCSI's customers were no longer willing to fund TCSI's research and development expenditures. As a result they knew that TCSI's ability to continue to achieve sequential quarterly net income and EPS growth was increasingly problematic and that TCSI's net income and EPS would likely decline in 1996. In addition, TCSI's insiders knew that TCSI was having extreme difficulty with a large imaging technology contract it had with United Parcel Service ("UPS") and that because of those difficulties it was likely that the UPS contract would result in a loss to TCSI and would severely impact TCSI's future results.
4. TCSI's insiders were intimately familiar with TCSI's business and the industry in which it operated and thus knew the nature and extent of the serious problems that were afflicting TCSI's business by late 1995, and what they portended for the near-term future of TCSI's business. Wagner wanted to sell off as much of his ownership of TCSI stock as possible before the decline in TCSI's competitive position and prospects became known, while other TCSI insiders also wished to sell off portions of their TCSI stock holdings for the same reason. TCSI's insiders also wanted to have TCSI sell new shares to the public to raise millions in additional capital, which they knew TCSI needed to help it survive the decline in its business due to its diminished competitive position which was already underway and the losses the insiders knew TCSI was going to suffer during 1996.
5. However, TCSI's insiders' desires to unload their own TCSI stock positions and have TCSI sell new shares to the public to raise capital were inhibited by TCSI's relatively low stock price. Despite TCSI's revenue, net income and EPS growth during 1993-1995, during the first nine months of 1995 TCSI stock was a very average performer and sold at around $9-$10 per share. TCSI's insiders realized that to push TCSI's stock up to the higher levels they desired so they could accomplish a large secondary public offering of TCSI's stock and so they could sell off some of their TCSI stock holdings at inflated prices, they needed the assistance of sophisticated investment bankers and market operators who could work with them to manipulate TCSI's stock price higher by distributing favorable information about TCSI's business and its prospects which would attract investor interest to TCSI and its stock. Thus, in the Fall of 1995, TCSI and its insiders recruited Smith Barney Inc. ("Smith Barney") and PaineWebber Inc. ("PaineWebber") (TCSI's existing investment bankers), and Alex. Brown & Sons Inc. ("Alex. Brown"), a firm specializing in promoting high-tech stocks, to help with an offering of TCSI stock in which TCSI could sell new shares to raise the capital it needed and Wagner could sell millions of his own TCSI shares -- a much larger number of shares than Wagner would ever have been able to sell into the open market -- and so that all the individual defendants could take advantage of TCSI's inflated stock price by selling off some of their TCSI stock into the open market.
6. Thus, beginning in October 1995, Smith Barney, Alex. Brown, PaineWebber and TCSI's insiders began to work together to condition the market for a TCSI stock offering, inflating the price of its stock by issuing extremely positive statements about TCSI in corporate press releases and reports, in meetings and conferences with analysts and institutional investors and in securities analysts reports, which presented false and misleading information about TCSI's business, competitive position, the demand for its products, its financial results and its prospects.
7. During the Class Period, defendants represented that TCSI's business was "strong and getting stronger"(3) and that its telecommunications business especially "'continues to be quite strong.'" Thus, TCSI's overall business position was "very positive" and "picking up steam" and TCSI was "on track" and "in good shape" to achieve increased revenue, net income and earnings per share throughout 1996 and 1997. According to TCSI, it was "particularly excited about the positioning of [Object Services Package]" which had attracted an "unprecedented number of customer[s]." Defendants also represented that "'TCSI's software is ahead of the competition.'" TCSI told investors that TCSI's "business model" -- its internal target -- was to "grow . . . earnings per share and . . . revenues [annually] between 25 and 35 percent," that TCSI was "very confident in the company's ability to continue to grow" and that TCSI's "'revenue growth . . . has averaged approximately 30% . . . and we expect this trend to continue.'"
8. As TCSI reported better than expected results for its first and second quarters of 1996, defendants stated they were "'pleased with the Company's ability to sustain its targeted financial growth rates as we expand operations on a worldwide basis.'" TCSI's purportedly strong first and second quarter 1996 results gave defendants "increased confidence in [its] growth prospects" thus causing defendants to forecast five year EPS growth of 30% for TCSI. According to defendants, TCSI's "1996 plans will continue to build on the successes of 1995" and TCSI's corporate strategy "will enable TCSI to target new customers with competitively positioned applications." Also during 1996, defendants indicated that even though TCSI was going to be spending more money on research and development due to changes in its relationships with its customers who previously had paid for most of TCSI's research and development as part of certain development contracts, TCSI would still achieve the revenue, net income and EPS growth in 1996 forecasted by and for it notwithstanding these increased research and development expenditures. As a result, defendants forecast that TCSI would achieve 50%-60% year-over-year growth in TCSI's telecommunications software business and this would lead to 1996 EPS of $.54-$.55 per share with third and fourth quarter 1996 EPS of $.14 and $.15, respectively.
9. Defendants were also very reassuring about TCSI's bookings or orders, an indication of the strength of its business. In reporting its 1995 results, TCSI indicated that its 1995 bookings reached $62 million due to its increased corporate focus and the "significant in-roads" it made with service providers as it "'successfully address[ed] this market opportunity.'" According to defendants they were "encouraged that TCSI [was] able to maintain its backlog at such a high level while continuing to generate revenue growth" and since TCSI entered 1996 with $43 million in backlog it "appeared on track for a solid 1996." When TCSI's bookings for the first quarter of 1996 were only $8 million, reducing TCSI's backlog to $32 million, defendants represented that this was only due to normal seasonal factors and did not indicate that there was any softness in TCSI's business or erosion of its competitive position. They also stated that TCSI's bookings in the second quarter were "strong" and TCSI expected bookings in the second quarter to be at least twice the level of the first quarter. Then, when TCSI's bookings actually continued to be weak during the second quarter, i.e., $13 million, and TCSI's backlog declined further to $23 million, defendants again assured investors that this decline did not indicate that there was any problem with TCSI's business or erosion of its competitive position and that TCSI's bookings during the third quarter would be "much stronger" than in the second quarter. In fact, during July 1995, they represented that TCSI's bookings in July alone exceeded its bookings during the entire second quarter and that TCSI would close a very large ($10-$15 million) contract with a Regional Bell Operating Company ("RBOC") during the third quarter. All in all, throughout the Class Period, defendants represented that TCSI was working on "several highly profitable deals" and that TCSI's business was so strong it was "straining to keep up with customer requests for object-oriented management solutions."
10. During the Class Period, the defendants also assured investors that while TCSI was no longer going to focus on sales to companies in the transportation business, it was successfully completing a large equipment pass through contract with UPS that would generate millions in revenue during 1996 and that even though the profit margin on this contract was lower than for TCSI's software business, completion of the UPS contract would not hurt TCSI's EPS during 1996 and TCSI's profit margins would "increase" upon completion of the UPS contract.
11. In late 1995 and early 1996, TCSI not only covered up the deterioration in its business by making the falsely reassuring representations and statements set forth above, they also falsified TCSI's reported financial results. TCSI's insiders falsified TCSI's reported financial results for the fourth quarter of 1995 (results included in TCSI's secondary offering prospectus) and the first and second quarters of 1996 to make it appear that TCSI was continuing to achieve growth in revenues and earnings, meeting or exceeding its internal corporate plan and investor expectations, when in fact its earnings were declining and were much lower than reported. TCSI's insiders accomplished this deception by failing to recognize in a timely fashion, as required by Generally Accepted Accounting Principles ("GAAP"), the multi-million dollar loss on the UPS contract which TCSI knew would result due to the escalating costs it was incurring to rework its technology to meet UPS' needs for which TCSI had no alternative use. In addition, when TCSI's insiders realized during 1995 that the Company's business was deteriorating, they changed TCSI's revenue recognition policy with regard to software license fees to make it easier for them to prematurely recognize revenue on software license agreements to create the appearance that TCSI's business was still succeeding and growing. Prior to 1995, TCSI's revenue recognition had been constrained by the phrase, "no revenue is recognized for unpaid license fees unless collection is assured." This constraint was removed by TCSI's insiders so that they could improperly accelerate the recognition of revenue, in part by selling to uncreditworthy customers and also by recognizing income before customers were firmly obligated to pay. Then, during the Class Period, to mask a decline in TCSI's business, TCSI's insiders prematurely recognized millions in revenue on software licensing transactions which artificially inflated TCSI's reported revenues, net income and EPS in the fourth quarter of 1995 and the first and second quarters of 1996.
12. As a result of TCSI's falsification of its financial statements and defendants' other false and misleading statements about TCSI, TCSI stock was an extraordinarily strong performer during the Class Period, substantially outperforming similar stocks. TCSI's stock price skyrocketed from $8-1/2 per share on Oct. 10, 1995 to $29-3/4 per share in late June 1996. This surge in TCSI's stock price enabled its insiders to unload approximately 4.4 million shares of their TCSI stock at artificially inflated prices as high as $26 per share during the Class Period, pocketing over $80 million. It also enabled TCSI to sell 1.5 million shares to the public at $18-5/8 per share, netting $26.6 million, while TCSI's underwriters pocketed $4.8 million of the March secondary stock offering proceeds.
13. By Sept. 1996, TCSI stock was still selling for $25 per share, near its all-time high. On Sept. 24, 1996, TCSI stock traded as high as $23 per share during the day before falling in late trading to close at $20-3/4 per share when rumors of an earnings shortfall for TCSI's third quarter first circulated. On Sept. 25, 1996, TCSI stock really began to collapse, falling by $6-11/16 per share to as low as $14-1/16 per share as rumors continued to circulate that TCSI was going to report third quarter results well below those previously forecast by and for it. After the close of trading on Sept. 25, 1996, TCSI admitted that rather than the substantial growth in revenues, net income and EPS it had forecast for 1996, its revenues for the third quarter of 1996 would decline from the prior quarter and TCSI would suffer a loss. Then on Oct. 17, 1996, TCSI reported that its revenues for the third quarter were only $9.8 million, a huge 55% decline from second quarter 1996 revenues of $21.8 million and a 31% decline from $14 million in revenues for the third quarter of 1995. As a result of this revenue decline and a large write-off on the terminated UPS contract, TCSI suffered a loss of $6.5 million in the third quarter or $.31 per share, a loss that more than wiped out all the profits TCSI had supposedly earned during the first half of 1996! As these losses were exposed, TCSI stock collapsed to as low as $5-3/4 per share, a decrease of 81% from its Class Period high of $29-3/4 reached just three months earlier, in late June 1996. TCSI has continued to report reduced revenues and losses and Roger Strauch, its Chairman and CEO, resigned. Neither TCSI's business nor its stock price have ever recovered as the table and chart below show:
TCSI Corporation
Quarterly Results
(in thousands, except EPS*)
1995
03/31 06/30 09/30 12/31 Year
Revenues $12,712 $13,371 $14,080 $15,199 $55,362
Net income 1,764 1,876 2,101 2,329 8,070
EPS $.09 $.10 $.11 $.12 $.42
1996
03/30 06/30 09/30 12/31 Year
Revenues $18,538 $21,831 $ 9,785 $10,079 $60,233
Net income 2,551 2,808 (6,506) 1,441 294
EPS $.13 $.13 ($.31) $.07 $.01
1997
03/31 06/30 09/30 12/31 Year
Revenues $ 9,834 $ 9,504
Net income (561) (919)
EPS ($.03) ($.04)
* Pre-06/30/96 EPS are adjusted to reflect 3-for-2 stock split.
14. The positive representations made by the defendants during the Class Period about TCSI's business were all false when made. The true facts, which they concealed, were:
(a) That TCSI's competitive position was being eroded due to the entry into its marketplace by competitors (including Objective Systems Integrators) who were offering superior and/or lower priced products resulting in a slowing of orders or bookings for TCSI's products;
(b) That demand for TCSI's object-oriented software had softened and as a result TCSI's rate of new orders had declined from prior levels which was having a materially adverse impact on TCSI's business;
(c) That because TCSI's customers were no longer willing to fund TCSI's research and development expenditures as part of contracts with TCSI, TCSI would be required to spend many millions of dollars a year of its own funds on research and development, which would adversely impact TCSI's earnings going forward;
(d) That TCSI's customers' decisions to stop funding TCSI's development expenses reflected those customers' diminished commitment to TCSI's technology and services and that the likelihood of future contracts with those customers had dropped significantly;
(e) That the decline in TCSI's orders during the first quarter of 1996 was not due to seasonal factors but rather to the erosion of its competitive position and resulting softness in its business specified above and thus was not a temporary situation but rather reflective of a major and permanent decline in TCSI's business;
(f) That the weakness in orders during TCSI's first and second quarters was due to an erosion of TCSI's competitive position and reflected a major and likely permanent decline in TCSI's business;
(g) That it was very unlikely that TCSI would obtain a major contract from an RBOC during the third quarter of 1996 as that RBOC had not committed to place an order by that timeframe and had indicated that it likely would not place that order before 1997 at the earliest;
(h) That TCSI was having severe difficulties with its large UPS contract and had been informed by UPS that UPS would likely terminate that contract during 1996 which would leave TCSI holding millions of dollars worth of custom-designed equipment for which it had no other use, and result in TCSI taking a write-off and suffering a loss;
(i) That the growth of TCSI's business had peaked in 1995 for the reasons stated above, and that to conceal the deterioration in its business, TCSI was falsifying its reported financial results for the fourth quarter of 1995 and the first two quarters of 1996 by not recording and reporting write-downs related to the UPS contract and by prematurely recognizing revenue on software licensing agreements transactions with its customers, as described in ¶¶89-105;
(j) That the rate of growth of TCSI's business was slowing materially due in part to the emergence of competitors which were offering more effective and competitively priced products, but, to mask this decline, TCSI was falsifying its financial statements as specified above;
(k) That, as a result of the foregoing, defendants knew that it was extremely unlikely that TCSI could achieve sequential revenue, net income and EPS growth throughout 1996 and in fact TCSI's revenues would stagnate or decline in 1996, due to the problems with its UPS contract and the weakening of demand for its products; and
(l) That, as a result of the foregoing, there was no reasonable basis in fact for defendants' repeated forecasts of strong revenue and earnings growth for TCSI during 1996 and 1997, and in fact, those forecasts were contradicted by the adverse facts set forth above and were therefore actually known by the defendants to have been false when made.
15. As a result of defendants' false and misleading statements, TCSI's stock price was artificially inflated throughout the Class Period, reaching a high of $29-3/4 per share. TCSI's insiders took advantage of this artificial inflation to sell off shares of TCSI stock at prices as high as $26 per share -- pocketing over $80 million from their illegal scheme. The table below shows the defendants' stock sales while TCSI stock was artificially inflated:
% of
Shares
Shares Sale Total Owned
Name Position Sold Prices Proceeds Sold
Banin Exec. V.P. and 45,000 $17.33-$22.33 $ 846,500 100%
General Mgr.
Bolger Director 16,500 $21.67 $ 357,500 79%
Farmer CFO, Secretary, 15,000 $22.94 $ 344,100 100%
Treasurer, V.P.
Hasler Director 26,000 $11.17-$26.00 $ 491,625 78%
Messerschmitt Director 20,000 $23.00-$24.75 $ 477,500 11%
Miller Director 132,500 $14.00-$25.54 $ 2,740,450 11%
Rao Senior V.P. 32,500 $18.49 $ 651,890 100%
Strauch President, CEO, 141,000 $11.33-$23.14 $ 2,693,030 8%
Chairman
Wagner Director, 4,050,000 $11.33-$19.83 $71,673,350 81%
Former Chairman
TCSI also benefited from its inflated stock price, as it sold 1.5 million new shares to the public at $18-5/8 per share, obtaining $26.6 million while the underwriters in the stock offering got $4.8 million of the proceeds. These stock sales by TCSI's insiders were unusual in timing and amount as shown by the charts below:
[Chart file "TSCIDV2" not available from Milberg Weiss web site as of 10/5/97]
16. The charts below demonstrate the price action of TCSI's shares during the Class Period, defendants' stock sales, the collapse of TCSI's share price as the previously concealed facts about TCSI's business emerged and the performance of TCSI's stock compared to an index of similar companies, which shows that the action of TCSI's shares was due largely to company-specific events and not market forces:
17. Jurisdiction exists pursuant to §27 of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §78aa, and 28 U.S.C. §1331. The claims asserted arise under §§10(b) and 20(a) of the Exchange Act, 15 U.S.C. §§78j(b) and 78t(a), and Rule 10b-5.
18. (a) Venue is proper in this District pursuant to §27 of the Exchange Act and 28 U.S.C. §1391(b). Many of the acts giving rise to the violations complained of occurred in this District; and
(b) Assignment of this action to the San Francisco Division is appropriate as a substantial part of the events or omissions identified herein occurred in Alameda County.
19. Defendants used the instrumentalities of interstate commerce, the U.S. mails and the facilities of the international securities market.
20. (a) Plaintiff Albert J. Copperstone purchased 4,400 shares of TCSI stock on Aug. 27-Sept. 25, 1996 at $17-1/2-$24 per share and was damaged thereby.
(b) Plaintiff Joseph Siciliano purchased 75 shares of TCSI stock on June 4, 1996 at $22-2/3 per share and was damaged thereby.
21. Defendant TCSI has its headquarters and principal place of business in Berkeley, California. The stock of TCSI was traded in an efficient market on the NASDAQ National Market System during the Class Period. TCSI provides object-oriented, enterprise software products and services primarily to telecommunications service providers and equipment manufacturers. TCSI sold 1.5 million new shares to the public in the March 1996 stock offering. Many of the shares sold by TCSI's insiders during the Class Period were acquired by them via the exercise of stock options and thus these shares were also sold by TCSI to its insiders during the Class Period who then resold them to the public.
22. (a) Defendant Harvey E. Wagner ("Wagner") founded TCSI and was its Chairman, a member of its Executive Committee and a director of TCSI until March 6, 1996 when he resigned as Chairman but remained a director. Because of defendant Wagner's positions, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. Based on inside information, Wagner sold 3,675,000 shares of his TCSI stock in the secondary offering in March 1996, pocketing $65.1 million, and sold an additional 375,000 shares during the Class Period for proceeds of $6.5 million -- 81% of his holdings, thus personally profiting from his participation in the illegal scheme.
(b) Defendant Roger A. Strauch ("Strauch") was President, CEO and Chairman of the Board of Directors. Because of defendant Strauch's positions, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Strauch sold 141,000 shares of TCSI stock -- 8% of his TCSI holdings -- for approximately $2.7 million, thus personally profiting from his participation in the illegal scheme.
(c) Defendant Daniel H. Miller ("Miller") was a director of the Company. Because of defendant Miller's position, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Miller sold 132,500 shares of TCSI stock -- 11% of his TCSI holdings -- for approximately $2.7 million, thus personally profiting from his participation in the illegal scheme.
(d) Defendant Harish S. Rao ("Rao") was Senior Vice President, Object Software Group and a member of the Executive Committee. Because of defendant Rao's position, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Rao sold 32,250 shares of TCSI stock -- 100% of his TCSI holdings -- for approximately $650,000, thus personally profiting from his participation in the illegal scheme.
(e) Defendant John C. Bolger ("Bolger") was a director of the Company and a member of the Audit Committee. Because of defendant Bolger's position, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Bolger sold 16,500 shares of TCSI stock -- 79% of his TCSI holdings -- for $357,500, thus personally profiting from his participation in the illegal scheme.
(f) Defendant Ram A. Banin ("Banin") was an Executive Vice President and General Manager of Object Software Group. Because of defendant Banin's positions, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Banin sold 45,000 shares of TCSI stock -- 100% of his TCSI holdings -- for $846,500, thus personally profiting from his participation in the illegal scheme.
(g) Defendant William A. Hasler ("Hasler") was a director and a member of the Audit Committee. Because of defendant Bolger's position, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Hasler sold 26,000 shares of TCSI stock -- 78% of his TCSI holdings -- for $491,625, thus personally profiting from his participation in the illegal scheme.
(h) Defendant David G. Messerschmitt ("Messerschmitt") was a director of the Company. Because of defendant Messerschmitt's position, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Messerschmitt sold 20,000 shares of TCSI stock -- 11% of his TCSI holdings -- for $477,500, thus personally profiting from his participation in the illegal scheme.
(i) Defendant Paul A. Farmer ("Farmer") was Chief Financial Officer, Secretary, Treasurer and Vice President of the Company. Because of defendant Farmer's positions, he knew the adverse non-public information about TCSI's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. During the Class Period, based on inside information, Farmer sold 15,000 shares of TCSI stock -- 100% of his TCSI holdings -- for $344,100, thus personally profiting from his participation in the illegal scheme.
(j) The defendants identified in ¶22(a)-(i) are referred to herein as the Individual Defendants.
23. (a) TCSI's Executive Committee was comprised of Strauch, Banin, Rao, Hatch Graham, Farmer and Wagner through March 1996, when Wagner resigned as Chairman of TCSI and left the Executive Committee.
(b) TCSI's Board of Directors has an Audit Committee composed of two members, Bolger and Hasler. The Audit Committee reviews and approves TCSI's financial statements and accounting procedures.
(c) Individual Defendants Wagner, Strauch, Miller, Rao, Bolger, Banin, Hasler, Messerschmitt, and Farmer were each aware of and approved the false statements issued by or on behalf of TCSI during the Class Period.
24. Defendants Wagner and Strauch, by reason of their executive positions and membership on the Board of Directors of TCSI, were controlling persons of TCSI and had the power and influence, and exercised the same, to cause TCSI to engage in the conduct complained of herein. TCSI controlled each of the Individual Defendants.
25. As officers, directors and/or controlling persons of a publicly-held company and as sellers of TCSI stock, each of the Individual Defendants had a duty to disseminate accurate and truthful information promptly with regard to TCSI and to correct any previously issued statements that had become untrue and to disclose any adverse trends known to them that would materially affect the operating results of TCSI, so that the market price of TCSI stock would be based upon truthful and accurate information. Notwithstanding their duty to refrain from selling TCSI stock while in the possession of material, adverse, non-public information concerning TCSI, the Individual Defendants sold 4,481,250 shares of the Company stock, pocketing over $80 million, thus personally profiting from their deliberate and dishonest acts.
26. The Individual Defendants controlled the contents of TCSI's SEC filings, corporate reports and press releases. Each of the Individual Defendants participated in writing or reviewing TCSI's corporate reports, press releases and SEC filings alleged to be misleading and thus had the ability and opportunity to prevent their issuance or cause them to be corrected. Because of their positions and access to material non-public information available to them, each of these defendants knew that the adverse facts specified herein had not been disclosed to and were being concealed from the public and that the positive representations which were being made were then materially false and misleading. Thus, each of the Individual Defendants is legally responsible for the falsifying of TCSI's public reports, financial statements and releases detailed herein at ¶¶40, 42, 57, 70, 78 and 83 as "group-published" information.
27. Each of the defendants is liable for participating in a scheme to defraud by making false and misleading statements and failing to disclose material adverse facts while selling shares of TCSI stock and as a participant in a fraudulent scheme which: (i) deceived the investing public regarding TCSI; (ii) artificially inflated the price of TCSI stock; (iii) caused Class members to purchase TCSI stock at inflated prices; and (iv) permitted the Individual Defendants to sell over 4.4 million shares of TCSI stock at inflated prices, pocketing over $80 million.
28. Each defendant had the opportunity to commit and participate in the violations of law described herein. The Individual Defendants were top officers and directors of TCSI and they controlled its press releases, corporate reports, SEC filings and its communications with analysts. Thus, the defendants controlled the public dissemination of, and could falsify, the information about TCSI's business, products and finances that reached the public and impacted the price of TCSI stock.
29. Each of the Individual Defendants also had the motive to commit and participate in the violations of law described herein. These defendants wanted to and did cover up the problems with and deterioration in TCSI's business to make it appear that TCSI's business was succeeding and growing, so that its stock would trade at artificially inflated levels and they could insider trade by selling off large amounts of their TCSI stock at artificially inflated prices, pocketing large sums for themselves. They also wanted TCSI to accomplish a huge offering of new shares of its stock by which it would raise millions in needed capital to help it survive the decline in its business which was then underway and which would allow its founder, long-time chairman and controlling shareholder, Wagner, to sell off millions of his TCSI shares, at artificially inflated prices before the truth about the decline in TCSI's business became known.
30. (a) TCSI's compensation program was also designed to incentivize TCSI's insiders to falsify its reported profits. TCSI's program established a base salary for each executive with annual cash incentives to be paid based on attainment of defined performance goals. The target bonus (30% to 40% of salary for executive officers) was paid to an individual achieving expected performance. Higher percentages are paid for extraordinary performance (90% to 120% of salary). The performance of executive officers is measured based on overall Company performance, as determined from EPS.
(b) The 1995 base salaries for Strauch, the CEO, and all other executive officers were increased at the end of 1994 due to TCSI's strong EPS performance. Effective January 1, 1995, the base salaries for Strauch and Farmer were increased from $215,000 to $245,000 and from $140,000 to $165,000, respectively. Banin and Rao's 1995 base salaries were increased from $180,000 to $210,000 and $140,000 to $180,000, respectively, for their roles in the earnings performance of the Object Software Group. In 1996 the base salaries of Strauch and Farmer were again increased to $250,000 and $180,000, respectively, for their continued participation in improving TCSI's EPS. The 1996 base salaries of Banin and Rao were increased to $230,000 and $205,000, respectively, for improving the earnings of the Object Software Group.
(c) Due to the Company's earnings performance in 1995, Strauch and Farmer were awarded bonuses of $150,000 and $125,000, respectively, and Banin and Rao were rewarded with bonuses of $200,000 and $175,000, respectively. Thus, these top insiders expected that causing TCSI to report higher earnings in 1996 would result in large bonuses and salary increases for them.
31. TCSI was formed in 1987 as a division of Teknekron Corporation which was then owned and controlled by Wagner, its Chairman and CEO, to sell object-oriented software, primarily to companies in the telecommunications industries. TCSI was later spun off of Teknekron and taken public in a 1991 stock offering underwritten by PaineWebber and Smith Barney. During 1993, 1994 and 1995 TCSI reported consistent net income and EPS growth on a quarterly and annual basis, shown below:
| YEARS ENDED | 1993 | 1994 | 1995 |
| Revenue | $32.1 million | $40.3 million | $55.4 million |
| Net Income | $ 2.6 million | $ 5.4 million | $ 8.1 million |
| Earnings Per Share | $ 0.15 | $ 0.30 | $ 0.42 |
| Quarter Ended(4) | Mar 31, 1994 | Jun 30, 1994 | Sept 30, 1994 | Dec 31, 1994 | Mar 31, 1995 | Jun 30, 1995 | Sept 30, 1995 | Dec 31, 1995 |
| Revenues: | ||||||||
| Services | $7,997 | $8,020 | $8,393 | $10,462 | $10,446 | $10,026 | $11,813 | $11,505 |
| Software licensing fees | 992 | 1,454 | 2,099 | 889 | 2,266 | 3,345 | 2,267 | 3,694 |
| Total Revenues | $8,989 | $9,474 | $10,492 | $11,351 | $ 12,712 | $ 13,371 | $14,080 | $ 15,199 |
| Net income | $1,133 | $1,305 | $1,423 | $1,569 | $1,764 | $1,876 | $2,101 | $2,329 |
| Earnings per share | $ .06 | $ .07 | $ .08 | $ .09 | $ .09 | $ .10 | $ .11 | $ .12 |
32. However, by the fall of 1995 TCSI's insiders realized that TCSI's business had peaked, that new competitors (including Objective Systems Integrators) and competitive products were making significant in-roads into TCSI's business, and thus TCSI's competitive position was eroding, the strength of demand for TCSI's products was diminishing and TCSI's customers were no longer willing to fund TCSI's research and development expenditures. As a result they knew that TCSI's ability to continue to achieve sequential quarterly net income and EPS growth was increasingly problematic and that TCSI's net income and EPS would likely decline in 1996. In addition, TCSI's insiders knew that TCSI was having extreme difficulty with a large imaging technology contract it had with UPS and that because of those difficulties it was likely that the UPS contract would be terminated during 1996 which would result in TCSI incurring a large write-off, likely causing a quarterly loss.
33. TCSI's insiders were intimately familiar with TCSI's business and the industry in which it operated and thus knew the serious problems that were afflicting TCSI's business by late 1995. Wagner wanted to sell off as much of his ownership of TCSI stock as possible before the decline in TCSI's business, competitive position and prospects became known, while other TCSI insiders also wished to sell off portions of their TCSI stock holdings for the same reason. TCSI's insiders also wanted to have TCSI sell new shares to the public to raise millions in additional capital which they knew TCSI needed to help it survive the decline in its business due to its diminished competitive position and the losses the insiders knew TCSI was going to suffer during 1996.
34. However, TCSI's insiders' desires to unload their own TCSI stock positions and have TCSI sell new shares to the public to raise capital were inhibited by TCSI's relatively low stock price. Despite TCSI's revenue, net income and EPS growth during 1993-1995, during the first nine months of 1995 TCSI stock was a very average performer and sold mostly around $9-10 per share. The charts below demonstrate how the defendants' stock sales prior to, and after, the Class Period were insignificant compared to the insider stock sales during the Class Period:
[Chart file "TSCIDV2" not available from Milberg Weiss web site as of 10/5/97]
35. Defendants' stock sales during the Class Period were also unusual in timing and amount when compared to their sales since the end of the Class Period. During the 11-month Class Period, the Individual Defendants sold 4.48 million shares, whereas during the 11 months since the end of the Class Period, these same Individual Defendants sold only 30,000 shares, including 15,000 shares sold by Strauch after he resigned.
36. TCSI's insiders realized that to push TCSI's stock price up to the much higher levels they desired so they could accomplish a large secondary public offering of TCSI stock and so Wagner and they could sell off some of their holdings of TCSI stock at inflated prices, they needed the assistance of sophisticated investment bankers and market operators who could work with them to manipulate TCSI's stock price upward by distributing extremely favorable information about TCSI's business and its prospects which would attract investor interest to TCSI and its stock. Thus, in the Fall of 1995, TCSI and its insiders recruited Smith Barney and PaineWebber (TCSI's existing investment bankers), and Alex. Brown, a firm specializing in promoting high-tech stocks, to help with an offering of TCSI stock in which TCSI could sell new shares to raise the capital it needed and Wagner could sell millions of his own TCSI shares -- a much larger number of shares than Wagner would ever have been able to sell into the open market -- and so that all the Individual Defendants could take advantage of TCSI's inflated stock price by selling off some of their TCSI stock into the open market.
37. TCSI and the Individual Defendants used the investment bankers to help them promote the stock of TCSI.
38. (a) PaineWebber, Smith Barney, Alex. Brown (collectively the "Underwriters") are investment banking houses and broker dealers which specialize, inter alia, in underwriting public offerings of securities. These firms each served as co-lead underwriters of the TCSI secondary stock offering in March 1996, and thus they sold millions of shares of TCSI stock to the public during the Class Period. Each of these firms was also a marketmaker in TCSI stock and thus was engaged in purchasing and selling TCSI stock on a daily basis throughout the Class Period. Each of these firms issued false and misleading reports on TCSI during the Class Period based on information given them by TCSI and its insiders. The false and misleading Smith Barney, PaineWebber and Alex. Brown reports on TCSI issued during the Class Period were intended by defendants to boost TCSI's stock price in anticipation of the March 1996 stock offering and to cover up defendants' scheme after that stock offering by maintaining TCSI's stock price at inflated levels for as long as possible.
(b) In order to merchandise TCSI's stock in the March offering, PaineWebber, Smith Barney and Alex. Brown participated in Roadshow presentations in major U.S. cities prior to the offering, during which it was represented that TCSI's new products had been both successfully introduced and were selling well. They also made glowing projections for TCSI's results in 1996 and 1997. PaineWebber, Smith Barney and Alex. Brown also issued false research reports on TCSI both before and after the offering, which also projected strong increases in revenues and EPS for TCSI throughout 1996 and 1997. In so doing, the Underwriters were acting for and on behalf of TCSI, serving as the means by which TCSI could distribute false and misleading information to the market and artificially inflate TCSI's stock price.
39. Thus, beginning in October 1995, defendants used Smith Barney, Alex. Brown and PaineWebber to condition the market for a TCSI stock offering, inflating the price of its stock by issuing extremely positive statements about TCSI in corporate press releases and reports, in meetings and conferences with analysts and institutional investors and in securities analysts reports, which presented false and misleading information about TCSI's business, competitive position, the demand for its products, its financial results and its prospects.
40. On October 11, 1995, TCSI issued a press release which stated:
"Demand for TCSI's object-oriented software continues to be quite strong and we expect the Company's third quarter performance will reflect the growing demand in the telecommunications industry for TCSI's distributed object technology," said Roger Strauch, president and chief executive officer. Current customers include Ameritech, Bell Atlantic, BellSouth, GTE, and NTT. "In the first nine months of 1995, TCSI's Object Software Group has seen a nearly 70% increase in revenues and we believe this is only the beginning," he added.
41. On October 11, 1995, Strauch and Farmer appeared for TCSI at the Alex. Brown Technology Seminar which was attended by institutional investors, money and portfolio managers and securities analysts and made a presentation during which they stated:
Strauch:
Object services package is our flagship product. It's a standards-compliant, object-oriented development and execution environment that improves service offerings while reducing maintenance and upgrading operational costs. At least 5 to 10 million dollars of license fees will be generated in 1996 based on this product. This product is a staging ground for applications, database, and system management systems integration, the corporate software integrator, and it is more complete and more functional than many comparable products offered by IBM, DEC, Sun, and smaller companies like Iona and ExpertSoft. * * * We're particularly excited about the positioning of OSP.
* * *
TCSI also offers our customers software at the heart of new digital wireless telephones. This software extends the battery life and improves the voice quality of these telephones, and what we're very excited about is that next year at least 1 to 2 million dollars of royalties will be generated by these products, and we generate these royalties by selling chips to telephone manufacturers, and that means that we're already having significant market penetration in the Japanese and the U.S. market, cellular telephones incorporating our software.
* * *
This has resulted in an unprecedented number of customer references for us, and, if you pick up the package that we're offering outside, it will list a number of the customer references that we're very proud to have earned and look forward to earning more. And, with that, I'll turn the presentation over to my colleague, Paul Farmer, the chief financial officer of our company.
Farmer: Currently, we've already reported ten consecutive quarters, that's through the second quarter of 1995, of increased revenues and EPS growth of in excess of 30 percent.
* * * Our business model, roughly, we'd like to grow our earnings per share and our revenues between 25 and 35 percent year over year. That's what we're targeting internally.
* * *
This is a look at the last couple of years, '93 and '94, and then, for comparison, the first six months of this year. You can see that we've already done 26 million in revenue and 29 cents. Last year's revenues were up 26 percent, and our EPS doubled. This is our last couple of quarters, second quarter of '95 versus second quarter of '94. Again, the revenues are up. In this case, they're up over 40 percent. Earnings per share are up approximately the same percentage.
* * *
This is our performance in the last ten quarters, and you can see our revenues and earnings per share have managed to go up sequentially in each of the quarters.
Strauch: Well, we're very pleased that we've been able to maintain that performance and very confident in the company's ability to continue to grow.
42. On October 19, 1995, TCSI reported its third quarter results by way of a release that stated:
TCSI Corporation . . . a worldwide software products and services provider, today announced third quarter 1995 revenues of $14.1 million, a 34 percent increase from the third quarter of 1994. Net income increased nearly 50 percent in the third quarter of 1994. Net income increased nearly 50 percent in the third quarter to $2.1 million from $1.4 million for the same period in 1994. Earnings per share were [$.11], on 12.8 million shares. "TCSI's annual revenue growth, since the first quarter of 1993, has averaged approximately 30 percent," said Roger Strauch, president and chief executive officer. "Our objective is to continue to grow through customer satisfaction. Currently more than 80 percent of TCSI's revenues are generated from our 1994 customers, and we expect this trend to continue."
"We believe TCSI's software is ahead of the competition, and we are well positioned for future growth."
43. On October 19, 1995, TCSI held a conference call for institutional investors, money and portfolio managers, securities analysts and large TCSI shareholders during which Strauch, Farmer and Wagner made presentations and answered questions, thus directly disseminating information to the markets. During that call and in follow-up, one-on-one conversations with analysts they stated:
44. On October 20, 1995, Smith Barney issued a research report, authored by Patrick Houghton, which repeated some of the information from the October 19, 1995 conference call and follow-up conversations with Strauch and Farmer. The report increased TCSI's forecasted 1996 EPS to $.52 and forecast a five-year EPS growth rate of 25% for TCSI. The report also stated:
- Opinion: TCSI reported EPS of [$.11] for the third quarter ended September 30, slightly above consensus EPS estimates of $0.15. Given the company's better than expected performance, we are fine-tuning our EPS estimates to [$.41] from [$.40] for 1995 and to [$.52] from [$.51] for 1996. We believe the main revenue producers for TCSI in the near term will be contract integration services and software license sales, primarily to telecommunications customers. Based on TCSIs recent contract wins in key areas of broadband and wireless communications, we have increased confidence in the long-term growth of contract revenue from TCSI's telecommunications business. Growth in telecommunications, combined with the outlook of increased license revenues from wireless communications chipsets in 1996/1997, gives us continued confidence in our 5 year compounded annual growth rate estimate of 25%.
* * *
- Backlog Stable: TCSIs backlog remained relatively flat at $43 million, compared to $45 million last quarter. We are encouraged that TCSI was able to maintain its backlog at such a high level.
- Growth Outlook for 1996: We are encouraged by recent contract wins in the telecommunications business, particularly the Bell South contract to develop software for managing and operating its PCS network in the Carolinas and Tennessee, and the Bell Atlantic contract to develop software to manage its broadband network for video-on-demand and interactive services. We believe that these contracts could provide TCSI with the opportunity to develop a framework product that will give it a competitive advantage in providing similar management and back-office operations systems to other PCS and broadband services providers. We believe the Telecommunications Group could grow its revenues 40% to $49 million in 1996. We estimate that license revenues from digital cellular phones and digital cordless phones could increase to $2 million 1996, helping grow the wireless business to $16 million in 1996.
45. On October 20, 1995, PaineWebber issued a report on TCSI, authored by Jeffrey Hines, which repeated some of the information from the October 19, 1995 conference call and follow-up conversations with Strauch and Farmer. The report increase the forecasted 1996 EPS for TCSI to $.52 "due to slightly higher than expected revenues this quarter and the expectation of higher revenues going forward."
46. On November 28, 1995, Smith Barney issued a report on TCSI, authored by Houghton. Houghton obtained the information for this report from Strauch and Farmer in conversations with them. The report forecast 1996 EPS of $.52 and a five-year EPS growth rate of 25% for TCSI. The report stated:
Backlog Stable
TCSI's backlog remained relatively flat at $43 million, compared to $45 million last quarter. We are encouraged that TCSI was able to maintain its backlog at such a high level.
GROWTH OUTLOOK FOR 1996
We are encouraged by recent contract wins in the telecommunications business, particularly the BellSouth contract to develop software for managing and operating its PCS network in the Carolinas and Tennessee, and the Bell Atlantic contract to develop software to manage its broadband network for video-on-demand and interactive services. We believe that these contracts could provide TCSI with the opportunity to develop a framework product that will give it a competitive advantage in providing similar management and back-office operations systems to other PCS and broadband services providers. We believe the Telecommunications Group could grow its revenues 40% to $49 million in 1996. We estimate that license revenues from digital cellular phones and digital cordless phones could increase to $2 million in 1996, helping to grow the wireless business to $16 million in 1996.
INVESTMENT CONCLUSION
Given the company's better-than-expected performance, we are fine-tuning our EPS estimates to [$.41] for 1995 and to [$.52] from [$.51] for 1996. We believe the main revenue producers for TCSI in the near term will be contract integration services and software license sales, primarily to telecommunications customers. Based on TCSI's recent contract wins in key areas of broadband and wireless communications, we have increased confidence in the long-term growth of contract revenue from TCSI's telecommunications business. Growth in tele-communications, combined with the outlook of increased license revenues from wireless communications chipsets in 1996/1997, gives us continued confidence in our five-year compounded annual growth rate estimate of 25%.
47. As part of the scheme to stimulate investor interest in TCSI and inflate its stock price, on December 14, 1995, Alex. Brown "initiated coverage" on TCSI with a report, written by Nicholas Coutros and Jennifer Germain. Coutros and Germain obtained the information for this report from Strauch and Farmer in conversations with them. The report forecast 1996 EPS of $.54 for TCSI, with 1996 quarterly EPS of:
1Q $0.12
2Q 0.13
3Q 0.14
4Q 0.15
Year $0.54
The Alex. Brown report also stated:
We have initiated research coverage of TCSI Corporation with a "buy" investment rating on the shares. We believe that TCSI is well positioned to benefit as telecom services providers turn increasingly to object-oriented software solutions for network management and operations support. . . . We believe that TCSI's OSG, which comprises 75% of total sales and is growing at well above a 50% annual rate, will become increasingly visible to investors as telco acceptance of object-oriented technology accelerates.
* * *
* Attractive business model -- importance of professional services revenue stream from existing customers, and "FAT" mix of products (frameworks, applications, and tools) lessens licensing-lump revenue-risk while delivering rapid growth and respectable returns.
* Recent and future events likely to drive re-thinking of attractive valuation -- announcements of new projects at existing customers, new customers; stock market success of competitors and comparable companies; AT&T "trivestiture," potential RBOC sale of Bellcore to public.
TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced this report and distributed it.
48. On December 18, 1995, Strauch had a lunch sponsored by PaineWebber in New York City with securities analysts, brokers, money and portfolio managers and institutional investors. Strauch told them that:
49. On December 26, 1995, Smith Barney issued a report on TCSI, authored by Houghton, which forecast five-year EPS growth of 30% for TCSI with 1996 and 1997 EPS of $.52 and $0.67, respectively. Houghton obtained the information for this report from Strauch and Farmer in conversations with them. The report also forecast 1996 quarterly EPS for TCSI of:
1Q $0.11
2Q 0.13
3Q 0.13
4Q 0.15
The report stated:
We believe that TCSI could show another very strong bookings quarter for 4Q95, primarily driven by growth in the telecommunications software business segment. This gives us increased confidence in our outlook for 1996 and for growth going forward. Based on our increased confidence in the companys [sic] growth prospects, we are increasing our five year CAGR estimate to 30% from 25%. We are also providing a preliminary 1997 EPS estimate of [$.67]. We continue to be comfortable with our 1995 EPS estimate of [$.41] and our 1996 EPS estimate of [$.52]. We believe the main revenue generator and growth driver for TCSI in the near term will be contract integration services and software license sales to telecommunications service providers. Based on TCSIs [sic] recent contract wins in key areas of broadband and wireless communications, we have increased confidence in the long-term growth of contract revenue from TCSIs [sic] tele-communications business. We estimate that the telecommunications software market is about $4 billion. Our anticipation of more rapid growth in the telecommunications software segment, combined with our outlook for increased license revenues from wireless communications chipsets in 1996/1997, gives us confidence in our new 5 year compounded annual growth rate estimate of 30%.
* * *
- Growth Outlook for 1996: We are encouraged by recent contract wins in the telecommunications business, particularly the Bell South contract to develop software for managing and operating its PCS network in the Carolinas and Tennessee, the Bell Atlantic contract to develop software to manage its broadband network for video-on-demand and interactive services, and the Motorola contract to provide fault and configuration management for new GSM cellular installations. . . . We believe the Telecommunications Group could grow its revenues over 50% to $53 million in 1996. We estimate that license revenues from digital cellular phones and digital cordless phones could increase to $2 million 1996, helping grow the wireless business to $15 million in 1996.
TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced this report and distributed it.
50. The positive representations made by the defendants from October to December 1995 about TCSI's business were all false when made. The true facts were:
(a) That TCSI's competitive position was being eroded due to the entry into its marketplace of competitors (including Objective Systems Integrators) who were offering superior and/or lower priced products resulting in a slowing of orders or bookings for TCSI's products;
(b) That demand for TCSI's object-oriented software had softened and as a result TCSI's rate of new orders had declined from prior levels which was having a materially adverse impact on TCSI's business;
(c) That because TCSI's customers were no longer willing to fund TCSI's research and development expenditures as part of contracts with TCSI, TCSI would be required to spend many millions of dollars a year of its own funds on research and development, which would adversely impact TCSI's earnings going forward;
(d) That TCSI's customers' decisions to stop funding TCSI's development expenses reflected those customers' diminished commitment to TCSI's technology and services and the likelihood of future contracts with those customers had dropped significantly;
(e) That TCSI was having severe difficulties with its large UPS contract and that due to the additional work and modifications TCSI was having to perform as part of the contract the insiders knew it was probable the contract would ultimately result in a loss for TCSI;
(f) That the growth of TCSI's business had peaked in 1995 for the reasons stated above, and that to conceal the deterioration in its business, TCSI was falsifying its reported financial results during the fourth quarter of 1995 by not recording and reporting write-downs related to the UPS contract and by prematurely recognizing revenue on software licensing agreements transactions with its customers as described in ¶¶89-105;
(g) That the rate of growth of TCSI's business was slowing materially due in part to the emergence of competitors which were offering more effective and competitively priced products, but, to mask this decline, TCSI was falsifying its financial statements as specified above;
(h) That, as a result of the foregoing, defendants knew that it was extremely unlikely that TCSI could achieve sequential revenue, net income and EPS growth throughout 1996 and in fact TCSI's revenues would stagnate or decline in 1996, due to the problems with its UPS contract and the weakening of demand for its products; and
(i) That, as a result of the foregoing, there was no reasonable basis in fact for defendants' repeated forecasts of strong revenue, and earnings growth for TCSI during 1996 and 1997, and in fact, those forecasts were contradicted by the adverse facts set forth above and were therefore actually known by the defendants to have been false when made.
51. On January 22, 1996, TCSI issued a release headlined and stating as follows:
TCSI Reports Bookings For 1995; Company Signs Contracts With Ten New Telecommunications Customers
TCSI Corporation reported today annual bookings for the year ended December 31, 1995. Sales of TCSI's object-oriented software products and services during the year led the way to bookings of $62 million. The Company attributes this year's bookings to a more focused approach on the telecommunications industry, which enabled the Company to make significant in-roads into additional levels of service providers and equipment manufacturers.
* * *
"With the growing acceptance of object-oriented technology in the telecommunications industry, we believe that our approach of combining a scalable, high performance development environment with business frameworks and customized services, enabled us to successfully address this market opportunity," said Roger Strauch, president and chief executive officer. "By satisfying the needs of emerging service providers and multi-billion dollar organizations, we believe we can build a reputation in the telecommunications industry that may lead to expanded distribution channels and cross-industry opportunities in the future."
52. On January 25, 1996, TCSI released its results for the fourth quarter and year ended December 31, 1995, including fourth quarter revenues of $15.2 million, net income of $2.3 million, and EPS of $0.18.
53. On January 25, 1996, TCSI held a conference call for institutional investors, securities analysts, money and portfolio managers and large TCSI shareholders during which Wagner, Strauch and Farmer made presentations and answered questions and directly disseminated information to the market. During the conference call and in later follow-up one-on-one conversations with analysts, these defendants stated:
54. On January 26, 1996, Smith Barney issued a research report on TCSI, written by Houghton, which repeated some of the information from the January 25, 1996 conference call and follow-up private communications with Wagner, Strauch and Farmer. The report repeated the information given Smith Barney by TCSI, forecast five-year EPS growth of 30% for TCSI and contained the following 1996 and 1997 earnings forecasts for TCSI:
1Qtr 2Qtr 3Qtr 4Qtr Year
1996 EPS $0.11E $0.13E $0.13E $0.15E $0.52E
1997 EPS $N/A $N/A $N/A $N/A $0.67E
The report also stated:
Given the companys [sic] strong bookings quarter and continued strong backlog, we continue to be comfortable with our EPS estimates of [$0.52] for 1996 and [$.67] for 1997. We believe the main revenue producers for TCSI in the near term will be contract integration services and software license sales, primarily to telecommunications customers. Based on TCSIs [sic] recent contract wins in key areas of broadband and wireless communications, we have increased confidence in the long-term growth of contract revenue from TCSIs telecommunications business. We estimate that the telecommunications software market is about $4 billion. Our anticipation of more rapid growth in the telecommunications software segment, combined with our outlook for increased license revenues from wireless communications chipsets in 1996/1997, gives us confidence in our 5 year compounded annual growth rate estimate of 30%.
* * *
- Backlog Stable: TCSI's backlog remained flat at $43 million, compared to $43 million last quarter and $45 million 2Q95. We are encouraged that TCSI is able to maintain its backlog at such a high level while continuing to generate revenue growth.
55. On January 31, 1996, PaineWebber issued a report on TCSI, written by Jeffrey Hines, which repeated some of the information from the January 25, 1996 conference call and follow-up private conversations between Hines and Wagner, Strauch and Farmer. The report stated:
1. We are raising our 1996 and 1997 revenue and earnings expectations for TCSI going forward after the company reported a solid 1995 last week.
* * *
4. TCSI ended 1995 with $43 million of backlog and prospects for TCSI's object-oriented software business based on sales of their flagship product Object Services Package (OSP) appear on track for a solid 1996.
* * *
TCSI's success in 1995 was evidenced by the fact that TCSI doubled the number of Tier 1 telecommunication services firms that it has as customers as well as doubling the amount of revenues these firms generated. The names read off like a who's who list in the telecom industry.
These customers will continue to use TCSI's products as they construct new networks and reduce operating costs through the use of OSP based networks. The retention of 1994 customers is a testament to the quality of TCSI's products and services and is evidence of the continued need for their services. With four more regional bell operating companies as new potential customers, strong worldwide growth, increasingly complex telecommunications networks and continued reduction in workforces all pointing to a favorable trend for the company we have increased our revenue growth projection up to over just over 40% in 1996 (from 30% previously) and to just over 30% (from 25% previously) in 1997.
Somewhat offsetting these higher top-line growth projections, we note that the company had previously indicated their operating margins would decrease slightly in the first half of 1996 due to the delivery of a lower margin order with the United Postal Service which combined low-margin equipment with higher margin software. It is not typical for TCSI to have these types of orders, so we expect margins to return to historical levels by the end of 1996. Also, TCSI indicated that they would be investing more in research and development going forward. . . . We view any investment in R&D as positive as the company continues to re-invest in their business in anticipation of long term growth in the industry. . . . The net-net is we are raising 1996 EPS estimate to [$.53] from [$.51] and 1997 EPS estimates to [$.70] from [$.63].
56. Defendants' false statements were successful in increasing the price of TCSI stock from $12 on January 25, 1996, to $21 per share by the end of February 1996. The Individual Defendants took advantage of this inflation in the price of TCSI stock, selling 518,250 shares at prices of $14.00-$19.83, for proceeds of $9.4 million.
57. On or about March 13, 1996, TCSI issued its 1995 Annual Report to Shareholders. The report included a letter signed by Strauch which stated:
In 1995, OSG's focus on the telecommunications market resulted in twice the level of bookings with traditional, full service telecom providers and network operators, such as AT&T and the regional bell operating companies (RBOCs) and national PTT telecom providers worldwide. We also attracted additional new business with emerging network operators, as well as with independent telephone and cable companies.
TCSI signed contracts in 1995 with more than a dozen new customers. The most significant new contracts were with North American telecommunications companies, including several RBOCs, that plan to deploy new services based on our flagship product.
* * *
Our 1996 plans will continue to build on the successes of 1995. We will enhance our products and services to efficiently respond to the changing needs of the telecommunications industry.
* * *
We believe this strategy will enable TCSI to target new customers with competitively positioned applications . . . .
58. The positive representations made by the defendants from Jan. 1, 1996 to March 13, 1996 about TCSI's business were all false when made. The true facts were:
(a) That TCSI's competitive position was being eroded due to the entry into its marketplace of competitors (including Objective Systems Integrators) who were offering superior and/or lower priced products resulting in a slowing of orders or bookings for TCSI's products;
(b) That demand for TCSI's object-oriented software had softened and as a result TCSI's rate of new orders had declined from prior levels which was having a materially adverse impact on TCSI's business;
(c) That because TCSI's customers were no longer willing to fund TCSI's research and development expenditures as part of contracts with TCSI, TCSI would be required to spend many millions of dollars a year of its own funds on research and development, which would adversely impact TCSI's earnings going forward;
(d) That TCSI's customers' decisions to stop funding TCSI's development expenses reflected those customers' diminished commitment to TCSI's technology and services and the likelihood of future contracts with those customers had dropped significantly;
(e) That TCSI was having severe difficulties with its large UPS contract and that due to the additional work and modifications TCSI was having to perform as part of the contract the insiders knew it was probable the contract would ultimately result in a loss for TCSI;
(f) That the growth of TCSI's business had peaked in 1995 for the reasons stated above, and that to conceal the deterioration in its business, TCSI was falsifying its reported financial results during the fourth quarter of 1995 by not recording and reporting write-downs related to the UPS contract and by prematurely recognizing revenue on software licensing agreements transactions with its customers, as described in ¶¶89-105;
(g) That, as a result of the foregoing, defendants knew that it was extremely unlikely that TCSI could achieve sequential revenue, net income and EPS growth throughout 1996 and in fact TCSI's revenues would stagnate or decline in 1996, due to the problems with its UPS contract and the weakening of demand for its products; and
(h) That, as a result of the foregoing, there was no reasonable basis in fact for defendants' repeated forecasts of strong revenue, and earnings growth for TCSI during 1996 and 1997, and in fact, those forecasts were contradicted by the adverse facts set forth above and were therefore actually known by the defendants to have been false when made.
59. To pull off the large March 1996 stock offering, it was necessary for defendants to make it look like TCSI would continue to grow and be profitable, and that TCSI had new and successful products and would achieve strong revenue and profit growth throughout 1996-1997. In order to convey this false impression to potential investors, the Underwriters orchestrated a multi-city Roadshow before the March offering, during which they and TCSI officers traveled around the U.S. and presented highly favorable information about TCSI (much more positive than that contained in the Prospectus) and which was designed to overcome and neutralize the risk factors in the Prospectus. These statements included representations that TCSI competed successfully, that TCSI's most important new products had been successfully introduced and were selling well, TCSI would receive millions more in revenue from the UPS contract and forecasts of strong revenue and profit growth for TCSI during 1996 and 1997. This created strong demand for TCSI stock so that more shares could be sold at a higher price in the offering, thus financially benefitting TCSI, its selling shareholders and the Underwriters.
60. Thus, on March 26, 1996, TCSI filed a Prospectus and Registration Statement with the SEC which was false and misleading due to the inclusion of TCSI's false and misleading fourth quarter 1995 financial results, as described in ¶¶89-105. In the Prospectus, TCSI represented the following:
The following table sets forth quarterly statement of operations data for the period beginning January 1, 1994 and ending December 31, 1995, as well as the percentage of the Company's revenues represented by each item. This unaudited quarterly information has been prepared on the same basis as the annual information presented elsewhere in this Prospectus and, in management's opinion, reflects all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of the information for the quarters presented when read in conjunction with the Company's Financial Statements and Notes thereto appearing elsewhere in this Prospectus. The operating results for any quarter are not necessarily indicative of results for any future period.
61. Defendants' scheme to pull off the March stock offering was successful. With the help of TCSI's lawyers and the Underwriters' lawyers, who helped draft false and misleading documents, the Underwriters helped create demand for the stock sold in the offering with the Roadshow, while defendants presented a positive picture of TCSI and forecast that the Company would achieve strong revenue and EPS growth in 1996 and 1997.
62. On March 26, 1996, TCSI completed the public offering of 5.1 million shares at $18-5/8 per share, underwritten by Alex. Brown, PaineWebber and Smith Barney who received $4.8 million of the sale proceeds for marketing the stock. TCSI sold 1.5 million shares for $26.6 million. Wagner sold 3.6 million shares for $65.1 million.
63. On April 2, 1996, Alex. Brown issued a report on TCSI, written by Michael Gordon, which recommended purchase of TCSI stock and forecast the following earnings for TCSI:
1996E 1997E
1Q $0.11 NE
2Q 0.13 NE
3Q 0.14 NE
4Q 0.16 NE
Fiscal Year $0.54 $.73
The report also stated:
- We are increasing our 1996 revenue estimates slightly to $78.8 million in revenue (+44%) (versus our old estimate of $75 million) based on higher pass-through hardware revenue, which only carries a 6% GM. We are maintaining our EPS estimate of [$.54] (versus [$.42]). We are raising our 1997 estimates to $94 million in revenue generating [$.73] in EPS versus our previous estimates of $90.5 million and [$.69], respectively.
- We believe the true potential growth rate of the Company over time is masked by the lower rate of growth of services (70-80% of revenue currently; goal is 50/50 services/licenses) as well as the inclusion of hardware revenue only in 1996. The Object Services Group or OSG represents the potential growth that TCSI could enjoy as revenues ramp over the next few years.
TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced the report and distributed it.
64. On April 3, 1996, Smith Barney issued a report on TCSI, written by Houghton, which stated:
We continue to be comfortable with our EPS estimates of [$.52] for 1996 and [$.67] for 1997. We [have] . . . increased confidence in the long-term growth of contract revenue from software market is about $4 billion. Our anticipation of more rapid growth rate estimate of 30%.
The report forecast 30% five-year earnings growth for TCSI and forecast the following 1996 and 1997 earnings:
1Qtr 2Qtr 3Qtr 4Qtr Year
1996 EPS $0.11E $0.13E $0.13E $0.15E $0.52E
1997 EPS $ N/A $ N/A $ N/A $ N/A $0.67E
TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced the report and distributed it.
65. On April 17, 1996, TCSI reported its first quarter 1996 results via a release that stated:
TCSI Corporation . . . reported today revenues of $18.5 million for the first quarter ended March 31, 1996. This reflects a 46 percent increase over revenues of $12.7 million a year ago. Net income for the first quarter of 1996 grew 45 percent to $2.6 million from $1.8 million in the prior year. Earnings per share increased to [$.13] from [$.09] in the first quarter of 1995.
"Worldwide deregulation, competition, and new technologies are compelling Telecom companies to rapidly bring new services to market. New software solutions are being designed to enable them to meet this demand, while simultaneously lowering operational costs and improving customer services," said Roger Strauch, chairman, president, and chief executive officer. "TCSI has successfully provided these solutions for more than a decade. This quarter's results reflect our ability to support the dynamic and evolving needs of the Telecom industry."
* * *
Internally funded research and development costs were $1.0 million in the first quarter of 1996. Prior to January 1, 1996, the Company's product development had been primarily funded by customers as part of the development of software applications.
66. On April 18, 1996, TCSI held a conference call for institutional investors, securities analysts, money and portfolio managers and large TCSI shareholders, during which Strauch and Farmer made presentations and answered questions and directly disseminated information to the market. In that call and in later follow-up communications with individual analysts Strauch and Farmer stated:
67. On April 18, 1996, Alex. Brown issued a report on TCSI, written by Michael Gordon. Gordon obtained the information for this report from Strauch and Farmer in conversations with them, the April 18, 1996 conference call and follow-up conversations with Strauch and Farmer. The report forecast the following results for TCSI in 1996 and 1997:
1996E 1997E
1Q $0.13A NE
2Q 0.13 NE
3Q 0.13 NE
4Q 0.15 NE
Year $0.54 $.73
The report stated:
- Quarter exceeds expectations.
* * *
- Core OSP and object-oriented product/service growth was 67% year-over-year. Wireline and wireless, incumbent and alternative carrier interest continues to be strong.
- Backlog was down sequentially in line with normal seasonality but bookings/visibility heading into 2Q were strong.
* * *
- Backlog declined sequentially to $32 million from the $42 million range in December. We note this is in line with TCSI's normal seasonality (and nearly all of the telecom equipment companies) and has occurred in five of the last six years. The bookings pipeline was strong, estimated at $8 million. Visibility into 2Q business was described at strong (75-80%). Typically TCSI sees 2x bookings Q2/Q1 and management noted it expects this to hold true for this year as well.
In the weeks after the offering, the Individual Defendants sold 102,000 shares out of the 150,000 shares which were excluded from the 90-day lockup agreement with the Underwriters. The 150,000 shares represented the maximum number which could be sold under the agreement for all officers and directors as a group.
68. On April 18, 1996, Smith Barney issued a report on TCSI, written by Houghton. Houghton obtained the information for this report from Strauch and Farmer in conversations with them, the April 18, 1996 conference call and follow-up conversation with Strauch and Farmer. The report forecast 30% five-year EPS growth for TCSI and the following EPS in 1996 and 1997:
1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Previous 12/96EPS $0.11E $0.13E $0.13E $0.15E $0.52E
Current 12/96EPS $0.13A $0.13E $0.13E $0.15E $0.53E
Previous 12/97EPS $ N/A $ N/A $ N/A $ N/A $0.67E
Current 12/97EPS $ N/A $ N/A $ N/A $ N/A $0.67E
The report stated:
TCSI reported EPS of [$.13] for its first quarter ended March 31, slightly above our EPS estimate of [$.11]. Bookings were down to $8 million, so backlog declined to $32 million from $43 million at the end of 4Q95. The first quarter is a seasonally weak quarter for the telecommunications industry. Since is appears that the order pipeline for TCSIs OSP product is very good, we anticipate a much stronger bookings quarter in 2Q96. Given the companys [sic] good earnings performance and our outlook for a stronger bookings quarter in 2Q96, we are raising our 1996 EPS estimate to [$.53] from . . . [$.52] and continue to be comfortable with our EPS estimate of [$.67] for 1997. . . .
Our anticipation of more rapid growth in the telecommunications software segment, combined with our outlook for increased license revenues from wireless communications chipsets in 1996/1997, gives us confidence in our 5 year compounded annual growth rate estimate of 30%.
* * *
- Telecommunications Continues to be strong . . . .
- Gross Margin Impact from UPS: About $2.8 million of revenues this quarter were from equipment pass-through business to deliver a contract to the UPS. We anticipate about $10 million in total equipment pass-through business to the UPS during 1996, mostly in the first half of the year. The equipment revenues carried a gross margin of 6.5%, so this significantly impacted TCSIs overall gross margins. Excluding the impact of the pass-through business, TCSIs gross margins on the rest of its software and services business was 61%.
* * *
- Backlog Down: TCSI's backlog declined to $32 million, compared to $43 million last quarter. This was because the first quarter is a seasonally weak quarter for sales to telecommunications customers, and as a greater percentage of TCSIs revenues are generated from the telecommunications market, we would anticipate that TCSIs revenue pattern will more closely follow historical telecommunications capital budget cycle. We are encouraged that TCSIs order pipeline appears to be strong, and anticipate a stronger bookings quarter in 2Q96.
- OSP Software Sales Drives Growth for 1996: We are encouraged by recent contract wins in the telecommunications business . . . . We believe the Telecommunications Group could grow its revenues by 50% to $55 million in 1996. We estimate that the wireless personal communications group and transportation group will both be flat to slightly down going forward, as the company focuses on its Telecommunications opportunity.
69. On April 18, 1996, PaineWebber issued a report on TCSI, written by Hines. Hines obtained the information for this report from Strauch and Farmer in conversations with them, the April 18, 1996 conference call and follow-up conversations with Strauch and Farmer. The report forecast 1996 and 1997 EPS of $.57 and $.73, respectively, and stated:
1. TCSI . . . reported Q1 results yesterday . . . which were better than expected with EPS of [$.13] (+36%) above our expectation of [$.11]. . . .
2. TCSI announced that it had signed a $4.9 million contract with Telestra, Australia's national telecommunications company, to provide it with TCSI's Object Services Package and related services.
3. We have adjusted our 1996 and 1997 EPS estimates upward by [$.03] . . . .
* * *
TCSI once again had a strong quarter beating ours and street estimates. Revenues increased 46% to $18.5 million on continued strong growth of TCSI's Object Services Package. Historically bookings for TCSI have doubled sequentially in the second quarter and we expect this to be the case at the minimum next quarter. We are therefore raising our estimates by [$.03] in 1996 and 1997 as we expect TCSI to continue to benefit from the proliferation of network management systems to telecom service and equipment manufacturers.
70. Beginning in mid-May 1996, TCSI reproduced and publicly distributed to the market, including members of the financial press, securities analysts, TCSI shareholders and potential investors in TCSI, an excerpt from the June 1996 "Buyside" magazine, stating it was "Sponsored by TCSI Corporation." The excerpt included summaries of three recent securities analysts research reports on TCSI which stated:
JEFF HINES
NatWest Securities
TCSI is a small cap company providing object-oriented software solutions into the telecommunications marketplace. TCSI's Object Software Group (80% of 1995 revenues) designs software-based network and operations management solutions needed to control and monitor large telecommunications networks in North America, Europe and the Pacific Rim. As telecommunications firms (e.g., the RBOCs and LDs) look to cut costs (e.g., people) at the same time they deploy more complex networks, object-oriented software solutions like those designed by TCSI fill the "productivity gap" that would otherwise develop. TCSI software is utilized by both the service providers looking to develop their own internal network software systems as well as the equipment suppliers looking to sell equipment to the service providers.
Our outlook going forward for TCSI is continued strong top-line revenue growth of 40% and 30% expected for 1996 and 1997.
PATRICK HOUGHTON
Smith Barney
We believe that the OSG Software Group's sales to the telecommunications industry will continue to drive growth in 1996. We are encouraged by recent contract wins in the telecommunications business, particularly the Telstra contract to install a broadband intelligent network signalling system for 8 million subscribers in Australia, the Bell South contract to develop software for managing and operating its PCS network in the Carolinas and Tennessee and the Bell Atlantic contract to develop software to manage its broadband network for video-on-demand and interactive services. We believe that OSG could grow its revenues by 50% to $55 million in 1996.
MIKE GORDON
Alex. Brown
We have initiated research coverage of TCSI Corporation with a "buy" investment rating on the shares. We believe that TCSI is well positioned to benefit as telecom services providers turn increasingly to object-oriented software solutions for network management and operations support. Results of the company's extraordinarily successful Object Services Group (OSG) have been partially masked by TCSI's continued investment in its Personal Communications Group (embedded software solutions for wireless consumer products), resulting in a stock market valuation lagging that of recently public comparable companies. We believe that TCSI's OSG, which comprises 75% of total sales and is growing at well above a 50% annual rate, will become increasingly visible to investors as telco acceptance of object-oriented technology accelerates.
The reprint also stated:
For more information contact:
Leigh Salvo
Director Investor Relations
2121 Allston Way
Berkeley, CA 94704
71. On or about May 20, 1996, Strauch appeared at the Smith Barney Technology Conference in San Francisco, attended by investors, securities analysts, money and portfolio managers and members of the financial press. At that conference, Strauch made a presentation on behalf of TCSI and stated that TCSI expected to grow its revenues at 30%-40% per year. He also stated that TCSI's software license fees were growing rapidly and TCSI expected $15-$20 million in such fees in 1996, which higher fees would enable TCSI to maintain 20% operating margins even while spending 6% of its revenues on research and development in 1996.
72. On or about June 3, 1996, TCSI held its regular quarterly operations conference call with institutional investors, TCSI shareholders and securities analysts during which Strauch, Banin and Farmer made presentations and answered questions, directly disseminating information to the market. During the conference call and in follow-up one-on-one conversations with analysts they stated:
73. On June 3, 1996, Alex. Brown issued a report on TCSI, written by Gordon. Gordon obtained the information for this report from Strauch and Farmer in conversations with them, the quarterly operations call and follow-up conversations with Farmer and Strauch. The report forecasted the following future earnings for TCSI:
1996E 1997E
1Q $0.11A [sic] $0.16
2Q 0.13 0.17
3Q 0.13 0.19
4Q 0.15 0.21
Year $0.54 $0.73
The report stated:
Software business outlook strong and getting stronger. . . . We attended a recent carrier conference and confirmed TCSI's technical leadership.
Off the shelf/packaged software strategy beginning to show results.
* * *
We believe the implications are two-fold: potentially to lower project time cycles (less time consuming custom programming) and higher license revenues.
* * *
Highlights of TCSI's regular quarterly update follow:
Tone of business very positive. TCSI focused on telecom now and interest in TCSI's object oriented, client/server software solutions is soaring due to carrier's need to offer new services in a timely manner to ward off competitive inroads.
Packaged software strategy picking up steam. . . . TCSI building an inventory of components. This is potentially very positive for future licensing revenue streams.
Broadband, SS7 and PCS applications particularly in demand. TCSI has already made two sales in SS7 and multiple three others are under consideration.
74. The positive representations made by the defendants from March 1996 to June 1996 about TCSI's business were all false when made. The true facts were:
(a) That TCSI's competitive position was being eroded due to the entry into its marketplace of competitors (including Objective Systems Integrators) who were offering superior and/or lower priced products resulting in a slowing of orders or bookings for TCSI's products;
(b) That demand for TCSI's object-oriented software had softened and as a result TCSI's rate of new orders had declined from prior levels which was having a materially adverse impact on TCSI's business;
(c) That because TCSI's customers were no longer willing to fund TCSI's research and development expenditures as part of contracts with TCSI, TCSI would be required to spend many millions of dollars a year of its own funds on research and development, which would adversely impact TCSI's earnings going forward;
(d) That TCSI's customers' decisions to stop funding TCSI's development expenses reflected those customers' diminished commitment to TCSI's technology and services and the likelihood of future contracts with those customers had dropped significantly;
(e) That the decline in TCSI's orders during the first quarter of 1996 was not due to seasonal factors but rather to the erosion of its competitive position and resulting softness in its business specified above and thus was not a temporary situation but rather reflective of a major and permanent decline in TCSI's business;
(f) That the weakness in orders during TCSI's first quarter was due to an erosion of TCSI's competitive position and reflected a major and likely permanent decline in TCSI's business;
(g) That TCSI was having severe difficulties with its large UPS contract and had been informed by UPS that UPS would likely terminate that contract during 1996 which would leave TCSI holding millions of dollars worth of custom-designed equipment for which it had no other use and result in TCSI taking a write-off and suffering a loss;
(h) That the growth of TCSI's business had peaked in 1995 for the reasons stated above, and that to conceal the deterioration in its business, TCSI was falsifying its reported financial results for the fourth quarter of 1995 (which results were included in the prospectus) and for the first quarter of 1996, by not recording and reporting write-downs related to the UPS contract and by prematurely recognizing revenue on software licensing agreement transactions with its customers as described in ¶¶89-105;
(i) That the rate of growth of TCSI's business was slowing materially due in part to the emergence of competitors which were offering more effective and competitively priced products, but, to mask this decline, TCSI was falsifying its financial statements as specified above;
(j) That, as a result of the foregoing, defendants knew that it was extremely unlikely that TCSI could achieve sequential revenue, net income and EPS growth throughout 1996 and in fact TCSI's revenues would stagnate or decline in 1996, due to the problems with its UPS contract and the weakening of demand for its products; and
(k) That, as a result of the foregoing, there was no reasonable basis in fact for defendants' repeated forecasts of strong revenue and earnings growth for TCSI during 1996 and 1997, and in fact, those forecasts were contradicted by the adverse facts set forth above and were therefore actually known by the defendants to have been false when made.
75. On June 24, 1996,(5) Smith Barney issued a report on TCSI, authored by Houghton. Houghton obtained the information for the report from Farmer and Strauch in conversations with them. The report increased the forecasted 1996 and 1997 EPS for TCSI as follows:
Previous 12/96 EPS $0.13A $0.13E $0.14E $0.14E $0.54E
Current 12/96 EPS $0.13A $0.13E $0.14E $0.14E $0.54E
Previous 12/97 EPS $ N/A $ N/A $ N/A $ N/A $0.67E
Current 12/97 EPS $ N/A $ N/A $ N/A $ N/A $0.67E
The report also forecast a five-year EPS growth rate of 30% for TCSI. TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced the report and distributed it.
76. On June 25, 1996, Alex. Brown issued a report on TCSI, written by Gordon. Gordon obtained the information for the report from Farmer and Strauch in conversations with them. The report stated:
TCSI's high-margin license revenue is and always has been difficult to predict and we believe a number of highly profitable deals are pending. We note the company has made or exceeded estimates for well over a year now. We believe TCSI is experiencing very strong demand and is straining to keep up with customer requests for object-oriented network management solutions. Telecom software is in our opinion one of the hottest investment areas within communications and TCSI is one of only two public plays (the other being OSII).
TCSI's top officers received this report before it was issued and approved it. TCSI later reproduced the report and distributed it.
77. On July 1, 1996, Alex. Brown issued a report on TCSI, authored by Gordon. Gordon obtained the information for this report from Farmer and Strauch. The report forecast the following earnings for TCSI, adjusted for the 3-for-2 stock split:
1996E 1997E
1Q $0.13A $0.16
2Q 0.13 0.17
3Q 0.14 0.18
4Q 0.15 0.22
Year $0.54 $0.73
78. On July 17, 1996, TCSI issued a press release headlined and stating:
TCSI NAMES FOUR NEW EXECUTIVES IN RESPONSE TO GLOBAL GROWTH
New Hires Bring Additional Telecom Software Experience To TCSI International Operations
TCSI Corporation, a global provider of software to the Telecom industry, announced today that it has hired four professionals to respond to the Company's international growth.
"This year, TCSI's five largest telecom customers include two North American regional carriers, one European carrier, and two service providers in the Pacific Rim. We believe the current geographic diversity of our customer base will create new opportunities for our software products and services in those markets with both existing and new customers," said Roger Strauch, president and chief executive officer. "Software licensing fees from our flagship product, Object Services Package (OSP), were up over 100 percent last year, and we believe the addition of these four seasoned professionals will better position us to take advantage of our growing marketplace."
79. On July 18, 1996, TCSI issued a press release reporting its second quarter results. The release stated:
TCSI Corporation, a global provider of software to the Telecom industry, reported today revenues of $21.8 million for the second quarter of 1996. This represents a 63 percent increase in revenue over the same period last year. Net income grew 50 percent to $2.8 million from $1.9 million in the second quarter of 1995. Earnings per share increased to $0.13 in the second quarter of 1996 from $0.10 in the second quarter of 1995.
"This quarter marks TCSI's sixteenth consecutive quarter of increased revenues and net income. We are pleased with the Company's ability to sustain its targeted financial growth rates as we expand operations on a worldwide basis," said Roger A. Strauch, president and chief executive officer. "We have expanded our international operations by opening a new facility in Europe, hiring additional sales and marketing professionals in North America and Asia, and entering into a strategic partnership with a software developer in India."
* * *
"TCSI continues to demonstrate the ability to respond to the Telecom industry's need for improved productivity, scalability, and effective change management on a global basis. We are encouraged by the additional business the Company is being awarded from existing telecom customers and equally as excited by the number of agreements being signed with new customers," added Strauch. "This quarter, we added ten new customers and signed more than $9 million in business with existing customers. New agreements were secured for cellular and PCS network management development, as well as OSP porting, training, and mentoring."
80. On July 18, 1996, TCSI (Strauch and Farmer) held a conference call for securities analysts, institutional investors and TCSI shareholders to discuss the second quarter results and to directly disseminate information to the market. During the call and in follow-up one-on-one conversations with analysts they stated:
81. On July 19, 1996, Smith Barney issued a report on TCSI, authored by Houghton. Houghton obtained the information for this report from Strauch and Farmer in conversations with them, the July 18, 1996 conference call, and follow-up conversations with Strauch and Farmer. The report forecast the following earnings for TCSI during the balance of 1996:
1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
$0.13A $0.13A $0.14E $0.14E $0.54E
The report also forecast five-year EPS growth for TCSI of 30%. The report stated:
TCSI reported EPS of $0.13 for its first fiscal quarter ended June 30, vs. EPS of $0.10 a year ago. This was in-line with the consensus estimate. Bookings were down to $13 million, higher than bookings of $8 million in 1Q96, but still less than sales, so backlog declined to $23 million from $32 million at the end of 1Q96 and $43 million at the end of 4Q95. However, management reported that TCSI has already booked an additional $13 million in orders in the first two weeks of 3Q96. In addition, management anticipates a multi-year contract on the order of $10 million to $15 million from an RBOC to be closed during the quarter. Therefore, we anticipate a much stronger bookings quarter in 3Q96. Given the company's good earnings performance, we continue to be comfortable with our 1996 EPS estimate of $0.54 and our 1997 EPS estimate of $0.67. . . . Our anticipation of more rapid growth in the telecommunications software segment gives us confidence in our 5 year compounded annual growth rate estimate of 30%.
82. On July 19, 1996, Alex. Brown issued a report on TCSI, authored by Gordon. Gordon obtained the information for this report from Strauch and Farmer in conversations with them, the July 18, 1996 conference call and follow-up conversations with Strauch and Farmer. That report forecast the following EPS for TCSI:
1996E 1997E
1Q $0.13A $0.16
2Q 0.13A 0.17
3Q 0.14 0.18
4Q 0.15 0.22
Year $0.54 $0.73
The report also stated:
- Business was strong across all geographies as well as both new and existing customers. Core OSP and related products and services grew 54% year-over-year to $13.3 million.
- The June quarter was back-end loaded like every TCSI quarter and just as with the last 11 straight quarters, the Company made or exceeded estimates.
- In line with Company strategy, R&D spending ramped sharply in the quarter rising 50% sequentially from $1.0 million to $1.5 million.
- Management announced that it believes it will be selected for a $10 million service activation contract for a large U.S. carrier customer. We believe this could be the first phase of a multi-phase contract.
83. On or about July 20, 1996, TCSI distributed its Second Quarter Report to Shareholders, signed by Strauch, which stated:
TCSI's second quarter performance further confirms our confidence in our telecom focused software products and services strategy.
* * *
This quarter's activity reflects the progress we are making towards meeting our corporate objectives of being a premier provider of software products, services, and solutions to the global Telecom industry. Let me briefly summarize:
On July 26, 1996, as the lock-up agreement with the Underwriters was expiring, the Individual Defendants began again to unload their holdings, selling 96,000 shares in the following three weeks for proceeds of over $2.3 mi