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Stanford University Law School
- Securities Class Action Clearinghouse
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MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH (68581)
KAREN L. THOMAS (149536)
THOMAS E. EGLER (189871)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
- and -
REED R. KATHREIN (139304)
ALISON M. TATTERSALL (149607)
222 Kearny Street, 10th Floor
San Francisco, CA 94108
Telephone: 415/288-4545
LAW OFFICES OF STEVEN E.
CAULEY, P.A.
STEVEN E. CAULEY
SCOTT E. POYNTER
JAMES K. HATCHER
Suite 218, Cypress Plaza
2200 Rodney Parham Road
Little Rock, AR 72212
Telephone: 501/312-8500
Co-Lead Counsel for Plaintiffs
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
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DAVID T. O'NEAL TRUST, DATED 4/1/77 Plaintiffs, vs. VANSTAR CORPORATION, RICHARD H.
Defendants. |
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No. C-98-0216-MJJ CLASS ACTION SECOND AMENDED COMPLAINT Plaintiffs Demand A |
1. This is an action on behalf of purchasers of Vanstar Corp. ("Vanstar"/ "Company") stock between 3/11/96 and 3/14/97 ("Class Period"). Vanstar sells computer products and services to corporate customers. Plaintiffs allege defendants misrepresented Vanstar's business and prospects to take Vanstar public on 3/11/96, raise over $74 million in desperately needed equity capital to reduce its oppressive debt burden and boost the book value of Vanstar's controlling shareholders' stock ownership by $33 million and create a trading market in Vanstar's stock so insiders could unload 665,000 of their shares, pocketing $15 million in insider trading proceeds, Vanstar could issue 1.3 million of its stock to make three acquisitions and Vanstar could sell $200 million in convertible debentures and achieve $130 million in accounts receivable sales to further reduce its debt burden.
2. Defendants made false statements about Vanstar's "proprietary service delivery system" called NOVA. Initially, they represented Vanstar "expect[ed] NOVA to be implemented" during the "second half of fiscal 1996," i.e., by 4/30/96, and NOVA would result in increased margins, "lower costs," and a "significant reduction in personnel costs." They said the final development and implementation of NOVA was going according to plan and they expected Vanstar's profit margins to expand due to NOVA. When a delay in the implementation of the NOVA system was first revealed in 5/96, defendants assured investors that the system "[was] complete," but there would be a "slight[] delay[]" in implementation and that the system would be "deployed during the summer." Later in 96, defendants admitted they had not actually begun implementing NOVA until 2Q97, but represented that the rollout of the NOVA system was "in progress" and would help Vanstar's profit margins. As 96 unfolded, defendants continued to represent that progress was being made in implementing the NOVA system, that it would be 50% rolled out by 12/96 and fully implemented by the end of F97, i.e., 4/30/97, and that they expected "NOVA to drive profitability."
3. Defendants also represented that Vanstar was obtaining sufficient supplies of computer hardware products to meet customer demand. Even when other resellers reported product shortages, defendants stated "[w]e're not seeing this terrible product problem people are talking about . . . [s]ales are strong," and "we are not seeing any real difference in our business compared to normal practices." Later, in 96, when defendants did disclose that supply of product was not keeping up with demand and that this would lead to somewhat lower than expected product sales, they assured investors that this would be "offset by much stronger-than-expected gross margin." Throughout this period, defendants assured investors that "demand [was] not an issue," and that Vanstar's order rates remained strong.
4. Defendants were also very bullish with respect to Vanstar's network integration and service businesses, representing that in 96 they had "begun to fulfill the promises made to investors during our public offering," that they saw "no problem in sustaining [services] rate of growth" and that the "rapidly growing Professional Services . . . business is providing an increasingly important contribution to [Vanstar's] revenue and margin growth." They also represented that Vanstar was succeeding in controlling its expenses, which would also contribute to its earnings per share ("EPS") growth. They said that "Vanstar is a lean, mean machine when it comes to product distribution," was successfully controlling its SG&A costs, that their "sharp focus on expense control" "enabled us to steadily increase our profitability," and that "[t]his move[s] Vanstar into a position as one of the most profitable companies in our marketplace." As a result, Vanstar would meet its goal of lowering costs to generate a 4% operating margin in the second half of F97. As the Class Period unfolded, defendants represented that Vanstar "continue[d] to hold the line on [SG&A expenses] as we reap the benefits of management systems and operational improvements put into place in the past four years."
5. Defendants also forecast strong revenue and EPS growth for Vanstar in F97 and F98, representing that Vanstar would achieve F97 EPS of $0.99-$1.10 per share, including 3Q and 4Q97 EPS of $0.27-$0.32 and $0.31-$0.33 and F98 EPS of over $1.35. They assured investors that "results in all our key business areas were strong," that they were "encouraged by our company's fundamental growth in revenues and income," and our "basic businesses are all moving along nicely." They also described Vanstar's business as "totally hot," said that Vanstar was "in the sweet spot of the corporate business market," and that "the current tone of business remains strong." They also assured investors that they expected Vanstar's "gross margins . . . to remain stable" and "[did] not see a problem with sustaining the present rate of network services growth." According to defendants, "[w]e [have] assembled exactly the right people, systems and processes needed to manage all aspects of PC network infrastructures across the enterprise." Thus, "we expect continued and substantial growth in both revenues and profitability" for Vanstar due, in part, to "explosive growth in client demand," which demand they represented remained "robust" throughout the Class Period. They told investors that the "future of the company . . . looks bright . . . [w]e continue to outgrow the market place and gain share . . . [and we] expect over-all growth rates to remain in the 20 percent to 30 percent range."
6. As late as 1/9/97, Vanstar's President stated that Vanstar's 10/96 sales were "solid" and its 11/96 and 12/96 sales were "strong." Defendants continued to represent, as late as 1/16/97, that Vanstar was well on its way to achieving its forecasted EPS of $0.27-$-0.28 per share for the 3Q97, $0.30-$0.31 for the 4Q97 and $1.06 for F97 as a whole.
7. Defendants' positive statements were each false and misleading when made. The true facts which defendants concealed were:
8. The truth began to emerge on 1/23/97, when Vanstar shocked the markets by revealing its EPS for the 3Q97 would be only $0.15-$0.16, far below the prior forecast of $0.27, due to weak sales caused by product shortages and poor demand. Vanstar's stock plummeted from $22-1/8 to $14-7/8, a one-day 32% collapse on volume of 5.7 million shares, the largest one-day price decline and the largest one-day trading volume in Vanstar's history!
9. On 1/23/97, Vanstar's Chairman made several admissions in a conference call. With respect to the NOVA system that was supposed to have been completely implemented by 4/30/96, and positively impacting Vanstar's operating results in the 4Q96, he admitted:
[W]e still are continuing with the process of bringing our NOVA . . . project[] up . . . [and] that process is in fact not completed and today is still costing us money . . . .
* * *
Finally, in the life cycle services business . . . in the quarter the conversion expenses . . . were running for NOVA -- as opposed to any benefits . . . .
[T]here is a huge impact in gross margins for NOVA.
With respect to product shortages he admitted:
[There were] some severe product shortages in November and . . . December [was] just so-so . . . . November was very weak . . . .
* * *
Product availability . . . was horrible in November.
* * *
[W]e had a terrible August and September . . . .
With respect to Vanstar's service business, he admitted:
[O]ur professional service business was short in its volume.
Vanstar thus admitted that, while defendants were telling investors and analysts during 8/96 and 9/96 that Vanstar would do even better than previously forecast, and were revising their EPS estimates upward, they privately knew that Vanstar in fact was suffering a "terrible" 8/96 and 9/96.
10. As defendants revealed weak demand for Vanstar's computer products, slowing growth of its services business, its failure to complete the development or implementation of its NOVA service delivery system, Vanstar's impaired competitive position, and that its inability to control escalating expenses would result in sharply declining EPS, Vanstar's stock fell to $9-5/8 on 3/14/97 and ultimately to $6-1/2. On 3/24/97, Information Week reported that Vanstar had still not completed its deployment of NOVA, that benefits from NOVA would not accrue to Vanstar until F98 and that delays in the rollout had resulted in substantial additional costs. As of 9/97, 18 months after the date by which defendants assured investors NOVA would be operational and benefitting Vanstar's bottom line, NOVA still had not been fully implemented!
11. Vanstar's poor performance during 3Q and 4Q97, with declining EPS compared to the large increases forecast is shown below:
VanStar Corporation
Quarterly Results
(In thousands, except EPS)
Fiscal 1996
07/31/95 10/31/95 01/31/96* 04/30/96*
Revenues $427,169 $445,128 $446,862 $485,654
Net Income $3,314 $4,951 ($7,537) $16,519
EPS $.10 $.15 ($.24) $.44
Fiscal 1997
07/31/96 10/31/96** 01/31/97** 04/30/97
Revenues $559,090 $543,733 $527,542 $548,201
Net Income $9,763 $11,078 $7,521 $1,632
EPS $.23 $.26 $.17 $.04
12. The graph below shows Vanstar's stock as defendants drove it to an artificially inflated Class Period high of $29-3/4. It also shows the collapse of Vanstar's stock as the previously concealed facts about Vanstar's business emerged as well as the performance of Vanstar's stock compared to an index of similar companies which shows that the action of Vanstar stock was due largely to company-specific events and not market forces:
13. Jurisdiction exists and venue is proper here pursuant to §27 of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §78aa.
14. David T. O'Neal Trust, Dated 4/1/77, purchased 1,000 Vanstar shares on 11/19/96 at $27-1/4. Tammy Newman purchased 100 Vanstar shares on 5/1/96 at $13-5/8.
15. Vanstar sells and services products to build and manage personal computer network infrastructures for large companies, what it calls the PC/network "Lifecycle" from (i) the decision to buy the network platforms (Consulting and Design) to (ii) buying and delivering the hardware (Acquisition and Deployment) to (iii) operating and maintaining the desktop PCs and the related network (Operations and Support) and to (iv) starting the cycle over by deciding to upgrade PCs or the network platform (Enhance and Migrate). Vanstar's stock trades in an efficient market on the New York Stock Exchange.
16. (a) William Tauscher was Vanstar's Chairman, CEO and a member of its Executive Committee.
(b) Richard Bard was a Vanstar Director and member of its Executive Committee.
(c) Jay Amato was President, COO and a Director of Vanstar, and in charge of the NOVA project.
(d) Jeffrey Rubin was Vice Chairman of Vanstar's Board and its CFO.
(e) Robert Kuntzendorf was SVP-Operations-Vanstar.
(f) Richard Anderson was SVP-Sales-Vanstar.
(g) Ahmad Manshouri was SVP/General Manager-Product Operations-Vanstar.
(h) Michael Moore was SVP-Management Information Services-Vanstar.
(i) Coleman Sisson was SVP/General Manager-Learning Network-Vanstar.
(j) Thanos Triant was SVP/Chief Technology Officer-Vanstar.
(k) Chris Laney was SVP-Networking Services-Vanstar.
(l) Stewart Gross was a Director of Vanstar, a member of its Executive and Audit Committees and on Vanstar's Compensation and Stock Option Committee. He was a Managing Director of Warburg (as defined in ¶18 below).
(m) William Janeway was a Director of Vanstar and on the Pricing Committee for the IPO. He was a Managing Director of Warburg.
(n) John Vogelstein was a Director of Vanstar. He was the President and Vice Chairman of Warburg.
17. The defendants identified in ¶¶15-16(a)-(n) are the "Vanstar Defendants," and defendants identified in ¶16(a)-(n) are the "Individual Defendants." The Vanstar Defendants controlled the contents of Vanstar's SEC filings, corporate reports and releases and each of them is legally responsible for the false statements in these documents as "group-published" information.
18. Warburg Pincus & Co., E.M. Warburg, Pincus & Co., Inc. and Warburg Pincus Capital Co., L.P. ("Warburg") were Vanstar's controlling shareholders. Before the IPO Warburg owned 50% of Vanstar, and as of the IPO, Warburg owned 13.8 million Vanstar shares -- 35% of its stock -- and had three representatives on Vanstar's Board. Another Warburg associate, Cary Davis, routinely participated in Board meetings, which were regularly held at Warburg's office in New York.
19. Tauscher, Bard, Gross, Vogelstein, Janeway and Warburg, by reason of their positions with Vanstar and their stock ownership, were controlling persons of Vanstar. Warburg controlled Gross, Vogelstein and Janeway. These controlling persons are liable pursuant to §20(a) of the 1934 Act.
20. Each defendant is liable for making false statements, selling Vanstar stock while failing to disclose adverse facts or participating in a fraudulent scheme and course of business which: (i) deceived investors and inflated Vanstar stock; (ii) permitted Vanstar to sell 14.7 million shares of stock in the 3/11/96 IPO and certain defendants to later sell 665,000 shares of Vanstar stock -- all at inflated prices; and (iii) permitted Vanstar to sell over $200 million in convertible debentures and to issue over 1.3 million shares of its stock to make three acquisitions during the Class Period.
21. As officers, directors and controlling persons of Vanstar and as sellers of its stock, each defendant had a duty to disseminate any material non-public information regarding Vanstar, so that the market price of its stock would be based upon accurate information. Notwithstanding their duty not to sell Vanstar stock while in the possession of such information, certain of the defendants sold 665,000 shares of their Vanstar stock, pocketing over $15 million in illegal insider trading proceeds.
22. Vanstar's Board was very much involved in the management of its business. On 8/5/96, PC Week reported:
Vanstar's board has operated more like the Joint Chiefs of Staff than the diplomatic corps. The directors are deeply involved in strategic decision making -- and, on occasion, day-to-day operations.
* * *
Bill Tauscher: "Our board meetings are pretty intense. A lot of people run meetings that last an hour or two. Ours last a day."
23. The Individual Defendants, other than Gross, Janeway and Vogelstein, were top executives of Vanstar. They ran Vanstar as "hands-on" managers, dealing daily with the most important issues facing Vanstar's business, i.e., orders for and sales of its products, availability of those products for sale, the development of Vanstar's NOVA system, demand for Vanstar's services and Vanstar's actual performance compared to budgeted levels.
24. Gross, Janeway and Vogelstein were much more involved in the day-to-day operations of Vanstar than would be the case with ordinary "outside" directors because they represented the largest Vanstar shareholder (Warburg) on Vanstar's Board. Warburg, by and through defendants Janeway and Gross, participated in planning, drafting and due diligence meetings with respect to the Vanstar IPO. Warburg employees attended status report meetings with Ernst & Young, LLP ("E&Y") regarding the NOVA project, including an 4/95 meeting in Atlanta. In the offering circular for its 9/96 offering of $200 million in convertible debentures, Vanstar admitted that Warburg exercised "significant influence over the management and policies of the Company." To protect the Warburg interests and to keep it informed on a current basis as to Vanstar's business and the value of Warburg's investment in Vanstar, Gross, Janeway and Vogelstein were actively involved in Vanstar's management and in constant contact with Tauscher, Amato and Rubin, and received the same reports and information as the other Individual Defendants.
25. Because the successful completion and implementation of the NOVA system, continued strong orders for Vanstar's products at good prices and resulting strong growth in the sales of those products and continued strong sales were indispensable elements to Vanstar meeting its internally budgeted and publicly disseminated F97/F98 revenue and EPS forecasts, defendants constantly monitored each of these key factors affecting Vanstar's business.
26. Because of their positions with Vanstar and involvement in the day-to-day management of its business, each Individual Defendant actually knew from internal corporate documents and conversations with other corporate officers and employees and their attendance at management meetings, the adverse non-public information concerning: Vanstar's core business including the status of its new automated service delivery system, NOVA; significant weakening demand for Vanstar's products; Vanstar's serious product constraint problems with high-end products, including those made with the Pentium Pro microchip; the significant slowing orders for its products, including slowing orders from one of its largest customers, Microsoft; and Vanstar's deteriorating revenue and EPS prospects, in part due to the termination of IBM's incentive rebate program at the end of 2Q97 . They also knew that as a result, Vanstar would not be able to achieve the F97/F98 revenue and EPS growth being forecast by and for it. Each of the defendants also knew about the material accounting policies and treatment of the Company including that Vanstar was improperly capitalizing expenses, including software development costs, related to the NOVA project during the Class Period in violation of Statement of Financial Accounting Standards ("FAS") No. 86. Each Individual Defendant actually knew that the public statements pleaded at ¶¶60-131 were false or misleading when made.
27. Because of the importance of completing NOVA during F96, Vanstar's top insiders received frequent reports on Vanstar's NOVA. Representatives of Vanstar's accountants and auditing firm met with members of Vanstar's management at least once each month to discuss the status of NOVA development and implementation and proper accounting treatment. Defendants were regularly briefed on NOVA status by defendant Amato at Vanstar's Board meetings. The defendants also closely monitored the performance of Vanstar's business via management reports which Vanstar's Finance Department generated on a monthly basis. There were "order reports" and "backlog reports" that summarized sales, orders and shipments. The Finance Department also distributed monthly reports comparing Vanstar's actual financial results to projected results. Thus, each defendant was apprised of the status of orders for and sales of Vanstar's products so that they knew where Vanstar stood in terms of current sales of and demand for Vanstar's products as well as orders and Vanstar's actual results compared to budget. Thus, the defendants knew that demand and orders for Vanstar's products were weakening, that it was encountering serious problems, was achieving sales below internally budgeted rates and that completion of NOVA would be delayed for many months and thus Vanstar's publicly disseminated F97/F98 EPS forecasts could not and would not be achieved.
28. In late 94, Vanstar hired E&Y to create NOVA -- an internal proprietary system designed to interface with Vanstar's customers for the service aspects of its business, invoicing, accounts receivable, inventory, warranty projects, parts, and scheduling. Defendants told the public that this system would allow Vanstar to substantially cut costs, through reduced head-count and inventory, better warranty capture and service, and would improve account receivables. The agreement called for Vanstar to pay E&Y a fixed $9.6 million fee, with $3.7 million deferred until the systems were implemented and Vanstar was realizing benefits. However, from the start the overall development of NOVA slipped significantly, well in advance of the IPO. As of 11/95, E&Y noted that Vanstar had caused at least 8,500 hours of overrun on the project due to scope changes, inefficiency, "unnatural design," screw-ups, misses, rework and extensive overruns. To try to keep costs to the fixed fee, NOVA functionality was significantly reduced. Defendants knew that a large portion of NOVA's functionality -- and thus its benefits to Vanstar -- had been "stripped" to reduce E&Y's fees and costs of the project. Defendants knew as a result of this reduced-down functionality that NOVA would not provide the benefits to Vanstar's bottom line and future financial performance that Vanstar had repeatedly promised to analysts and the public. In fact, before the IPO, Vanstar privately admitted to E&Y that it was not clear that the NOVA project would be a net benefit to Vanstar at all. Vanstar complained to E&Y that they thought that they were contracting to buy an "eagle," but they were getting a "duck" instead. By late 95 Vanstar had taken over much of the project from E&Y, including data cleanup, data creation and creation of software interfaces to link NOVA to Vanstar's systems.
29. By early 96, Vanstar had still not completed critical tasks necessary to use the system, including: (1) converting and cleaning up data on its over 8000 customers for use with the system; (2) selecting a reporting tool and creating the hundreds of reports NOVA was expected to generate; (3) creating various software interfaces necessary for use of the system. None of these critical tasks, necessary to the operation of the system, had been completed by Vanstar as of the IPO.
30. Just weeks before the 3/11/96 IPO, defendants knew, from reports of tests of the NOVA system conducted in late 95 and early 96 that the NOVA system did not work as designed. The system was supposed to handle all customers' service needs with one quick call. The system was not sufficiently "scaleable," in that it could not handle anywhere near the number of users necessary for Vanstar's business, which served over 8000 customers. Testing also revealed that the NOVA system was far too slow, taking as long as 39 minutes to process a purchase order, and would be perceived by users not as an upgrade or new industry standard, but as defective and not sufficient for their business needs. The problems included both the software architecture and the AS/400 computer platform.
31. At the 3/28/96 Vanstar Board meeting, the directors discussed these problems, and were told: NOVA was experiencing its second month of delay because it would not run on an AS/400; that additional headcount needed would increase costs; and that E&Y had oversold its experience, which was in outdated technology and that E&Y did not know how to solve the problem. In 4/96, just weeks after the IPO, Tauscher met with E&Y representatives to discuss alternatives. As of 6/96 Vanstar was still discussing the alternatives and no decision had been made about how to fix the problems with the bulk of the NOVA functions. Finally, Vanstar decided to use an entirely new platform designed by IBM, the CA400, despite the fact that the CA400 was still being beta tested and was so new no CA400 production site existed for E&Y or Vanstar to test. As defendants knew, getting every component to the 32 Bit release level for use with the CA400 and putting the software stack back together and getting it all to run had not been attempted or tested. This would take a considerable amount of time until all vendors' products could arrive at a stable release that allowed Vanstar to integrate them.
32. NOVA was originally designed to be a single seamless system with various areas of functionality. In the spring of 96, defendants decided to break the system up into two pieces and roll out the Logistics piece first, to be followed by the Service Delivery system, which contained the remaining NOVA functions. Thus instead of creating a new, seamless, restructured system, Vanstar decided to construct a "NOVA Bridge" to link the NOVA Logistics function with Vanstar's older, existing Stargate and Orion software, and to graft the NOVA Logistics piece onto its current computer systems. Vanstar had not even begun to create the "NOVA Bridge," nor test the ability of the Stargate and Orion systems to handle the volume of its NOVA Logistics system. As to the larger, more complicated Service Delivery system, as of 6/96 defendants were still discussing options to deal with the fact that the majority of the system's functions did not work due to software and hardware problems.
33. As of 7/96 the pilot of the NOVA Logistics piece, the first production piece of the NOVA system, still had not been tested and the NOVA Bridge had neither been installed nor tested. At that time E&Y told Vanstar that they were uncomfortable with Vanstar's implementation efforts and that NOVA would be a fiasco, that Vanstar's methods for NOVA implementation could be "fatal to NOVA," and that implementation and support was "inadequate." E&Y also pointed out that Vanstar's poor data integrity would cause the NOVA application to not be used effectively by the user, and would cause a slow system or an inaccurate system that could not handle business needs. As of 8/96, Vanstar employees were disappointed and frustrated with the NOVA rollout, complaining that "we make decisions about the rollout schedule, then for some reason they change the schedule." As of 9/96, the NOVA Logistics effort still was nowhere near completion; the pilot system, running in a handful of locations, was experiencing software bugs and was unable to run any reports; the NOVA development team was so overwhelmed with bug-fixing efforts that necessary testing and rebuilding of the system was at a standstill; and certain hardware necessary to development and running of NOVA reports had not even been ordered.
34. As of the time of the 10/2/96 private placement offering of $200 million in convertible debentures, the NOVA Bridge to Vanstar's existing Stargate system, essential to rollout of NOVA Logistics, still was not stable and was unusable. The Logistics system installed at pilot locations was continuing to experience "anomalies." As of 11/21/96, Vanstar's customer data still was not ready for production use in NOVA, preventing NOVA's deployment, because Vanstar had never cleaned up the customer and contract information as was necessary to implement the NOVA system. Vanstar's NOVA team noted that Vanstar could not implement at the current rate, and that the "schedule was out of control."
35. By 12/96 Vanstar was predicting that NOVA would be a total failure requiring a $20 million writeoff by Vanstar. Other employees had simply "given up" months before after repeatedly pointing out the inaccuracy of the NOVA data with no solution in sight. And, the performance of the Stargate system, so critical to the NOVA Logistics rollout, had begun deteriorating rapidly at the end of 11/96, stalling to such an extent in 12/96 that Vanstar's customer service operations had to write customer data on paper rather than enter it into Stargate -- a "catastrophe."
36. In 1/97 Vanstar senior management, including defendants Amato and Tauscher, members of the NOVA team and E&Y representatives, had an all day meeting regarding Vanstar's NOVA implementation. At that meeting participants questioned the eventual success of the NOVA project; noted that continued slippage of dates was to be expected; and discussed the fact that the NOVA Bridge was far from production ready, as design, development, and testing still were not complete. In fact, the NOVA Bridge had never been load tested; 8000+ customers' data still had not been through initial cleanup/audit effort by Vanstar; the data was often found to be missing and the Sybase database was unstable; and initial users, whose approval was critical to the success of the project, hated NOVA and were having "strong disagreement" with the processes that NOVA imposed. As of 4/97, these problems were still not resolved.
37. Defendants knew Vanstar's financial results reported for 2Q and 3Q96 in the Prospectus were false and misleading in that they included $3.5 million of improperly recognized distribution fee revenue due from Merisel. Vanstar had previously sold its franchise and distribution operations to Merisel. In connection with that sale Vanstar continued to obtain a distribution fee from Merisel. In 95 Merisel was experiencing financial problems and by 7/95 was negotiating with Vanstar to reduce the fees it owed Vanstar as part of its distribution services agreement, in part based on financial problems. Yet Vanstar continued to recognize the same fee revenue in the 1Q and 2Q96, ended 7/95 and 10/95, despite defendants' knowledge that Merisel was unlikely to pay the higher fee. Instead, in the Prospectus, defendants portrayed Vanstar as having just found out from Merisel's 2/96 announcement that Merisel was experiencing financial difficulties, implying that Vanstar was being conservative in taking a reserve against its Merisel receivable. Vanstar did not reveal that $3.5 million of that reserve reflected a reversal of fee revenue Vanstar should not have recognized in the first place. In fact, to comply with Generally Accepted Accounting Principles ("GAAP"), Vanstar should have restated its 1Q and 2Q96 results as presented in the Prospectus which would have reduced its profit by about $0.10 per share. Rather than restate those quarters, and inform investors that they had known for nine months of Merisel's problems and had improperly recognized that revenue to show a tiny profit, defendants decided, in order to maintain investor interest in Vanstar's IPO, that they would falsely portray Vanstar as having acted conservatively in the face of a sudden, unexpected business downturn for Merisel, by taking a reserve in 3Q96.
38. Defendants also had knowledge that their forecasts were unreasonable, not believed, or undermined by significant undisclosed facts. In addition to their knowledge of NOVA, Merisel and improper capitalization of software development expenses, defendants regularly received reports comparing Vanstar's budgets, actual results, and forecasting for each quarter and the fiscal year and regular business update reports.
39. At the time they faxed a 2/96 forecast to analysts which showed a benefit from NOVA to operating income of $800,000 in 4Q96 and $2.35 million in each quarter of F97, for a positive impact of $9.4 million in F97, defendants knew NOVA had failed the tests administered in 12/95 and 1/96, and knew that the benefits they forecast for F96 and F97 would not be realized.
40. Defendants knew at the time they decided to roll out the Stargate-Logistics piece of NOVA, in early F97, that Stargate was not budgeted as a go forward production environment and thus no support for Stargate was budgeted for F97.
41. Defendants knew that a significant portion of Vanstar's gross margins on product sales came from rebates from large OEM suppliers including IBM, and that Vanstar was dependent on these rebates for its gross margins on product sales. During 2Q97, ended 10/31/96, Vanstar had a deal with IBM whereby IBM would pay Vanstar a 4% rebate on volumes of $200-$300 million of product sales -- a potential $8-$12 million impact on Vanstar's gross margins. Defendants knew this rebate program would expire at the end of 2Q97, and that Vanstar would not be benefitting from that rebate program in the 3Q97.
42. As of 11/96 defendants also knew, by virtue of the reports they received, that sales to one of Vanstar's three big customers, Microsoft, were more than 10% below budget for the fiscal year; that forecasted sales for 12/96 were more than 15% below budget and more than 25% below plan, as sales continued to be negatively impacted by Microsoft's reduction of capital budget dollars available to purchase computer equipment. In fact, while defendants told analysts that 11/96 and 12/96 were "strong" months for sales of Vanstar's products, they knew from these reports that both 11/96 and 12/96 were weak due to decreased demand and continuing increased product constraints.
43. In addition to having actual knowledge of the falsity of Vanstar's forecasts, statements concerning NOVA and Vanstar's financial statements, each of the defendants had the opportunity to commit the fraud. They were top Officers and Directors and large shareholders of Vanstar. They controlled the public dissemination of, and could falsify, the information about Vanstar that reached the public and impacted its stock.
44. The defendants had a motive to commit the fraud. Vanstar is the successor of ComputerLand, which became virtually insolvent in 85-86. In 87, in re-capitalizing ComputerLand, Tauscher, Bard and Warburg received 2.2 million, 1.3 million and 13.8 million shares of ComputerLand stock for $81 million. They then sold ComputerLand's distribution business, acquired computer service businesses from NYNEX and re-named ComputerLand Vanstar. However, Vanstar's business continued to lose $80 million from operations in 92-94, accumulating a huge debt of over $360 million, requiring annual interest payments of $33 million.
45. By 1/96, Vanstar was on the verge of a collapse which would wipe out the controlling shareholders' $81 million investment. As of 10/31/95, Vanstar had $744 million in total assets and $714 million in total liabilities, including long-term debt of $361 million. The book value of Warburg's, Tauscher's and Bard's Vanstar shares was a negative ($0.19) per share. Compounding Vanstar's extreme leverage was the fact that Vanstar's product sales business had tiny gross margins (less than 10%), yet was very capital intensive in that Vanstar had to purchase and maintain a large inventory of computer products in order to be able to "resell" those products. Because Vanstar was chronically undercapitalized, it had to borrow large amounts to finance its working capital needs. Vanstar obtained its financing needs through a credit agreement with IBM Credit Corp. ("IBMCC"), which carried very expensive variable interest rates.
46. The IBMCC agreement also prohibited Tauscher and Warburg from reducing their ownership (in the aggregate with NYNEX), to below 51%, except upon a public offering of Vanstar stock. By late 95, Vanstar was in desperate need of cash. It had to increase its IBMCC credit line to keep operating, but then used up virtually all of the extended line and was in technical default of that line. It had also failed to repay $2.46 million owed NYNEX. Vanstar's suppliers were also threatening to refuse to ship product to it. Vanstar was virtually out of cash and could not obtain any more credit from IBMCC, its suppliers or banks.
47. Vanstar's controlling shareholders realized that, to avoid the collapse of Vanstar and the loss of their $81 million investment, they needed to take Vanstar public. An IPO was the only way for them to salvage their investment, as only an IPO could raise a large amount of cash to reduce Vanstar's debt and its huge interest payments and boost the book value of the Vanstar shares owned by them back into positive territory. Only an IPO would enable Vanstar to repay its debt to NYNEX, and cure its default under the IBMCC facility. Only an IPO would create the trading market in Vanstar's stock defendants needed to be able to sell more Vanstar equity securities to raise additional cash to further reduce Vanstar's debt and permit certain Vanstar insiders to sell off their Vanstar stock.(1) And, only an IPO would create a trading market in Vanstar stock and enable Vanstar to make acquisitions using Vanstar's stock.
48. For F95, ended 4/30/95, Vanstar eked out tiny net income of just $1.2 million or $0.04 per share on sales of $1.3 billion. However, this provided the opportunity for Vanstar, its controlling shareholders, insiders and investment bankers to take advantage of Vanstar's achievement of profitability by taking it public. Vanstar's controlling shareholders and insiders hurried to take Vanstar public, as they realized that adverse facts concerning Vanstar's increasing costs and delays with the NOVA system could not be concealed indefinitely and, if they became known, would prevent an IPO, leaving them locked in their unfavorable and illiquid investment position and result in Vanstar's insolvency and the loss of their $81 million investment.
49. The IPO was originally planned to take place in early 12/95. By 9/95, defendants retained investment bankers and were hard at work on the IPO. However, they realized Vanstar could face great difficulty in marketing an IPO, as it was barely profitable, was very highly leveraged, and that, even after a successful IPO it would still have to borrow over $200 million in order to finance its huge working-capital requirements. Moreover, the defendants wanted to raise the large amounts of cash needed by issuing as few shares as possible so that they would not unduly dilute the ownership stake of Vanstar's controlling shareholders. To do this, they wanted to sell Vanstar stock in the IPO at as high a price as possible. To obtain a high price for Vanstar's stock in the IPO, they knew they would have to persuade investors that Vanstar was no longer merely a reseller of computer products, a very capital-intensive/low-profit-margin business, but was becoming more of a provider of computer services, a service business which required less capital and produced significantly higher profit margins and that, as a result, Vanstar was transforming into a high-profit-margin business, which would be able to achieve consistent EPS growth. Defendants told investors the NOVA system was part of this transformation, and would contribute to Vanstar's increasing gross margins.
50. In Vanstar's 3/11/96 IPO, Vanstar sold eight million shares for $74.7 million. Vanstar's controlling shareholders salvaged their $81 million investment in Vanstar. Vanstar's IPO also raised enough cash to increase the book value of their Vanstar shares from $(0.19) to $1.69 -- a $32.9 million windfall for Warburg, Tauscher and Bard, who owned 17.3 million shares! As a result of the infusion of cash from the IPO, Vanstar was able to obtain a reduction in its interest rate from IBMCC, from prime plus 1-1/8 points pre-IPO to prime minus 1/2 point as of 5/1/96.
51. Armed with cash from its IPO and now having freely tradable stock, Vanstar went on an acquisition binge. In 5/96, Vanstar acquired Dataflex Corp. for $37 million in cash. On 9/4/96, Vanstar acquired Mentor Technologies for 300,000 shares of Vanstar stock. On 12/16/96, Vanstar acquired National Technology Group/Contract Data Services for 952,491 shares of stock. On 1/9/97, Vanstar acquired inventory and equipment from DCT Systems, Inc. for cash and 180,000 shares of Vanstar stock. In 9/96, defendants took advantage of Vanstar's soaring stock price to sell $200 million in convertible debentures to re-finance Vanstar's IBMCC variable-rate debt with lower cost, fixed-rate debt on an equity security convertible into Vanstar's common stock.
52. As Vanstar's stock climbed toward its all-time high levels upon the expiration of the "lock-up" on 9/11/96, certain Individual Defendants sold off their Vanstar stock. In 9/96 and 12/96, they unloaded over 665,000 shares, at as high as $25.88, selling 68% of their collective holdings, pocketing $15 million in illegal insider-trading proceeds. These stock sales were unusual. They had never before sold any Vanstar stock. They began to sell their stock immediately upon the expiration of the 180-day IPO "lock-up" agreement and as Vanstar stock was soaring to all-time highs. Just weeks after the last of these sales, Vanstar's stock collapsed. These defendants sold no stock after the stock collapsed. However, in 5/97, after the horrible news about Vanstar's business had finally been fully revealed and Vanstar's stock had fallen to its all-time low of $6-1/2, 35% below its $10 IPO price and 78% below its Class Period high of $29-3/4, Warburg purchased 2,604,100 shares of Vanstar stock on the open market at $6-3/4 -- just $1/4 per share above the stock's all-time low price!
53. Defendants made admissions during and after the Class Period evidencing their knowledge of the significant problems with the development of the NOVA project and its adverse impact on Vanstar's earnings, Vanstar's severe product shortages and the weakness of sales in 11/96 and 12/96 (at the same time certain defendants unloaded shares), as well as the terrible 8/96 and 9/96 business conditions. In a conference call on 1/23/97, Tauscher, Rubin and Amato admitted:
54. Ultimately, defendants even admitted their improper capitalization of the NOVA project expenses. In 2Q98, Vanstar took a write-off of up to $9 million for the write-off of capitalized software, much of which related to NOVA. Defendants further admitted that they had decided to abandon part of the NOVA project in favor of outsourcing Vanstar's parts procurement and repair function, writing off some $16 million.
55. Before the Class Period, Vanstar made several positive announcements to cause increased investor interest in Vanstar and to enable Vanstar to increase its stock price on the IPO.
56. In 7/95, Vanstar announced it was in the "final stage" of its NOVA project. Vanstar stated the NOVA project would result in the elimination of 200 positions in F96 and
The NOVA project . . . will be functional by late September, first at Vanstar's Atlanta National Technical Center. Field locations will be brought online between this October and March 1996. NOVA will then be implemented to its overseas locations.
The press release went on to explain the great benefits of the NOVA system:
Vanstar believes that NOVA systems and processes will improve customer service in the following areas: increased uptime, more accurate matching of parts and skill levels, more accurate and timely billing, more customized service delivery, better reporting, more reliable warranty capture, and more management information for asset optimization. Vanstar believes that disclosure of NOVA Project capabilities was instrumental in Vanstar's recent award of a major manufacturer's contract for retail service business. . . . Vanstar expects internal cost savings to result primarily from reduced cycle time on accounts receivables, substantially better warranty capture, reduced parts inventory and reduced head count in non-technical positions. Approximately 200 U.S. based non-technical positions are expected to be eliminated over the six month implementation beginning in September 1995.
57. By 9/95, defendants were hard at work on the Vanstar IPO. To create the investor interest necessary to sell the over 14 million shares to be marketed in the IPO, defendants knew from testing in 12/95 and 1/96 that the distribution of favorable information about Vanstar and its prospects was necessary. Thus, on 1/29/96, Tauscher, Rubin and Amato faxed a Vanstar EPS forecast to analysts, which showed Vanstar's projected services revenues and expenses for its North American Operations for F96-F98, based on a significant contribution from NOVA including revenues of $1 million, $5.2 million and $5.4 million in the 4Q96, F97 and F98. This forecast also showed that deployment of the NOVA system would reduce Vanstar's expenses by $900,000, $7.4 million and $9.48 million in the 4Q96, F97 and F98, boosting Vanstar's EPS in the 4Q96, F97 and F98. On 2/5/96 Vanstar faxed another forecast to analysts, which included a positive impact by NOVA on Vanstar's operating income of $800,000 during the 4Q96, and $2.35 million in each quarter of F97, for a positive impact on operating income of $9.4 million in F97, and $11.8 million in F98.
58. Defendants also organized a "roadshow" prior to the IPO where Vanstar's top executives met with institutional investors, money and portfolio managers, brokers and potential investors to make presentations about Vanstar. This included a "slide show" and EPS forecasts not included in the IPO Prospectus. The roadshow took place from 2/19/96-3/7/96 -- during which Tauscher, Amato and Rubin made presentations in Paris, London, Zurich, Baltimore, Boston, San Francisco, San Diego, Los Angeles, Portland, Chicago, Milwaukee, Texas, New York City, Minneapolis and Denver.
59. During the roadshow presentations in connection with Vanstar's IPO in New York (3/4-5), Boston (2/23), Chicago (2/29), Los Angeles/San Diego (2/27) and San Francisco (2/26), Tauscher, Rubin and Amato stated:
60. The information distributed to analysts and investors prior to Vanstar's 3/11/96 IPO, as pleaded in ¶¶56-59, was part of the total mix of information impacting Vanstar's stock price at the time of the IPO and thereafter. Vanstar's 3/11/96 IPO Registration Statement and Prospectus, signed by Tauscher, Bard, Amato, Rubin, Gross, Janeway and Vogelstein, stated:
The Vanstar Solution
* * *
Vanstar's NOVA system is a proprietary service delivery system for the management of the Company's systems engineering help desk, dispatch, repair, installation, moves/adds/changes and asset management service offerings. The Company expects NOVA to be implemented during the second half of fiscal 1996 [i.e., by April 30, 1996]. Vanstar believes that its proprietary automated systems significantly enhance its ability to satisfy its customers' needs.
* * *
NOVA is complemented by more than 40 strategic stocking locations in the United States, and parts can be delivered the same day or shipped overnight to either the customer location or the field service engineer. The Company believes that NOVA will result in increased customer network uptime, more accurate matching of part and field service engineer skills to service needs, more accurate and comprehensive information management and lower costs.
In short, defendants assured investors in the Prospectus that NOVA would be up and running in six weeks and, thus, the schedule announced in 7/95 for NOVA would be adhered to and that the NOVA Project was on schedule.
61. These statements were false and misleading because at the time they were made defendants knew from testing in 12/95 and 1/96 that the NOVA system did not work as designed, that it had to be redesigned, that the system was too slow and could only operate with a very small number of users. Based on these facts, defendants knew NOVA would not be implemented during the "second half of fiscal 1996" and defendants knew that NOVA implementation in fact was not occurring, and that none of NOVA was yet in production.
62. The Prospectus also stated the following with respect to Vanstar's relationship with Merisel:
On February 20, 1996, Merisel, Inc. ("Merisel") announced that (i) the release of its fourth quarter and fiscal year financial results for the periods ended December 31, 1995 would be delayed pending completion of its fiscal year-end audit; (ii) Merisel anticipates that its fourth quarter net loss will be significantly greater than the expected loss of $0.15 to $0.20 per share; (iii) Merisel is negotiating with its lenders regarding potential non-compliance with certain financial covenants under certain of its loan agreements; and (iv) Merisel has engaged a financial advisor to assist in assessing its strategic options in order to maximize shareholder value. Through February 29, 1996, Merisel FAB, Inc. is current in its payments to the Company.
As a result of the announcement by Merisel, the Company has decided to record a $31.1 million provision against its receivables due from Merisel FAB at January 31, 1996. See Note 18 of Notes to Consolidated Financial Statements. The provision will be reflected in the Company's results of operations for the quarter ended January 31, 1996. The Company expects to report total revenues of $446.9 million and a gross margin of $58.9 million for the three months ended January 31, 1996. Before recording the provision, the Company would have reported operating income of $13.1 million and net income of $5.1 million for the three months ended January 31, 1996. Including the provision, the Company expects to report an operating loss of $18.0 million and a net loss of $7.5 million for the three months ended January 31, 1996. Such quarterly information is preliminary and subject to change; however, any adjustments made are not expected to be material. The preliminary results for the three months ended January 31, 1996 are not necessarily indicative of results for any future period or for a full fiscal year.
63. The Prospectus and these statements about Merisel were false and misleading, as they concealed that Merisel and Vanstar had begun renegotiating the distribution services agreement in 7/95 with Merisel seeking to reduce the quarterly distribution fee based in part on its financial difficulties. As the quarterly results included in the Prospectus reveal, Vanstar improperly continued to recognize the old, higher distribution fee in the quarters ended 7/31/95 and 10/31/95, even though the Individual Defendants knew it was doubtful Merisel would ever agree to pay the higher fee, thereby inflating Vanstar's results in the 1Q and 2Q96. The Prospectus also failed to disclose that part of the 1/31/96 adjustment related to Merisel was to reverse $3.5 million in previously recognized Merisel distribution fee revenue.
64. On 4/1/96, Vanstar announced its results for the 3Q96, the quarter ended 1/31/96. Tauscher stated:
"Vanstar's operating results in all our key business areas were strong for the third quarter and first nine months of fiscal year 1996 and we're very encouraged by our company's fundamental growth in revenues and income."
65. On 4/2/96, Amato, Rubin and Tauscher spoke to dozens of analysts, institutional investors, money and portfolio managers, Vanstar shareholders and brokers in a conference call. Vanstar had previously provided to analysts EPS forecasts including a positive impact by NOVA on Vanstar's operating income of $800,000 during 4Q96, and $2.35 million in each quarter of F97, for a cumulative positive impact by NOVA of $9.4 million on Vanstar's F97 EPS. Defendants also assured analysts that NOVA alone would increase Vanstar's operating income by some $11.8 million in F98. Defendants told analysts that NOVA would generate an additional 10%-15% operating margin for network services for acquisitions. During the call and in later conversations with analysts, defendants stated:
Q1 $ .16
Q2 $ .23
Q3 $ .30
Q4 $ .31
Year $ 1.00
Following this call, defendants held additional discussions with those analysts they considered to be their "key analysts" -- Robertson Stephens & Co., The Robinson-Humphrey Co. and Alex. Brown & Sons Inc. During this call, they discussed additional information, including EPS projections and sales to new customers.
66. On 4/8/96, Robertson Stephens issued a report on Vanstar, written by Susan Lacerra, which repeated information provided her in the conference call and follow-up conversations with Tauscher, Rubin and Amato. It forecast F97 and F98 EPS of $.99 and $1.17 and stated:
Product business continues strong; gross margins are holding steady, backorders have been strong -- $18M at the end of February, lower manufacturer pricing spurring demand.
* * *
Internally the big event over the next couple of quarters is the rollout of the company's NOVA project, a system that creates efficiencies in dispatch and monitoring of staff deployment. Support Services margins are expected to expand from 4% in fiscal 1996 to 8% in fiscal 1997 due to the implementation of the NOVA project.
67. On 4/8/96, Alex. Brown issued a report on Vanstar, written by Edward Caso, which repeated information provided in the conference call and follow-up conversations with Amato, Rubin and Tauscher. It forecast the following F97 EPS for Vanstar:
Q1 $ .16
Q2 $ .23
Q3 $ .30
Q4 $ .31
Year $ 1.00
It also stated:
While continuing to strongly grow its hardware resale business . . . [g]ross margins on service are significantly higher than those on products, and therefore growth in service income will have a significantly larger impact on bottom-line growth. . . . Our initial EPS estimates for . . . FY 1997 [is] $1.00 . . . .
* * *
Management has invested heavily in . . . a project called NOVA, which is a proprietary automated service delivery system and is expected to allow for a significant reduction in personnel costs over the next 12 months.
The 4/8/96, Robertson Stephens and Alex. Brown reports were "booster shots," issued in connection with the Vanstar IPO.
68. On 4/8/96, an article in Computer Reseller News quoted Tauscher as stating: "Our basic businesses are all moving along nicely . . . . Our network consulting practice is a business that's running along today at around $75 million, just in fees. It's growing at 80 percent, compound."
69. The positive statements in ¶¶60-68 were each false and misleading when made. The true facts defendants concealed, included:
70. On 4/15/96, in the Computer Reseller News, Tauscher stated that Vanstar was experiencing certain "constraints" in obtaining some products, but reassured investors:
"We're not seeing this terrible product problem people are talking about. Sales are strong, and we are at the biggest backlog we've ever had."
* * *
Inventory levels rose to $337.9 million from $298.7 million at the end of April, but Tauscher said Vanstar is seeing standard inventory rises and drops based on the time of year.
71. On 4/23/96, Vanstar made an announcement that referred to Vanstar's "soon-to-be-released service-management system, called Vanstar NOVA."
72. On 5/13/96, an article in Computer Reseller News disclosed, for the first time, that the deployment of the NOVA system was delayed. However, Tauscher assured investors that it would be deployed during the summer:
Vanstar Corp.'s NOVA system . . . will start to be rolled out over the next few months, after a period of delay . . . .
* * *
NOVA will make its debut in two parts, said William Y. Tauscher . . . .
The logistics piece, which tracks parts, will come out in June. . . .
* * *
The second part, which will handle dispatching field technicians and other human aspects of support, will not be ready for use until September.
"The system is complete, but when we went to stress-test it, we found we needed to change some things. . . . We had a choice. We could bring it in and worry about capacity and growth, or we could redo some things."
Stress tests occurred in the fall of 1995.
73. On 6/3/96, Robertson Stephens issued another "booster shot" report on Vanstar in connection with Vanstar's IPO. The report was written by Lacerra, based on information provided to Lacerra by Tauscher and Rubin. Tauscher or Rubin reviewed and approved the report before it was issued. It forecast the following F97 EPS for Vanstar:
Q1 $ .15
Q2 $ .23
Q3 $ .29
Q4 $ .31
Year $ .99
The report also stated:
INVESTMENT THESIS: Vanstar is capitalizing on strong industry trends . . . . In addition, Vanstar is facing a large market opportunity . . . . In addition, Vanstar's business is shifting to its services offerings, which are much growing [sic] faster and have higher profitability than its traditional product business. . . . Margins are more attractive on the services businesses; we estimate gross product margins at 9% compared with 40-45% for networking, and 35-40% for support services. The services businesses are becoming very important to profitability; we estimate networking and support services comprise 30% of gross profit dollars in fiscal 1996.
74. On 6/11/96, Vanstar issued a press release headlined:
VANSTAR ANNOUNCES STRONG EARNINGS INCREASE . . . FOR FISCAL YEAR ENDING APRIL 30, 1996; COMPANY ACHIEVES RAPID GROWTH IN HIGH-VALUE SERVICES
The release reported 4Q96 net income of $16.5 million and EPS of $0.44:
"This was our first quarter out of the blocks after our Initial Public Offering," said Vanstar Chairman William Y. Tauscher. "The growth and accomplishments in this quarter were a result of the commitment of Vanstar's people and the strengthened market position of the company. Our Network Integration and Service businesses have begun to fulfill the promises made to investors during our public offering. Our product business continued to gain share on stable margins. . . . In the coming fiscal year, Vanstar will continue to build on its position as a leader in helping corporations improve the strategic value and reduce the costs of ownership of their desktop and network infrastructures."
* * *
"Our effective utilization of Management Systems and the productivity improvements undertaken in the last few years are paying big dividends permitting us to invest in enhanced services capabilities and overhead efficiencies while continuing to reduce the relative cost of SG&A," said Vanstar Chairman William Y. Tauscher.
75. On 6/10/96, Vanstar held a conference call with money and portfolio managers, institutional investors, analysts, large Vanstar stockholders and brokers to discuss Vanstar. During this call and in subsequent one-on-one conversations with analysts, Tauscher, Rubin or Amato stated:
Q1 $ .15-$ .16
Q2 $ .23-$ .24
Q3 $ .29-$ .30
Q4 $ .31-$ .32
FY $ .99-$ 1.03
76. On 6/12/96, Robertson Stephens issued a report on Vanstar entitled "Conference Call Highlights" written by Lacerra which repeated information from the conference call and follow-up conversations with Tauscher, Rubin or Amato. The report forecast the following F97 EPS for Vanstar:
Q1 $ .15
Q2 $ .23
Q3 $ .29
Q4 $ .31
FY $ .99
The report also stated:
* Training business is turning: Our model assumes the training business breaks even in F97; however, management believes the base business . . . will turn to profitability in 1Q97. . . .
* * *
* Product business strong in 4Q: Some resellers are reporting a slowdown in product due to shortages; Vanstar is not seeing this; revenue growth continues strong in May and we believe gross margins remain stable.
* * *
Vanstar is capitalizing on strong industry trends . . . . In addition, Vanstar's business is shifting to its services offerings, which are much growing [sic] faster and have higher profitability than its traditional product business. . . . Margins are more attractive on the services businesses; we estimate gross product margins at 9% compared with 40-45% for networking, and 35-40% for support services. The services businesses are becoming very important to profitability; we estimate networking and support services comprise 30% of gross profit dollars in fiscal 1996.
77. On 6/12/96, an article ran in the San Francisco Chronicle, which quoted Tauscher as stating that Vanstar "went through a valley of death" but came out on the other side "stronger than ever."
78. On 6/14/96, Alex. Brown issued a report on Vanstar by Caso which repeated information from the conference call and subsequent conversations with Tauscher, Rubin or Amato. It forecast F97 and F98 EPS of $1.00 and $1.20, and stated:
-- Reported better-than-expected revenues . . . while containing SG&A costs
-- Management reiterated that the current tone of business remains strong
* * *
Highlights of the Quarter and Management Conference Call
1) Gross Margin on Product Remains Stable. . . . Management noted in its conference call that it does not foresee significant fluctuations in product margin.
2) Strong Service Revenue Growth Fueled by High-Margin Network Services. . . . During its conference call, management noted that it does not see a problem with sustaining the present rate of network services growth . . . .
A draft of the report and Alex. Brown's revised financial model for Vanstar were provided to Rubin for comment before the report was issued.
79. On 6/14/96, Robinson-Humphrey issued a report on Vanstar by Robert Anastasi, which repeated information from the conference call and follow-up conversations with Tauscher, Rubin or Amato. It forecast the following F97 EPS for Vanstar:
Q1 $ .16
Q2 $ .24
Q3 $ .30
Q4 $ .32
FY $ 1.02
80. The positive statements in ¶¶70-79 were each false and misleading when made. The true facts which defendants concealed were:
81. On 6/24/96, the Computer Reseller News quoted Tauscher as stating:
"There has been some talk about availability hampering sales, but we are not seeing any real difference in our business compared to normal practices."
82. In late 6/96, Vanstar issued its Annual Report to Shareholders for the fiscal year ended 4/96. The Annual Report identified the following Vanstar "Systems":
Systems
* * *
NOVA Vanstar's full range of project management, billing, and deskside support services is managed from one integrated system
It also stated:
Vanstar Corporation . . . is a leading provider of products and services designed to build and manage personal computer network infrastructures for large enterprises. The Company provides customized, integrated solutions that support its customers' network infrastructures throughout their life cycle, from design and deployment through enhancement and migration. Vanstar provides these integrated solutions by combining four elements: a comprehensive suite of value-added services, proprietary automated systems, a nationwide field force of experienced people, and proven processes for building, managing and enhancing enterprise-wide personal computer networks.
It also contained a letter from Tauscher:
We grew our business strongly throughout fiscal 1996 and maintained a sharp focus on expense control, which enabled us to steadily increase our profitability. . . . This moved Vanstar into a position as one of the most profitable companies in our marketplace.
* * *
We [have] assembled exactly the right people, systems and processes needed to manage all aspects of PC network infrastructures across the enterprise. . . . Our information systems and methodologies can track and account for the entire life cycle of a single PC or an entire PC network, from purchase to disposal. . . .
* * *
Our plans for fiscal 1997 include three major growth thrusts. The first is expanding our field force in the Network Services and Training areas.
* * *
The second growth thrust is acquiring companies that complement our own resources.
* * *
Our third major growth initiative is to increase our investments in information systems, to make sure our automated internal systems and electronic links to customers keep pace with our business growth. Given successful execution of all three initiatives, we expect continued and substantial growth in both revenues and profitability.
83. On 7/10/96, Robertson Stephens issued another "booster shot" report on Vanstar, issued in connection with Vanstar's recently completed IPO. It was written by Lacerra, based on and repeating information provided by Tauscher or Rubin. It forecast the following F97 EPS for Vanstar.
Q1 $ .18
Q2 $ .24
Q3 $ .28
Q4 $ .31
Year $ 1.01
It also stated:
* We believe the services business is performing in line or slightly better than expectations so far.
84. On 7/11/96, an article about Vanstar in Investor's Business Daily, stated:
Chairman William Tauscher describes the company as a "new-age systems integrator that happens to push a lot of hardware and software across the table."
* * *
By switching from retailing to systems integration, Vanstar cut sales expenses in half. The goal is to translate lower costs into 4% operating margin, Tauscher says.
Vanstar should reach that goal in the second half of this fiscal year given growth of the company's higher margin service business, said Robinson-Humphrey Inc.'s Anastasi.
The basis of Anastasi's statement was information given him by Tauscher.
85. On 7/12/96, Robinson-Humphrey issued another "booster shot" report on Vanstar, issued in connection with Vanstar's recently completed IPO. It was written by Anastasi, based on and repeating information from Tauscher and Rubin. It increased the forecast F97 EPS for Vanstar as follows:
Q1 $ .20
Q2 $ .24
Q3 $ .29
Q4 $ .31
Year $ 1.04
It also stated:
Until FY95, Vanstar's financial record exhibited high revenue growth but only modest profit from operations. That changed in FY95 when the company reached critical mass in its profitable network services business and as overall operating expenses declined to a more manageable 13% of revenue. Margins have since been further enhanced by the addition of other value added services and expense efficiencies.
* * *
Vanstar has invested approximately $24 million over the past three years developing proprietary, automated systems that enhance and optimize service delivery. These tools/systems include NOVA -- an $18 million project thus far that re-engineers Vanstar's service delivery process and includes a new call management and dispatch system.
* * *
Margins on support services should gradually improve in FY97 as the benefits of automated tools to improve service delivery (NOVA) begin to kick in . . . leading to our $1.04 EPS estimate.
Anastasi provided a draft of the revised earnings model to Rubin for comment before issuing this report.
86. On or about 7/16/96, Vanstar filed its Form 10-K for F96, signed by Tauscher, Rubin, Amato, Bard, Janeway, Gross and Vogelstein. It stated:
The Company expects NOVA to be implemented during the second quarter of fiscal 1997. Vanstar believes that its automated systems significantly enhance its ability to satisfy its customers' needs.
* * *
The Company expects NOVA to be implemented during the second quarter of fiscal 1997. NOVA's resource allocation system is designed to insure that the appropriate technical personnel are available to respond to customer service calls. Service calls placed by customers are received through Vanstar's First Touch program. NOVA automatically determines which field engineer is available and sends all relevant customer information to the field engineer through a field computing device via radio. NOVA is backed by more than 50 strategic parts stocking locations in the United States; spare parts can be delivered the same day or shipped overnight to either the customer location or the field service engineer. The Company believes that NOVA will result in increased customer network uptime, more accurate matching of parts and field service engineer skills to service needs, more accurate and comprehensive information management, and lower costs.
87. On 7/26/96, an article appeared in the San Francisco Business Times which quoted Amato as stating that Vanstar was enjoying "explosive growth in client demand."
88. By 7/96, Vanstar was orchestrating a convertible debenture offering to raise money to refinance its IBMCC variable-rate debt with lower cost debentures, which were convertible into Vanstar stock. However, because Vanstar stock had only advanced to $16-3/4 by 8/1/96, defendants embarked on a concerted publicity campaign to flood the market with favorable information about Vanstar's business and its prospects to drive Vanstar's stock higher during this crucial period by convincing the market that Vanstar's business was performing even better than expected and its F97 and F98 EPS would be higher than earlier forecast.
89. On 8/13/96, Alex. Brown issued a report on Vanstar by Caso, which was based on and repeated information provided to him during conversations with Rubin in 7/96 and Rubin's comments to a draft of Caso's revised Vanstar earnings model, and on conversations on 8/9-10/96 with Tauscher, Rubin and Amato. It stated:
-- Based on a recent visit with management . . . we believe that product revenue during F1Q (July) 1997 will rise a higher-than-expected 30%.
* * *
-- We are raising our F1Q 1997 EPS estimate from $0.16 to $0.21 and our FY 1997 and FY 1998 EPS estimates by $0.07 each to $1.07 and $1.27, respectively.
A draft of this report and the revised earnings model for Vanstar were provided to Tauscher, Rubin and Amato, who reviewed and made comments on it before it was issued.
90. On 8/27/96, Vanstar issued a release announcing its 1Q97 results headlined:
VANSTAR ANNOUNCES STRONG EARNINGS AND REVENUE INCREASES FOR FIRST QUARTER OF ITS FISCAL YEAR; SUBSTANTIAL GROWTH IN REVENUES FROM PROFESSIONAL SERVICES AND PRODUCT SALES DRIVE FINANCIAL PERFORMANCE
The release stated:
"During the first quarter, the company benefited from a growing demand for our network services, as large corporate customers continued to transition to new higher performance technologies and client/server networks. We also experienced continued strong product sales," said William Y. Tauscher, Chairman of Vanstar.
* * *
Selling, general and administrative expenses were $56.9 million, or 10.2 percent of revenues for the quarter ending July 31, 1996. . . . "We continue to hold the line on this important measurement as we reap the benefits of management systems and operational improvements put into place in the past four years," Tauscher said. "One of our major initiatives in this area has been the development of NOVA, our proprietary service delivery system. During this period, we began implementing NOVA, which is designed to reduce costs through improved parts logistics, resource allocations and billing procedures. We expect this program to be deployed and operational by April of 1997, culminating a two-year, $25-million corporate commitment."
91. This press release was false and misleading in that NOVA was not helping reduce Vanstar's SG&A expenses or maintain them at lower levels, but instead NOVA was drastically increasing Vanstar's expenses, a fact defendants concealed by improperly capitalizing those expenses as software development costs in violation of FAS No. 86 as set forth in ¶¶133-140 below. In fact, as of 8/96, a critical piece of the NOVA Logistics system still was not running accurately; the system had not been performance tested; the system was still unable to produce any reports because Vanstar still had not created them; the system was experiencing software bugs and other anomalies and operating problems; the necessary customer data for rollout had not been converted; and the Sybase database, to be used with the NOVA system, was not stable.
92. On 8/27/96, Amato, Rubin and Tauscher spoke to analysts, institutional investors, money and portfolio managers, large Vanstar shareholders and brokers in a conference call. During the call and in later one-on-one conversations with analysts, they stated:
Q1 $ .23A
Q2 $ .23-$ .24
Q3 $ .30-$ .31
Q4 $ .31-$ .32
FY $ .99-$ 1.07
93. On 9/12/96, Vanstar, via Tauscher, Rubin and Amato, made a presentation at the Robinson-Humphrey annual investor conference in New York City. On 9/13/96, Vanstar held its annual stockholders meeting at the Waldorf Astoria Hotel in New York City. During the investors conference and annual meeting, Tauscher, Rubin and Amato disseminated the same information they had disseminated during the 8/27/96 conference call.
94. On 9/16/96, Vanstar appeared at the Donaldson Lufkin & Jenrette Securities Conference in New York City. During their presentation, Tauscher and Rubin disseminated the same information as in the 8/27/96 conference call and the 9/12/96 and 9/13/96 presentations.
95. On 9/24/96, Vanstar appeared at the Robertson Stephens Conference in San Francisco. During his presentation, Tauscher disseminated the same information disseminated in the 8/27/96 conference call and the 9/12/96, 9/13/96 and 9/16/96 presentations.
96. Tauscher, Rubin and Amato participated in roadshow presentations to investors and analysts in Houston, Kansas City, San Diego, Los Angeles, Minneapolis, Milwaukee, New York and Boston, between 9/17-26/96. They stated NOVA was having a positive impact, causing "revenue improvement," improving Vanstar's "logistics management" and its productivity, including reducing administrative support, improving field engineer productivity and improving management's expense control. Defendants further represented that NOVA would enable Vanstar to make strategic acquisitions in the network services area as NOVA would give Vanstar economies of scale with regard to overhead and administrative expenses. Defendants engaged in these efforts to stimulate interest in Vanstar, drive its stock higher and sell the largest dollar amount of convertible bonds possible on the most favorable terms.
97. The positive statements in ¶¶81-96 about Vanstar were each false and misleading when made. The true facts which defendants concealed were:
98. Defendants' publicity campaign in 8/96 and 9/96 had the desired impact as Vanstar's stock soared from $14-1/8 on 7/23/96 to $19-1/8 on 9/11/96 and on to its then all-time high of $29-3/4 that same month.
99. As a result of the false statements in the preceding paragraphs, Vanstar's convertible debenture sale was in progress, generating very strong demand for these convertible debentures, enabling Vanstar to sell $200 million in debentures on 9/27/96, well in excess of the $125 million it originally intended to sell. As Vanstar stock moved toward its all-time high and the "lock-up" expired on 9/11/96, certain of the Individual Defendants sold off their Vanstar stock. Between 9/6-20/96, Bard, Kuntzendorf, Anderson, Moore and Laney sold 583,259 Vanstar shares, pocketing more than $12.9 million in illegal insider trading proceeds.
100. On 9/27/96, Tauscher, Rubin and Amato held a conference call for analysts, institutional investors, money and portfolio managers, and large Vanstar shareholders. In that call and in one-on-one conversations with analysts after the call, Tauscher, Rubin and Amato stated that:
Q1 $ .23A
Q2 $ .24-$ .25
Q3 $ .30-$ .31
Q4 $ .31-$ .32
FY $ 1.08-$ 1.11
101. On 10/2/96, Alex. Brown issued a report on Vanstar by Caso, which repeated information given him in the 9/27/96 conference call and follow-up conversations with Tauscher, Rubin or Amato. It forecast F97 and F98 EPS:
F97 F98
Q1 $ .23A Q1 $ .27
Q2 $ .25 Q2 $ .31
Q3 $ .29 Q3 $ .36
Q4 $ .32 Q4 $ .37
Year $ 1.09 Year $ 1.31
It also stated:
[W]e are raising our FY 1997 (April) EPS estimate to $1.09 from $1.07. Based on continued strong execution of its strategic plan and a strong business outlook, we are raising our FY 1998 estimate to $1.31 from $1.27. We believe both estimates remain conservative. We remain upbeat on the near-term share price outlook given strong business momentum . . . .
* * *
1) REASONS WHY WE REMAIN POSITIVE ON VANSTAR MARKET LEADER. . . . We see no let up in the strong pace of business since late August.
* * *
5) BUSINESS IS GOOD AND MANAGEMENT IS EXECUTING. Vanstar has beaten our estimates three quarters in a row, and our expectation is that this trend will continue.
102. On 10/18/96, Tauscher, Rubin and Amato also conducted a conference call for money and portfolio managers, analysts, institutional investors and large Vanstar stockholders. During that conference call and in subsequent one-on-one conversations with analysts, Tauscher, Rubin and Amato stated:
103. On 10/21/96, Alex. Brown issued a report on Vanstar by Caso, which repeated information provided during the 10/18/96 conference call. It raised the F97/F98 EPS forecasts for Vanstar to $1.09/$1.31, and stated:
-- Management, during an analysts' conference call, endorsed a F2Q (October) 1997 EPS range of $0.23-$0.25, while indicating FY 1998 Street estimates may prove conservative.
* * *
During a recent business review Vanstar management endorsed the Street's F2Q 1997 EPS estimate range of $0.23-$0.25, and indicated that the FY 1998 estimates may prove light. . . . We are increasingly comfortable with both our FY 1997 and FY 1998 EPS estimates of $1.09 and $1.31, respectively. . . .
* * *
OTHER HIGHLIGHTS:
1) MANAGEMENT INDICATES THAT FY 1998 ANALYSTS' ESTIMATES MAY PROVE TO BE LOW. . . .
* * *
2) PRODUCT DEMAND REMAINS STRONG; SUPPLY HAS BECOME AN ISSUE. Management noted that product demand remains robust, but that the supply from the manufacturers, as they are all updating their models, is not keeping up. Management noted that although product revenue will be up sharply year over year, the sequential qtr comparison will be flat to slightly down. The somewhat lower-than-expected product sales, however, will be offset by much stronger-than-expected gross margin, which management believes will exceed the last quarter's impressive 9.9% (we had been modeling for 9.6%). . . .
104. On 10/30/96, Robertson Stephens issued a report on Vanstar by Steven Lacerra, which repeated information provided during the 10/18/96 conference call. It stated:
* We have increased our fiscal 1997 (April) EPS estimate from $1.01 to $1.08 . . . . During 1Q, strong PC demand and better than expected results in services drove revenue and profit gains. We believe 2Q product revenue growth is tempered somewhat by tightly constrained product. We expect this situation to improve in the second half of the fiscal year.
* * *
Rollout of the delayed NOVA project is in progress. We believe NOVA will help the LifeCycle Services division achieve its margins goals of 40-45% with NOVA's full implementation, which should occur in fiscal 1998. . . . We expect NOVA to drive profitability as greater efficiency in execution and benefits in the field offset growth in the number of field engineers (FE's).
105. On 11/11/96, Alex. Brown issued a report on Vanstar by Caso, which was based on and repeated information provided him by Tauscher and Rubin. It stated:
INVESTMENT SUMMARY. We have raised our investment rating for Vanstar to "strong buy" from "buy" based on an improving business outlook, a growing belief our estimates will prove conservative, particularly in FY (April) 1998 . . . . We remain comfortable with our FY97 and FY98 estimates of $1.09 and $1.31, respectively.
* * *
Vanstar's outlook only improves, our estimates remain upwardly biased and the business model is increasingly influenced by more predictable service revenues. We believe recent (August/September) product supply constraints (which will dampen product resale revenue in the October quarter), have come back strongly beginning in October, and may have been a reason for recent weakness. Our expectation is that the short-term weakness in sales volume will be made up for by higher margins.
106. On 11/15/96, Deutsche Morgan Grenfell issued a report on Vanstar by Steven Fortuna, which was based on and repeated information provided him by Tauscher, Amato and Rubin, and in a meeting between Fortuna and Amato in Atlanta. It stated:
Vanstar has a tremendous growth opportunity ahead of it . . . .
Vanstar's bottom-line growth should benefit from a rapidly expanding services business which now accounts for 12% of sales but could rise to 15% by fiscal 1999. With service margins 250%-350% higher than hardware margins, this mix shift points to leveraged upside in Vanstar's operating margins over the next several years, leading to earnings growth in the 30% range.
Meanwhile, Vanstar's top line growth should remain robust, driven by strong corporate PC demand for Pentium and Windows NT-based products. We expect the current upgrade cycle could continue for two or more years given the obsolescence of the installed base coupled with 305 annual gains in PC price/performance. We forecast sales increases of 31% in fiscal 1997 and 26% in fiscal 1998.
A draft of this report was provided to defendants Tauscher, Amato and Rubin, who reviewed the report and made comments before it was issued.
107. The statements in ¶¶98-106 were false and misleading when made. The true facts, which defendants concealed, were:
108. On 12/2/96, Vanstar issued a release reporting its 2Q97 results which was headlined:
VANSTAR CORPORATION CONTINUES STRONG EARNINGS GROWTH IN SECOND QUARTER OF FISCAL YEAR: RAPID EXPANSION OF PROFESSIONAL SERVICES HIGHLIGHTS STRONG FINANCIAL PERFORMANCE
The release stated:
The improvement reflects continuing rapid growth in demand for all of Vanstar's service offerings, product margin improvements, and a trend toward longer-term relationships with corporate customers.
* * *
"Vanstar's rapidly growing Professional Services and Life Cycle Services business is providing an increasingly important contribution to revenue and margin growth," said William Y. Tauscher, Chairman of Vanstar.
* * *
"Our product business reflects an increasing trend by Vanstar's customers to utilize us for outsourcing and life cycle procurement services where Vanstar becomes the single source for both products and services," said Tauscher.
109. On 12/3/96, Tauscher, Amato and Rubin held a conference call for over 90 money and portfolio managers, analysts, institutional investors and large Vanstar stockholders. During that call and in subsequent, one-on-one conversations with analysts, Tauscher, Rubin and Amato, stated:
Q1 $ .23A
Q2 $ .26A
Q3 $ .27-$ .29
Q4 $ .30-$ .32
FY $ 1.06-$ 1.10
After the call, Tauscher, Amato and Rubin held discussions with key analysts at Alex. Brown, Robertson Stephens, Robinson-Humphrey and Deutsche Morgan Grenfell concerning these topics, including projections of product revenue growth and new accounts.
110. On 12/3/96, Robertson Stephens issued a report by Lacerra, which was based upon and repeated information from the conference call and follow-up conversations with Tauscher, Rubin or Amato and stated:
* We are increasing our fiscal 1997 EPS estimate by 2 pennies from $1.07 to 1.09 . . . . However, we are very bullish on Vanstar's prospects and believe that once product constraints have eased, significant pent up demand will be unleashed . . . .
* * *
We expect gross margins at support services to expand as the NOVA project increase[s] field engineer utilization; we expect full deployment of NOVA by mid-1997. The company has already begun deployment of the parts & spares module and we expect will begin deployment of the field engineer and dispatch module in 4Q97.
111. On 12/3/96, Deutsche Morgan Grenfell issued a report on Vanstar by Fortuna, which was based upon and repeated information from the conference call and follow-up conversations with Tauscher, Rubin or Amato and stated:
* Based on a higher than expected services mix and what we believe will be strong product growth in Q3/Q4, we are raising EPS estimates to $1.06 and $1.40 for fiscal years 1997 and 1998 from our original estimates of $1.02 and $1.36. . . .
* * *
* Product revenue of $463 million was up 19% from last year but suffered from vendor supply constraints. . . . We expect the constraint on supply to be alleviated substantially in the second half of the fiscal year.
* * *
* Gross margins of 34.2% vs. 37.2% in the first quarter reflect transition costs and other expenses related to the company's new NOVA resource allocation tool which should be fully operational by the end of the fiscal year next April. We expect the benefits of NOVA, in the form of reduced costs, to have positive impact beginning in fiscal 1998.
112. On 12/4/96, Robinson-Humphrey issued a report on Vanstar by Anastasi, which was based upon and repeated information provided during the conference call and follow-up conversations with Tauscher, Rubin or Amato. It forecast 3Q97 EPS of $0.27, 4Q97 EPS of $0.30, F97 EPS of $1.06 and F98 EPS of $1.30 for Vanstar.
113. On 12/5/96, Vanstar appeared at the Deutsche Morgan Grenfell Technology Conference in Phoenix. During his presentation, Tauscher disseminated the same information as in the 12/3/96 conference call. At the conference, Tauscher also participated in one-on-one meetings with institutional investors, including Fidelity Research and Omega Investors during which he disseminated the same information.
114. On 12/5/96, Alex. Brown issued a report on Vanstar by Caso, which was based upon and repeated information provided in the 12/2/96 conference call and follow-up conversations with Tauscher, Rubin or Amato. It forecast the following EPS for Vanstar:
FY April: 1997E 1998E
1Q $0.23A $0.29
2Q $0.26A $0.30
3Q $0.29 $0.34
4Q $0.32 $0.38
Fiscal Year $1.10 $1.31
The report also stated:
INVESTMENT HIGHLIGHTS
-- We view the quarter very positively given that EPS surprised despite a shortfall in product resale revenue, reflecting success in management's efforts to improve earnings quality through a focus on rapid growth in higher-margin service income and long-term life cycle contracts, as well as a dramatic improvement in financing costs.
* * *
1) SUPPLY CONSTRAINTS IMPACT OCTOBER QTR. All four of Vanstar's major product suppliers (IBM, Compaq, HP and Toshiba) transitioned to new products in the quarter, causing a (normal) short-term imbalance in supply. DEMAND IS NOT AN ISSUE. Much of the supply imbalance has corrected itself beginning in the month of October, with strong improvement in activity in both October and November.
* * *
3) NOVA MOVING FORWARD. Vanstar's large back-office automation process is now approximately 50% rolled out, working successfully and expected to be completed by fiscal year-end.
115. The statements contained in ¶¶108-114 were false and misleading when made. The true facts, which defendants concealed, were:
116. During 12/6-13/96, Manshouri, Sisson and Triant capitalized on the continuing artificial inflation of Vanstar stock and sold 82,215 shares of their Vanstar stock, pocketing over $2 million in illegal insider trading proceeds.
117. On 12/9/96, Computer Reseller News reported "Tauscher said the sales issue [was] not a concern. 'We continue to outgrow the marketplace and gain share. We have focused the company to sell services first and found product sells right along with it.'"
118. On 12/16/96, Computer Reseller News reported:
Chairman Bill Tauscher said the future of the company . . . looks bright. "We continue to outgrow the marketplace and gain share," [Tauscher] said, adding he would expect overall growth rates to remain in the 20 percent to 30 percent range.
119. On 12/19/96, Vanstar held phone meetings one-on-one with institutional investors, including Putnam and Fidelity. In these phone calls, Amato and Rubin repeated the information disseminated in the 12/2/96 conference call and at the 12/5/96 conference.
120. On 12/19/96, Robertson Stephens issued two reports on Vanstar by Lacerra, based on and repeating information provided by Tauscher and Rubin. They forecasted 3Q97, 4Q97 and F97 EPS of $0.28, $0.32 and $1.10 and F98 EPS of $1.30 for Vanstar and stated:
* We believe 3Q (Jan) is shaping up well despite continued product constraints. We expect total revenues at $610M versus $447M (+36%).
* We are optimistic about both the networking and support services business; earlier this month we had increased both our revenue and gross margin forecasts for both businesses slightly. We expect networking revenues up 94% to $32.1M versus $16.5M last year and up 16% sequentially from $27.6M in the 2Q.
* We expect support services revenues up 19% to $41.4M versus $34.8M last year. We believe Vanstar is gaining share in the support services business and believe this forecast may be conservative.
* We expect product revenues at $525M versus $391M last year (+34%) and remain comfortable with this forecast despite continued product constraints.
* * *
* We believe our fiscal 1998 forecast is conservative. For example, the recent acquisition of NTG group is not yet in our forecast . . . . In addition, in our opinion recent contract wins by Vanstar add visibility to our $1.30 forecast.
* A public record of excellent execution. Vanstar has exceeded expectations . . . in each of its 4 quarters since coming public. . . . In addition, the NOVA project is being implemented and should benefit profitability in fiscal 1998.
121. On 12/26/96, Vanstar implemented a revolving funding trade receivables securitization facility (the "Securitization Facility") with the Pooled Accounts Receivable Capital Corporation (the "Pool"), which provided the Company with up to $175 million in available credit. Immediately, Vanstar sold an interest in certain accounts receivable to the Pool for approximately $130.5 million, $105.5 million of which was used to repay Vanstar's IBMCC debt. The Company's plan to eliminate virtually all its expensive IBMCC debt was complete.
122. On 1/8/97, Robertson Stephens issued a report on Vanstar by Lacerra, based on and repeating information from Tauscher and Rubin. It stated:
* We believe 3Q97 (Jan) is shaping up well, given the constrained product environment. We are comfortable with our EPS forecast of $0.28 versus $0.16 (up 75%).
* We forecast revenues at $610M versus $447M (+36.5%). Our revenue forecast breakout is as follows:
* * *
* We believe our 3Q product revenue forecast of $525M is high on the Street. We believe Street forecasts are at about $510 million. We believe the product constraint situation is starting to ease for Vanstar. New order rate is strong as customers are learning that inventory is becoming available.
123. On 1/9/97, Vanstar participated in a Deutsche Morgan Grenfell-sponsored conference call for approximately 80 money and portfolio managers, analysts and institutional investors. During the call, Amato stated:
Based on this information, on 1/10/97, Deutsche Morgan Grenfell issued a report on Vanstar by Fortuna, which repeated this information to the market.
124. On 1/15/97, Alex. Brown issued a report on Vanstar by Caso, based on and repeating information from Tauscher and Rubin. It forecast 3Q97, 4Q97 and F97 EPS of $0.29, $0.32 and $1.10, and stated:
Management indicated that sell-through was below expectation during the November-December time frame, although [it] indicated it had lost no meaningful accounts and had actually gained some.
* * *
2) AFTER SLOW START TO JANUARY QTR PRODUCT SALES ACCELERATING IN MONTH OF JANUARY. In small part due to product transitions and therefore availability issues early in the quarter, and the long Christmas holiday, product sales had been running slightly behind Company expectations. January, due to both new corporate IT budgets allocations and the fact that it's the last month of Vanstar's quarter (and therefore salespeople are more motivated), has historically strong sales. Recent activity indicates that sales have picked up meaningfully and field management believes the strong sales should continue well into the spring.
3) MANAGEMENT ONLY GIVING COMFORT (AT THIS TIME) TO STREET AVERAGE FOR QUARTER. Given the importance of the month of January, and the somewhat slower start to the quarter than planned (although business is up sharply in the last few weeks), management is only willing to give comfort to the Street average consensus of $0.27 (versus $0.16 a year ago).
125. On 1/16/97, Rubin conducted one-on-one investor meetings in Boston with various institutional investors, including Putnam, Fidelity and Keystone. Rubin also made a presentation at an Alex. Brown-sponsored lunch for other large Vanstar investors, including State Street Research, Eaton Vance and Standish Ayerwood. In these discussions and presentations, Rubin addressed questions concerning revenue, earnings growth and product availability by disseminating the same information that was disseminated in the 1/9/97 presentation.
126. On 1/16/97, Deutsche Morgan Grenfell issued a report on Vanstar by Fortuna, which repeated information given Fortuna by Amato:
* The following comments are based on conversation we had with Jay Amato, Vanstar's President and Chief Operating Officer on Thursday, January 16, 1997:
1. We feel that the $0.27 consensus estimate is achievable, but there likely won't be much upside to this number due to constrained product supply at the high-end. We'd like to point out that other channel companies such as Inacom, MicroAge, and Tech Data are not feeling this nearly as much due to their lower-end customer base. Remember that Vanstar sells primarily to the Fortune 1000 and focuses on high-end desktop solutions.
2. Product supplies have been getting somewhat better over the past couple of months as was indicated in last week's DMG channel conference call. More importantly, we believe that product supplies will get substantially better going into Vanstar's fourth quarter, which ends in April. As a result we believe that our Q4 EPS estimate of $0.31 (vs. consensus of $0.30) may prove to be conservative.
127. On 1/22/97, Donaldson Lufkin & Jenrette issued a report on Vanstar by Thomas Rooney, based on and repeating information from Tauscher and Rubin. It forecast 3Q97 EPS of $0.27, 4Q97 EPS of $0.31 and F97 EPS of $1.06, and stated:
Looking forward, we believe that the company is poised to gain market share based on the following factors: (1) Vanstar has the necessary infrastructure investments in people (more than 3,200 service professionals in the United States), facilities (highly automated distribution centers) and productivity tools (Navigator, Cockpit, and NOVA); (2) the company possesses a broad service offering to support the PC network infrastructure throughout its life cycle; and (3) it has the ability to leverage its already extensive customer base . . . . Based on these factors, we believe that Vanstar can realize annual growth that is 25-50% above the blended average for its target market.
128. On 1/22/97, Robertson Stephens issued a report on Vanstar by Lacerra, based on and repeating information from Tauscher and Rubin. It stated:
* We are adjusting our 3Q97 product forecast, primarily due to product constraints, especially of Pentium Pro high end processors.
* For 3Q97, we have decreased our product revenue forecast from $525 million to $495 million versus $391 million last year, still a very strong increase of 27%.
* We believe the constraint situation has begun to ease.
* * *
* We remain comfortable with our forecasts for the services business. We forecast Professional Services (Networking) revenues at $32.1 million versus $16.5 million last year (+94%) and gross margins at 43.0% versus 38.5%. We forecast LifeCycle (or Support) Services at $41.4 million versus $34.8 million last year (+19%) and gross margins at 35.7% versus 37.6%.
* We have maintained our 3Q97 EPS estimate of $0.28 versus $0.16.
129. Suddenly, on 1/23/97, Vanstar shocked the markets when it revealed it expected its 3Q97 EPS to be much lower than the $0.27 forecasted. In a conference call, Tauscher, Rubin and Amato admitted:
Vanstar stock fell dramatically on 1/23/97, from $22-1/8 to $14-3/4.
130. On 3/3/97, Vanstar announced that its 3Q97 net income was just $7.5 million and EPS was $0.17 per share.
131. On 3/14/97, Vanstar again shocked the markets when it announced that its 4Q EPS would be very poor due to poor demand, excessive expenses and the lack of NOVA being implemented. Vanstar's stock plunged to $9-5/8. That same day Robinson-Humphrey reported that expenses relating to NOVA were roughly $2 million above plan for Q4, and that the benefits had not begun to accrue. On 3/24/97, Information Week reported that Vanstar had still not completed its deployment of NOVA, that benefits from NOVA would not accrue to Vanstar until F98 and that delays in the rollout had resulted in substantial additional costs. Vanstar's stock dropped to $6-1/2, 78% below the Class Period high.
132. On 6/11/97, Vanstar announced 4Q97 EPS of $0.04 as compared to $0.44 the year before. Vanstar later reported 1Q and 2Q98 EPS of $0.15 and $0.21, well below the forecasts of $0.27-$0.29 for 1Q98 and $0.30-$0.31 for 2Q98. As of 9/97, NOVA still had not been implemented. The aftermath of the failed NOVA project has continued. In its most recent 10-Q, for 2Q ended 10/31/98, Vanstar took a staggering write-off relating to NOVA of up to $25.5 million, including a $9 million write-off of capitalized software and systems associated with the centralized dispatch and scheduling functions -- NOVA. As defendants told the public before and during the Class Period, NOVA was to reduce costs associated with spare parts procurement and repair, centralizing that function, reducing inventory and increasing Vanstar's margins. Instead, just a year after defendants claimed NOVA had been fully implemented, Vanstar decided to "outsource" this function and was forced to write-off $16.5 million of excess spare parts due to the "outsourcing" of a substantial portion of its spare parts procurement and repair to a single vendor.
133. In order to inflate its Class Period EPS, Vanstar understated its costs by improperly capitalizing and failing to write-down capitalized costs Vanstar recorded related to the NOVA project. During the Class Period Vanstar improperly capitalized, in violation of GAAP,(2) approximately $8 million in costs associated with developing the NOVA system. Vanstar stated in footnote 6 of its 4/30/96 10-K that:
Capitalized software represents the costs associated with development of software for the Company's internal use. Such costs are capitalized in accordance with Statement of Financial Accounting Standards No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED, and are amortized over the remaining useful economic life of the software of up to five years. . . .
134. In its 10-Q's for the three quarters of F97 Vanstar stated:
The financial statements for Vanstar corporation (the "Company") for the three month periods ended July 31, 1996 and July 31, 1995 are unaudited and have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission regulations. . . . In the opinion of management, the financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1996.
135. These statements, repeated in each of Vanstar's 10-Qs, were false in each of the three quarters of F97 because Vanstar's financial statements were not prepared in accordance with GAAP due to improperly capitalized costs associated with the NOVA project.
136. GAAP, as set forth in FAS No. 86, states in part that:
At each balance sheet date, the unamortized capitalized costs of a computer software product shall be compared to the net realizable value of that product.
* * *
The Board recognized that the majority of companies expense all costs of developing software for internal-use, and the Board was not persuaded that this current predominant practice is improper. Also, this Statement clarifies activities that are research and development activities and establishes a high capitalization threshold that is likely to be applied to costs incurred in developing software for internal use as well as for sale or lease to others.
* * *
The Board agreed that the capitalized costs of each software product should be subsequently valued, in each reporting period, at the lower of its remaining unamortized cost or net realizable value.
FAS No. 86, ¶¶10, 26, 47.
137. GAAP, as set forth in Statement of Financial Accounting Concepts No. 6 - Elements of Financial Statements, states in part:
Future economic benefit is the essence of an asset. An asset has the capacity to serve the entity by being exchanged for something else of value to the entity, by being used to produce something of value to the entity, or by being used to settle its liabilities.
* * *
To assess whether a particular item constitutes an asset of a particular entity at a particular time requires at least two considerations in addition to the general kinds of evidence just described: (a) whether the item obtained by the entity embodied future economic benefit in the first place and (b) whether all or any of the future economic benefit to the entity remains at the time of assessment.
* * *
Although an entity normally incurs costs to acquire or use assets, costs incurred are not themselves assets. The essence of an asset is its future economic benefit rather than whether or not it was acquired by a cost.
FASB Statement of Concepts No. 6, ¶¶172, 174, 179.
138. GAAP, as set forth in FASB Statement of Concepts No. 5, ¶87, states:
An expense or loss is recognized if it becomes evident that previously recognized future economic benefits of an asset have been reduced or eliminated, or that a liability has been incurred or increased, without associated economic benefits.
139. Even though Vanstar was required to assess the capitalized costs every quarter and was required to record a loss or expense if it became evident that the previously recognized figure, economic benefit, had been reduced, Vanstar failed to record the necessary write-downs or write-offs required to fairly state the true value of the NOVA project. Vanstar ignored the requirements of GAAP and failed to recognize that the software and spare parts capitalized on the unsuccessful NOVA project did not and would not have future economic benefit that it was carrying as an asset on its books. In fact, Vanstar knew that the costs of the NOVA project had materially exceeded the recorded value during the Class Period as described in ¶¶28-36 herein.
140. By improperly capitalizing rather than expensing or writing off costs associated with the failing NOVA project, defendants materially overstated Vanstar's earnings during the three quarters of fiscal 1997. In violation of GAAP, Vanstar improperly capitalized and failed to write-down the NOVA asset by at least $8 million which caused Vanstar's net earnings to be overstated by at least $5 million during the three quarters of fiscal 1997.
141. Vanstar's insiders sold over 665,000 shares of their Vanstar stock, pocketing over $15 million in illegal insider trading proceeds.
% of Total
Shares Owned/
Individual Shares Aggregate Sold During
Defendants Sold Proceeds Class Period
Bard, R. 420,596 $ 9,844,331 59%
Kuntzendorf, R. 69,999 $ 1,399,980 94%
Anderson, R. 48,940 $ 910,477 98%
Moore, N. 38,724 $ 728,356 90%
Laney, C. 5,000 $ 116,250 100%
Manshouri, A. 54,215 $ 1,374,829 97%
Sisson, C. 12,000 $ 296,445 100%
Triant, T. 16,000 $ 409,710 91%
Individual Defs'l
Total 665,474 $ 15,080,378 68%
142. These sales of Vanstar stock were unusual in timing and amount. None of these defendants had ever sold any of their Vanstar stock before. Approximately 580,000 of these shares were sold just days after the expiration of the "lock-up" in 9/96. Over 80,000 shares were sold in 12/96, immediately upon the heels of what Tauscher later admitted was Vanstar's extremely poor sales performance in 11/96 and during Vanstar's poor sales performance in 12/96.
INSIDER SHARES SHARES
NAME DATE SOLD PRICE PROCEEDS ACQUIRED PRICE HOLDING
Anderson 09/06/96 34,040 $18.54 $ 631,102 34,040 $3.00
09/11/96 14,900 $6.00
09/11/96 14,900 $18.75 $ 279,375 801
48,940 $ 910,477 48,940
% Shares Sold 98%
Bard 07/31/96 303,030 $15.14
09/18/96 100,000 $23.00 $2,300,000
09/19/96 98,300 $23.00 2,260,900
09/19/96 1,700 $23.25 39,525
09/19/96 100,000 $23.50 2,350,000
09/20/96 50,000 $24.00 1,200,000
09/20/96 25,000 $24.50 612,500
09/20/96 5,996 $23.50 140,906
09/20/96 39,600 $23.75 $ 940,500 300,094
420,596 $9,844,331
% Shares Sold 58%
Kuntzendorf 09/13/96 69,999 $20.00 $1,399,980
03/26/97 2,500 $6.00 4,676
69,999 $1,399,980 2,500
% Shares Sold 94%
Laney 09/19/96 5,000 $3.00
09/19/96 5,000 $23.25 $ 116,250 0
5,000 $ 116,250 5,000
% Shares Sold 100%
Manshouri 12/06/96 2,705 $25.50 $ 68,978 30,000 $3.00
12/06/96 12,500 $25.63 320,375
12/06/96 17,500 $25.50 446,250
12/06/96 12,295 $25.50 313,523
12/09/96 500 $25.63 12,815
12/09/96 2,715 $25.88 70,264
12/10/96 5,500 $23.75 130,625
12/10/96 500 $24.00 $ 12,000 1,507
54,215 $1,374,829 30,000
% Shares Sold 97%
Moore 09/09/96 20,000 $18.63 $ 372,600 20,000 $5.55
09/11/96 7,224 $5.55
09/11/96 11,500 $6.00
09/11/96 18,724 $19.00 $ 355,756
38,724 $ 728,356 38,724 4,115
% Shares Sold 90%
Sisson 12/13/96 10,500 $24.75 $ 259,875
12/13/96 1,500 $24.38 36,570
12/13/96 12,000 $3.00 0
12,000 $ 296,445 12,000
% Share Sold 100%
Triant 12/06/96 1,000 $25.63 $ 25,630
12/06/96 1,000 $25.75 25,750
12/06/96 3,500 $25.88 90,580
12/06/96 10,500 $25.50 267,750 16,000 $5.00 1,499
16,000 $ 409,710 16,000
% Share Sold 91%
INSIDER TOTALS: 665,474 $15,080,378 456,194 68%
143. Defendants, with knowledge of or reckless disregard for the truth, made misrepresentations and failed to disclose material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
144. Defendants violated §§10(b) and 20(a) of the 1934 Act and Rule 10b-5 as they:
(a) Employed devices, schemes and artifices to defraud;
(b) Made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(c) Engaged in acts, practices and a course of business that operated as a fraud or deceit upon plaintiffs and others similarly situated in connection with their purchases of Vanstar common stock during the Class Period.
145. In reliance on the integrity of the market, plaintiffs and the Class paid artificially inflated prices for Vanstar stock and were damaged.
146. Plaintiffs bring this class action via Federal Rule of Civil Procedure 23(a) and (b)(3) for all purchasers of Vanstar stock during the Class Period, excluding defendants.
147. Vanstar had more than 39 million shares of stock outstanding, owned by hundreds of shareholders. Class members are so numerous that joinder of them is impracticable.
148. Questions of law and fact common to the Class exist and predominate over questions which may affect individual Class members. They include:
(a) Whether the federal securities laws were violated;
(b) Whether defendants omitted and/or misrepresented material facts;
(c) Whether defendants knew or recklessly disregarded that their statements were false;
(d) Whether Vanstar stock was artificially inflated; and
(e) The extent and measure of damage sustained by Class members.
149. Plaintiffs' claims are typical of those of the Class because they all sustained damages from defendants' wrongful conduct.
150. The prosecution of separate actions would create a risk of inconsistent and varying adjudications.
151. Plaintiffs will adequately protect the interests of the Class and have no interests which conflict with those of the Class. They have retained competent and experienced counsel.
152. A class action is superior to other available methods for the fair and efficient adjudication of this controversy.
153. The safe harbor for forward-looking statements does not apply to the false statements pleaded. Any forward-looking statements pleaded in ¶¶60, 62, 65-68, 71-74, 76, 78-79, 82-83, 85 were made in connection with Vanstar's IPO and are not eligible for protection. To the extent the statements in ¶¶84, 86, 89-90, 92-96, 100-106, 108-114, 116-120, 122-130, 133-138 contained forward-looking statements, none of them were identified as "forward-looking statements." Nor was it stated that actual results "could differ materially from those projected." Nor were the statements accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from the statements made. To the extent that the statutory safe harbor does apply to any "forward-looking" statements pleaded, defendants are liable because at the time each of those statements was made, the speaker knew the statement was false and the statement was authorized and/or approved by an executive officer of Vanstar who knew that those statements were false when made.
154. Because the Private Securities Litigation Reform Act, §21D(c) of the 1934 Act, requires complaints to be pleaded in conformance with Federal Rule of Civil Procedure 11, plaintiffs have alleged the foregoing based upon the investigation of their counsel, which included a review of Vanstar's SEC filings, securities analysts' reports and advisories about the Company, press releases issued by the Company, media reports about the Company, private investigations and discussions with consultants, and, pursuant to Rule 11(b)(3), believe that after reasonable opportunity for discovery, substantial evidentiary support will likely exist for the allegations set forth at ¶¶7, 69, 80, 91, 97, 107, 115, 133, 139, 140.
WHEREFORE, plaintiffs pray for judgment as follows:
1. Declaring this to be a proper class action;
2. Awarding damages and other costs;
3. Awarding extraordinary, equitable and/or injunctive relief, including the imposition of a constructive trust upon the proceeds of defendants' insider trading, pursuant to Rules 64, 65 and any appropriate state law remedies; and
4. Awarding other just and proper relief.
Plaintiffs demand a trial by jury.
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DATED: March 11, 1999 |
MILBERG WEISS BERSHAD _________________________________ 600 West Broadway, Suite 1800 MILBERG WEISS BERSHAD _________________________________ 222 Kearny Street, 10th Floor STEVEN E. CAULEY, P.A. BERNSTEIN LIEBHARD & LIFSHITZ Attorneys for Plaintiffs |
VANSTAR\2NDAMEND.CPT
1. It is customary in IPOs for the controlling shareholders and top corporate insiders to agree with the underwriters not to sell any of their stock in the corporation for 180 days after the offering. This is known as a "lock-up" agreement.
2. GAAP encompasses the rules, conventions and practices recognized and employed by the accounting profession for preparation of financial statements. The SEC requires that financial statements filed with the Commission must conform with GAAP. Such financial statements that are not prepared in compliance with GAAP are presumed misleading and inaccurate. Regulation S-X (17 C.F.R. §210.4-01(a)(1)).
I, the undersigned, declare:
1. That declarant is and was, at all times herein mentioned, a citizen of the United States and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interested in the within action; that declarant's business address is 222 Kearny Street, 10th Floor, San Francisco, California 94108.
2. That on March 11, 1999, declarant served the SECOND AMENDED COMPLAINT FOR VIOLATION OF THE SECURITIES EXCHANGE ACT OF 1934 by depositing a true copy thereof in a United States mailbox at San Francisco, California in a sealed envelope with postage thereon fully prepaid and addressed to the parties listed on the attached Service List and that this document was forwarded to the following designated Internet site at:
http://securities.milberg.com
3. That there is a regular communication by mail between the place of mailing and the places so addressed.
I declare under penalty of perjury that the foregoing is true and correct. Executed this 11th day of March, 1999, at San Francisco, California.
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_______________________________ |
Source: Milberg Weiss Bershad Hynes & Lerach LLP website