Plaintiffs, as and for their consolidated amended complaint, allege the following upon personal knowledge as to themselves, their counsel, and their own acts, including plaintiffs' suitability to serve as class representatives. All other allegations herein are based upon the investigation of Compaq Computer Corp. ("Compaq" or the "Company") conducted by plaintiffs by and through their attorneys, which included, inter alia, a review of public filings of defendant Compaq with the Securities and Exchange Commission ("SEC"), securities analyst reports, press releases and news articles pertaining to Compaq and the personal computer industry, as well as other matters of public record.

1. This Court has jurisdiction over this litigation under Section 27 of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. Section 78aa.

1. The claims herein arise under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. Sections 78j(b) and 78(t)(a) and Rule 10b-5, promulgated thereunder by the Securities and Exchange Commission ("SEC") (17 C.F.R. Section 240.10b-5).
2. Venue is proper in this district pursuant to Section 27 of the Exchange Act because defendant Compaq has its principal place of business in this district and transacts substantial business in this district, and many of the alleged acts, transactions and conduct constituting violations of law, including the preparation, issuance and dissemination to

the investing public of materially false and misleading information, occurred, at least in part, in this district.

1. In connection with the conduct complained of herein, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including the mails and interstate telephone communications and the facilities of a national securities exchange.

NATURE OF THE ACTION

1. This action is brought as a class action to remedy violations of the Exchange Act on behalf of a class of persons who purchased securities of Compaq between July 10, 1997, and March 6, 1998, inclusive (the "Class Period"), and were damaged thereby (the "Class").
2. Compaq is the self-described, largest personal computer (PC) manufacturer in the world. In 1994, Compaq controlled 11.5% of the desktop PC market. Combined, its three largest competitors, IBM, Hewlett Packard and Dell Computer Corp. ("Dell"), accounted for roughly only 14% of the market in that year.

1. During the past five years, Dell has emerged as Compaq's chief competitor in the PC industry based in large part on Dell's direct sales strategy. Under that strategy, Dell builds each PC to order and keeps virtually no inventory of finished PC's or components in stock or at distributors or dealers. Dell sells directly to PC users without any middlemen. By contrast, Compaq's sales model requires it to project customer demand and manufacture enough product in different configurations to meet projected demand. In addition, Compaq delivers all its finished product to distributors and dealers, known in the industry as the "channel", for ultimate sale to customers. Compaq's sales model, therefore, unlike Dell's, has been historically heavily dependent upon the channel, and requires it to maintain large inventories of all components as well as finished product both in its warehouses and in the distribution channel. Historically, Compaq sold 90% of its products as pre-configured computers into the channel.

1. By mid-1996, approximately one year prior to the beginning of the Class Period, Company management realized that Compaq was rapidly losing ground to Dell, and that to achieve its earnings and market share goals it would need to begin to challenge Dell's direct sales method with a less inventory-intensive sales model of its own. Accordingly, Compaq began to develop a new sales model, which it called its "Optimized Distribution Model" (ODM), described in greater detail below.
2. By July 10, 1997, the beginning of the Class Period, defendants realized that the ODM was failing miserably and would not work to stem the tide of eroding market share to Dell. Consequently, defendants recognized that Compaq's earnings could not be sustained at the levels they had hoped. However, for several reasons, defendants were determined to postpone this negative news about the Company, and the inevitable hemorrhaging of the Company's stock price, until 1998. First, defendants wanted to acquire other companies, using the Company's stock as currency. Therefore, it was important for defendants to keep the Company's stock price as high as possible until after the acquisitions took place. Defendants succeeded on this score: Defendants used the high price of Compaq's stock to purchase both Tandem computers, Inc. ("Tandem") for $3 billion in Compaq stock during the Class Period, and then acquired Digital Equipment Corporation ("DEC"), with almost $5 billion in Compaq stock, towards the end of the Class Period.
3. Second, the Individual Defendants had much of their wealth tied up in Compaq stock and options, and needed to keep the price of Compaq as high as possible until they could sell as much of their stock as possible. Defendants also succeeded on this score: During the Class Period, while the stock price was artificially inflated, defendants sold Compaq stock in record numbers. In all, during the Class Period defendants sold nearly 2.5 million shares⁽¹⁾ of Compaq stock for proceeds of over $120,000,000.
4. Third, much of the Individual Defendants' compensation was in the form of year-end bonuses, which were tied to increased net income for the Company and return on invested capital (ROIC) measured at year end. It was therefore incumbent on defendants to postpone the disclosure of any negative news that would affect ROIC until 1998 when their bonuses for 1997 had been fixed.
5. In order to postpone the decline in the Company's stock price, throughout the Class Period defendants painted a picture of a growing company with a successfully developing new sales model, with earnings on target with the market's expectations, and with a growing market share. The truth, however, was quite to the contrary: Defendants knew throughout the Class Period that the ODM was not working, or at best they knew that the ODM was so fraught with risk and uncertainty that it was highly unlikely that it would work in the short term. In fact, by the beginning of the Class Period, the channel had balked at Compaq's ODM plan and was suffocating Compaq's efforts to compete with Dell in a direct sales model for fear that the model would ultimately exclude them.

1. Moreover, defendants' fraud required two additional elements. First, in order to mask the difficulty the Company was having with the ODM, and to give the appearance of robust sales, Compaq stuffed inventory into the channel. This means that defendants persuaded resellers and distributors to accept more product than they needed in return for certain incentives. Although these practices allowed the Company to report high sales and profitability figures in 1997, defendants were, in fact, perpetrating a fraud on the market by sacrificing future sales and income to paint a false picture of present success. Of course, channel stuffing was never acknowledged by defendants during the Class Period. Second, to prevent the market from discovering this channel stuffing, defendants began factoring receivables, i.e., selling receivables at a discount, in the second quarter of 1997. This also artificially inflated ROIC, which directly supported increased salary and bonuses for Compaq executives. In fact, at the end of the Class Period, defendant Mason admitted that one of the reasons Compaq factored receivables was to increase ROIC. Of course, for most of the Class Period defendants gave no indication of the factoring of receivables, and never during the Class Period discussed why receivables were being factored.
2. The market, including numerous securities analysts closely following the Company, bought defendants' deception lock, stock and barrel. Throughout the Class Period, as a result of defendants' deception, the market was convinced that the ODM was working and that earnings were not slowing. As a consequence, Compaq's stock price rose 60% during the Class Period, from $24 per share at the beginning of the Class Period, to a high of over $39.⁽²⁾

1. On February 26, 1998, after the last of the insider sales was completed, news of Compaq's channel stuffing began to filter into the marketplace. The Company's stock price fell from $34 per share on February 26, 1998 to $27 per share by March 5, 1998. Then, on March 6, 1998, the Company stunned the investing public when it announced that it would have no earnings for the first quarter, falling $500 million short of expectations. Compaq's stock price further collapsed on this news, falling on Monday, March 9, 1998 to $24-3/4 per share, i.e., the price at which it was trading at the beginning of the Class Period. Plaintiffs and the other members of the Class lost hundreds of millions of dollars as a result.

Plaintiffs

1. During the Class Period, plaintiffs and each member of the Class purchased securities of Compaq in the open market without knowledge of the misconduct of defendants alleged in this complaint and suffered damages as a result. Plaintiffs and each member of the Class directly or indirectly relied upon the individual defendants' and Compaq's public reports, press releases, and other public statements, as more fully described below, and/or upon the integrity of the market for Compaq's common stock.
2. Plaintiffs Mindy Aber, Mark Berger, Michael Brown, John Butler, Sid Cash, Henry Chaker, Alexander Chwick, Robert Defibaugh, Farhad Dehghan, Aline Demin, Nasser Fazlulahi, Robert Fishbein, Gary Fruchter, Paul Giorgi, Bagher R. Harandi, Kenneth & Sandra Joe, Dr. Allen Johnston, Ronald Klentz, Nick Kolokithias, Donald Margolin, Vibhuti Mehta, Mings Inc, Lilia Mistetsky, Ron Nabhan, Mohammed Najam, Louis Nilwoke, John & Carol Pedranghelu, Steve Pfeffer, Frank Pisco, John Pressley, Bnos Rochel, Amir Sabetian, Mark A. Salitan, Sam D. Samuels, Benjamin Schulman, Edward Steudtner, and Philip Ziegler purchased Compaq securities during the Class Period, as outlined in their plaintiff's certifications attached hereto, and were damaged thereby.

Defendants

1. Defendant Compaq is a Delaware Corporation with its principal offices located at 20555 SH 249, Houston, Texas 77070. Compaq designs, develops, manufactures and markets a wide range of computing products, including desktop and portable computers and PC servers.
2. Defendant Eckhard Pfeiffer ("Pfeiffer") has been President, Chief Executive Officer, and a Director of Compaq since 1991. Defendant Pfeiffer was one of the Company's primary spokespersons during the Class Period and issued many of the within detailed false and misleading statements. According to the Notice of 1998 Annual Meeting of Shareholders and Proxy Statement dated March 6, 1998 (the "1998 Proxy"), in 1997 defendant Pfeiffer received cash compensation from Compaq of $4,500,000, including $3,250,000 as a performance bonus. He also received options to purchase 1.75 million shares of Compaq stock as part of his 1997 bonus compensation.
3. Defendant Earl L. Mason ("Mason") has been Senior Vice President of Finance and Chief Financial Officer of Compaq since June 1996. Defendant Mason, as one of the Company's primary spokespersons during the Class Period, issued many of the within detailed false and misleading statements. Defendant Mason was also the Company's chief contact with securities analysts during the Class Period. According to an October 16, 1997 report by Credit Suisse First Boston Corp., Mason "attends with great regularity" institutional investors' conferences. According to the 1998 Proxy, in 1997 defendant Mason received cash compensation from Compaq of $1,175,000, including $700,000 as a performance bonus. He also received options to purchase 650,000 shares of Compaq stock as part of his 1997 bonus compensation. Defendant Mason sold over $3,700,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
4. Defendant Benjamin Rosen ("Rosen") has been Chairman of the Board of Compaq since 1983. Defendant Rosen sold over $14,000,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
5. Defendant John T. Rose ("Rose") was elected Senior Vice President of Enterprise Computing Group for Compaq in July 1996 and held that position throughout the Class Period. Prior to that time he was Senior Vice President of Compaq's Desktop PC Division. According to the 1998 Proxy, in 1997 defendant Rose received cash compensation of $1,150,000, including $700,000 as a performance bonus. He also received options to purchase 650,000 shares of Compaq stock as part of his 1997 bonus compensation. Defendant Rose sold nearly $2,500,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
6. Defendant John W. White ("White") was appointed Vice President and Chief Information Officer of Compaq in February 1994 and held that position throughout the Class Period. Defendant White sold $6,000,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant White's compensation was tied, in part, to the Company's earnings and ROIC.
7. Defendant Robert W. Stearns ("Stearns") was appointed Senior Vice President of Technology and Corporate Development for Compaq in January 1996 and held that position throughout the Class Period. Defendant Stearns sold over $13,800,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Stearns' compensation was tied, in part, to the Company's earnings and ROIC.
8. Defendant Michael Winkler ("Winkler") has been Senior Vice President of PC Products for Compaq since November 1996. Defendant Winkler sold over $3,000,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Winkler's compensation was tied, in part, to the Company's earnings and ROIC.
9. Defendant Thomas J. Perkins ("Perkins"), former Chairman of Tandem Computers, became a Director of Compaq in the Summer of 1997 when Compaq acquired Tandem. Defendant Perkins sold $33,000,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
10. Defendant J. David Cabello ("Cabello") was appointed Senior Vice President, General Counsel, and Secretary of Compaq in December 1996 and held those positions throughout the Class Period. Defendant Cabello sold over $450,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Cabello's compensation was tied, in part, to the Company's earnings and ROIC.
11. Defendant Michael Heil ("Heil") has been Senior Vice President of Worldwide Sales, Marketing, Service and Support for Compaq since January 1998. Prior to this position he served as Compaq's Senior Vice President, Consumer Products Groups since 1995. Defendant Heil sold over $3,600,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Heil's compensation was tied, in part, to the Company's earnings and ROIC.
12. Defendant Gregory E. Petsch ("Petsch") has been Senior Vice President of Manufacturing and Quality for Compaq since July 1993. According to the 1998 Proxy, in 1997 defendant Petsch received cash compensation from Compaq of $1,100,000, including $675,000 as a performance bonus. He also received options to purchase 600,000 shares of Compaq stock as part of his 1997 bonus compensation. Defendant Petsch sold $7,700,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
13. Defendant Kenneth L. Lay ("Lay") has been a Director of Compaq since 1987. Defendant Lay sold over $1,400,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
14. Defendant Roel Pieper ("Pieper), former Chief Executive Officer of Tandem, was appointed Senior Vice President and General Manager of Compaq's Worldwide Sales, Marketing, Service, and Support Group on September 10, 1997. He resigned those positions on or about January 12, 1998. According to the 1998 Proxy, in 1997 defendant Pieper received cash compensation from Compaq of $1,786,869, including $1,286,869 as a performance bonus. He also received options to purchase 650,000 shares of Compaq stock as part of his 1997 bonus compensation. Defendant Pieper sold over $21,000,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information.
15. Defendant Andreas Barth ("Barth") has been Senior Vice President of Compaq's Europe, Middle East and Africa Operations since 1991. Defendant Barth sold over $10,400,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Barth's compensation was tied, in part, to the Company's earnings and ROIC.
16. Defendant Rodney Schrock ("Schrock") has been Vice President of Consumer Products Group for Compaq since January 1998. Prior to that time he was Vice President of Compaq's Presario PC Division. Defendant Schrock sold over $900,000 of his own Compaq shareholdings at artificially inflated prices during the Class Period in order to profit from defendants' fraudulent conduct, and did so while in possession of material non-public information. Defendant Schrock's compensation was tied, in part, to the Company's earnings and ROIC.
17. Defendants Pfeiffer, Mason, Rosen, Rose, White, Stearns, Winkler, Perkins, Cabello, Heil, Petsch, Lay, Pieper, Barth, and Schrock (hereinafter, the "Individual Defendants"), as the senior operating executive officers and directors of Compaq, had day-to-day responsibilities for managing and supervising the operations of Compaq. As officers, directors and/or controlling persons of a company that is and, at all relevant times, was registered with the SEC under the federal securities laws, the Individual Defendants had a duty to disseminate complete, accurate and truthful information with respect to the Company's operations, to correct any previously issued statements that had become materially misleading or untrue and to disclose any trends that would materially affect the present and future financial operating results of Compaq, so that the market price of the Company's publicly traded securities would be based upon truthful and accurate information. Under rules and regulations promulgated by the SEC under the Exchange Act, specifically Item 303 of Regulation S-K, the Individual Defendants also had a duty to report all trends, demands or uncertainties that were reasonably likely to impact (i) Compaq's liquidity; (ii) Compaq's revenues and/or income; and/or (iii) previously reported financial information such that it would not be indicative of future operating results. The Individual Defendants' statements and omissions during the Class Period violated these specific requirements and obligations, among others.

The Individual Defendants Were Control Persons Of Compaq

1. By reason of their stock ownership or other financial interests, their business relationships and their status as officers and/or directors of Compaq, the Individual Defendants were, at all relevant times, "controlling persons" of Compaq within the meaning of Section 20(a) of the Exchange Act and had the power and influence (which they exercised) to cause Compaq to engage in the unlawful conduct complained of herein. Because of their positions of control, the Individual Defendants were able to and did, directly and/or indirectly, control the conduct of Compaq's business, and the information about its business contained in its public statements, filings with the SEC, and presentations to securities analysts concerning the Company. Throughout the Class Period, the Individual Defendants were provided with copies of, reviewed and approved, and/or signed press releases and other reports prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or to cause them to be corrected. As a result, each of these defendants was responsible for the accuracy of the public reports, releases and statements detailed herein as "group published" information and are therefore responsible and liable for the representations contained therein.
2. As direct participants in the wrongs complained of herein, each of the named defendants is jointly and severally liable for the damages suffered by plaintiffs and other purchasers of Compaq securities during the Class Period for the violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder.

CLASS ACTION ALLEGATIONS

1. Plaintiffs bring this action for violations of Sections 10(b) and 20(a) of the Exchange Act as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure on behalf of a Class of all persons who purchased Compaq securities during the period July 10, 1997, through March 6, 1998, inclusive and were damaged thereby (the "Class Period"). Plaintiffs Mindy Aber, Mark Berger, Sid Cash, Henry Chaker, Robert Defibaugh, Farhad Dehghan, Aline Demin, Nasser Fazlulahi, Robert Fishbein, Gary Fruchter, Bagher R. Harandi, Kenneth & Sandra Joe, Dr. Allen Johnston, Ronald Klentz, Nick Kolokithias, Donald Margolin, Mings Inc., Lilia Mistetsky, Ron Nabhan, Mohammed Najam, Steve Pfeffer, Frank Pisco, Bnos Rochel, Amir Sabetian, Mark A. Salitan, Sam D. Samuels, and Benjamin Schulman (the "20A Plaintiffs") also bring this action for violations of Section 20A of the Exchange Act on behalf of a subclass of all persons and entities who purchased Compaq common stock contemporaneously with the sales of Compaq stock by the Individual Defendants during the Class Period (the "Subclass"). Excluded from the Class and the Subclass are the defendants, members of the immediate family of the Individual Defendants, any entities in which any defendant has a controlling interest, and the legal representatives, heirs, successors, predecessors in interest, affiliates or assigns of any defendant.
2. The members of the Class and Subclass are so numerous that joinder of all members is impractical. As of February 27, 1998, Compaq had approximately 1,500,000,000 shares of common stock outstanding. While the exact number of Class and Subclass members is unknown to plaintiffs at this time and can only be ascertained through appropriate discovery, plaintiffs believe that there are at least several thousand members of the Class and Subclass located throughout the United States.
3. Plaintiffs' claims are typical of the claims of the members of the Class because all members of the Class were similarly affected by defendants' wrongful conduct in violation of the federal securities laws complained of herein. The 20A Plaintiffs, as purchasers of Compaq stock contemporaneous with the Individual Defendants' sales of Compaq stock, also have claims typical of the Subclass.
4. Plaintiffs will fairly and adequately protect the interests of the members of the Class and Subclass and have retained counsel competent and experienced in class action and securities litigation. Plaintiffs have no interests antagonistic to or in conflict with those of the Class or Subclass.
5. Common questions of law and fact exist as to all members of the Class and Subclass and predominate over any issues affecting solely individual members of the Class and Subclass. Among the common questions of law and fact are:
1. whether the federal securities laws were violated by defendants' acts as alleged in this complaint;
2. whether defendants issued false and misleading statements concerning Compaq's financial and operational condition and/or omitted to disclose material information concerning Compaq in Compaq's public statements disseminated before and during the Class Period;
3. whether defendants acted with knowledge or reckless disregard for the truth when disseminating false information about Compaq;
4. whether the prices of Compaq securities were artificially inflated due to defendants' misrepresentations and omissions complained of herein;
5. whether the Individual Defendants violated Section 20A of the Exchange Act by trading Compaq common stock without disclosing material adverse information; and
6. whether the members of the Class and Subclass have sustained damages and, if so, the proper measure of those damages.
6. A class action is superior to other available methods for the fair and efficient adjudication of this controversy because, inter alia, joinder of all members is impracticable. Furthermore, because the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it impossible for Class members to individually redress the wrongs done to them. There will be no difficulty in the management of this action as a class action.
7. Plaintiffs will rely, in part, upon the presumption of reliance established by the fraud-on-the-market doctrine in that:
1. defendants made public misrepresentations during the Class Period, as alleged in this complaint;
2. the misrepresentations were material;
3. shares of Compaq common stock were traded on a developed national stock exchange, namely the New York Stock Exchange, which is an efficient market within the meaning of that term in the context used in this complaint;
4. Compaq options were traded on a developed national exchange, namely the Chicago Board Options Exchange, which is an efficient market within the meaning of that term in the context used in this complaint; and
5. plaintiffs and the other members of the Class purchased Compaq securities between the time defendants made the misrepresentations alleged herein and the time the truth was at least partially revealed, without knowledge of the falsity of the misrepresentations.
8. Based upon the above, plaintiffs are entitled to a presumption of reliance upon the integrity of the market. Similarly, plaintiffs are entitled to a presumption of reliance with respect to the omissions alleged in this complaint.

NO SAFE HARBOR

1. The statutory safe harbor, which may shield a defendant from liability for both oral and written forward-looking statements, does not apply to those materially false or misleading statements complained of herein that concerned present or historical facts. To the extent that any written or oral statement complained of herein concerned wholly future events and facts and can thus be deemed forward-looking, such statement is not protected by the statutory safe harbor because either: the specific statements pleaded herein were neither identified as "forward-looking statements" when made, nor accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the specific statements or, in the case of oral forward-looking statements and statements made through securities analysts, the statements were not accompanied by a statement that additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statement was contained in a readily available written document or portion thereof.
2. In addition, the statutory safe harbor does not apply to any of the forward-looking statements pleaded herein because: (1) in the case of a statement made by a natural person, the statement was made with actual knowledge by the person that the statement was false or misleading, or (2) in the case of a statement made by a business entity, the statement was made by or with the approval of an executive officer of Compaq who knew that the statement was false or misleading.

Compaq's Position In The PC Market

1. Founded in 1982, Houston, Texas-based Compaq is the largest manufacturer of personal computers in the world. Compaq develops and markets hardware, software, solutions and services, networking and communication products, commercial desktop and portable products and consumer PCs. Compaq's products are sold in more than 100 countries.
2. From its inception, Compaq quickly established itself as one of the leaders in the desktop PC market. By 1993, Compaq had launched its Presario family of consumer PCs, and by 1994 Compaq controlled 11.5% of the market for desktop PCs.
3. On July 25, 1996, as published in The New York Times, Compaq reported that earnings for the second quarter rose 8.5%, to $267 million, or 97 cents a share, from $246 million or 90 cents a share, in the comparable period of the prior year. One of the keys to these results, as reported by the Company, was that Compaq was able to reduce "the number of its products held in inventory by $400 million. That allowed Compaq to increase its profit margins by reaping the benefit of declining prices for key components like memory chips and disk drives." According to the article:

Inventory management has become critical to success in the fast-paced personal computer industry, because when the retail prices of computers decline, the profit margins on every computer that is already built begin to erode. Companies with low inventories can capitalize on lower component prices by rapidly integrating the cheaper parts into their products.

(Emphasis added.)

1. As further reported in the article, Compaq and its senior executives were telling the investing public that they expected that the Company was poised for a bright future:

"Our outlook calls for a strong second half," said Eckhard Pfeiffer, the president and chief executive. "In fact, we believe we are in an excellent position to gain market share and achieve improved profitability for the balance of the year."

1. The New York Times noted, however, that Compaq faced severe challenges: "But the relentless competition from rivals like Dell, IBM and Hewlett-Packard puts Compaq under intensive pressure to continue operating at peak efficiency. Any mistake and the company could see its profit margins decline." This relentless competition, particularly from Dell, which had been steadily increasing its market share at the expense of Compaq⁽³⁾, made Compaq realize that its position within the PC market would be severely jeopardized if it did not adapt to changing marketplace demands. Accordingly, Compaq realized that to compete successfully with Dell, it would need to develop a build-to-order sales and distribution model.
2. Compaq therefore announced that it had begun to develop the ODM program. The ODM, according to Compaq's management, was to develop in three phases. The first phase of the ODM was Compaq's Build-to-Order concept, pursuant to which Compaq would produce products after receiving an order from a channel partner, i.e., a distributor or reseller. The second phase of the ODM was the Channel Configuration Program. Compaq would deliver partially built configurable products to channel partners who would then custom-build them to particular customer needs. The third and final phase of the ODM was to be the Configure to Order plan, whereby Compaq would offer either a configuration of standard product types, including certain hardware and software, while doing less of the configuration for customers whose clients require more differentiation. The ODM was supposed to lower channel inventories, reduce costs, and allow faster delivery to end users.

Defendants Promote Their New Sales Model

1. On July 29, 1996, Asia Computer Weekly reported that Mike Winkler, Senior Vice President and General Manager of Compaq's PC Products Group wanted to "return Compaq to the No. 1 position in portables by the end of next year" by, among other things, adopting a "strategy that includes raising the Company's build-to-order (BTO) capability to outproduce and outsell the competition." (Emphasis added.) According to the same article, "Winkler said the Company will push BTO from 70 percent of manufacturing now to 95 per cent by year-end. 'The goal is to produce more with less inventory. We want to meet orders within five working days and to keep inventory down to two weeks,' said Winkler."
2. An article appearing in Information Week on November 25, 1996, based on an interview with Jim Schraith, Compaq's Vice President and General Manager of North America, highlighted Compaq's anticipated business shift, stating:

Compaq also is taking a page from Dell's playbook by testing a build-to-order PC program for large corporate customers. "We don't think we need to do everything in our factory, but if we can add more value in terms of software for the customer, we'll do it." says Schraith.

Compaq will begin testing the build-to-order model early next year, he says. It's the same model that has helped Dell achieve record growth rates in recent quarters and has attracted corporate users that once depended on top-tier manufacturers such as HP and IBM.

(Emphasis added.)

1. Contrary to the representations in the Information Week article, Compaq's build-to-order model was different from that of Dell in at least one key respect - - Compaq was not planning to sell directly to consumers, but, rather, was planning to continue to sell through its distribution channels. In fact, foreshadowing the problems that would befall Compaq during the Class Period, an article appearing in the December 26, 1996 edition of Investor's Business Daily described the distinction between Dell's distribution model and that planned by Compaq:

Compaq Computer Corp. of Houston, Texas and International Business Machines Corp. of Armonk, N.Y., all want a piece of Dell's direct business.

But they're trying to do what Dell does without really doing it. While Dell is a true direct seller - taking orders directly from corporate clients - others are trying a different tack.

They're considering a deal where their resellers still take orders, but they also get a piece of the manufacturing action by building final assembly of PCs. The advantage is computers can be customized at a point just before they reach corporate clients.

The problem in going direct for HP, IBM and Compaq is they have entrenched relationships with thousands of distributors and resellers. Those companies have been key contributors to their success.

Dell's ability to tailor orders to a specific customer's needs has been the envy of the industry. Its direct sales method allows Dell to save because it keeps little inventory on hand.

As a result, Dell has enjoyed higher earnings growth rates in recent quarters than IBM, HP or Compaq. . . .

Compaq officials are expected to announce within weeks of their intention to start a reseller assembly program. "I think most of our channel partners would like that," said Earl Mason, Compaq's chief financial officer.

Eckhard Pfeiffer, Compaq's chief executive, has set a mandate to make the $15 billion-in sales company hit $40 billion by 2000. That's roughly a 22% per-year growth rate, which analysts say is reasonable.

But they add that Compaq may have to scratch to find ways to increase revenue. That's one reason why Compaq - which sells a small number of machines via direct sales - is considering this approach.

"It can work," says Steve Baker, an analyst at International Data Corp. in Framingham, Mass. "I think one of the things they have to do is find a way to keep that part of the Company separate."

IBM started its program three years ago, but did not fully commit to it until last year, company officials say. The company was more involved in another program which was more Dell-like, known as Direct PC.

The reseller assembly program languished until last year. IBM Chairman Louis Gerstner proclaimed in late '95 that the company was shooting itself in the foot by competing with resellers through its Direct PC program, a traditional direct selling effort.

(Emphases added.)

1. Defendants obviously wanted investors to believe that Compaq could avoid the problems suffered by IBM and, therefore, embarked on a publicity campaign to convince the market that its build-to-order program could thrive without alienating resellers. In early 1997, they also began a road show of sorts with the channel in an attempt to convince the channel to get on board with the build-to-order program.
2. The hype surrounding Compaq's build-to-order plans increased in 1997. As reported in the January 23, 1997 Houston Chronicle, Compaq not only had record quarterly and annual sales for 1996, but predicted that 1997 would be just as strong:

Compaq expects to continue its strong growth in 1997, said Earl Mason, the company's chief financial officer. Compaq's chief executive, Eckhard Pfeiffer, has said he wants Compaq to have revenues of $40 billion by the turn of the century, and Mason said the company is "right on target" to meet that goal.

The benefits of Compaq's recent re-engineering efforts contributed to the company's sales growth, Mason said. Compaq has been moving to a build-to-order system, where it only makes computers when it has orders for them. As a result, Compaq is able to keep its inventories low and keep pace with demand.

Analysts said Compaq's build-to-order system borrows heavily from direct-sales companies such as arch rival Dell Computer in Austin.

William Conroy, an analyst with Williams Mackay & Jordon in Austin, said Compaq is "starting to run its business more like a direct business."

"The impact of that is they can carry less inventory, and it's a cheaper way to build the machine - and a less expensive way to build their business," he said.

Mason said the company will expand its build-to-order concept into configuration-to-order, in which entire computer networks sold to big customers will be configured for that customer as they come off the factory floor.

(Emphasis added.)

1. To implement its strategy, Compaq needed to convince the market, not just its resellers, that build-to-order could work even without direct sales. According to the March 10, 1997 Computer Reseller News, Jim Schraith, Compaq's Vice President and General Manager of North America, said that Compaq's new strategy "responds to the needs of our channel as well as our major end-user customers." Mike Pocock, Compaq's Vice President of North American Sales added that "we want to leapfrog our competitors and not just offer a me-too program."
2. Compaq tried to convince its channel partners that they were not being phased out and that Compaq was not using build-to-order as a platform for moving to a direct sales distribution method. As reported in PC Week Online on March 21, 1997, '"we have no plans to make direct sales a significant part of the revenue stream,' said Compaq spokesman Mike Berman." The article pointed out however, that "suspicions were raised when Compaq hired Richard Snyder, formerly Dell's Senior Vice President and General Manager of North America, to be Compaq's Senior Vice President and General Manager of Worldwide Sales, Marketing, Service and Support."
3. These suspicions may have been well founded since Compaq tried twice in early 1997 to entice Gateway 2000, a direct sales PC company, to entertain a buyout overture. However, in April 1997 Gateway rebuffed Compaq's overtures, although neither company spoke publicly about the discussions.

1. On March 24, 1997, Computer Reseller News reported defendants' assurances that Compaq's build-to-order program would not attempt to circumvent the channel:

"We can pass the savings on in the form of lower prices, more demand creation and higher reseller margins," said Jim Schraith, Compaq's vice president and general manager, North America. "At the end of the day, we can become the most competitive vendor out there. We can beat Dell on price beyond a shadow of a doubt."

Compaq, for its part, is dubbing its re-engineered logistical supply chain model the Optimized Customer Delivery Mechanism, which includes a channel configuration program (CCP) and an internal configure-to-order (CTO) capability that will see Compaq configure and ship product to either the channel or end-user accounts. The decision on whether to use Compaq to configure product or have the channel perform final assembly will be left to the [Value Added Resellers or] VAR, Schraith said.

Details of the CCP will be worked out within the next 30 days, with a rollout of the channel assembly program and Compaq's internal CTO plan to be completed by midyear, he said.

As much as 80 percent of Compaq's PCs and servers sold in the United States could flow through the CCP-CTO model by year's end, Schraith said, adding that laptops and the new Compaq workstations will not be included in the channel assembly program.

Word that Compaq intended to do some configuration internally initially sparked fears within the channel that Compaq may start taking some business direct in a Dell-type model. But Compaq flatly denied that scenario, and an unprecedented visit by Compaq Chief Executive Eckhard Pfeiffer to the channel apparently allayed those concerns (CRN, March 17).

"I'm relying on Eckhard's personal word that they will not take business direct," said Bill Taucher, chairman and chief executive of Vanstar Corp., Pleasanton, Calif. "That's a dangerous game to start playing when you've assembled the kind of channel that he's assembled."

(Emphasis added.)

1. At Compaq's Innovate Forum on April 8, 1997, defendant Pfeiffer unveiled the Company's build-to-order plan, stating "Compaq is on track to creating the most effective distribution model in the industry. Compaq is building products to order rather than to forecast. We'll build and ship standard products within one to five days after receiving an actual customer order."
2. On April 8, 1997, reporting on the Forum, Reuters Financial Service, stated:

"This is huge. It provides the flexibility of the indirect (sales) model, with all the efficiencies of the direct model," said Dick Snyder, a Compaq senior vice president.

Pfeiffer said major resellers had been consulted and were in agreement with the plan. "The indirect channel remains our primary means of delivering products and services," he said.

Some experts have said the build-to-order format could allow Compaq to cut its prices by as much as 10 percent.

Pfeiffer did not give specific figures but said customers would "reap the benefits of lower prices, greater product availability and a more predictable delivery."

The Compaq president said customers would be able to custom-order Compaq computers either through resellers or directly from the Company.

"Channel partners (resellers) can buy products configured exactly to an end-customer's order and then deliver," he said.

"At the same time, Compaq is creating an internal configure-to-order capability in Houston and other Compaq plants around the globe," he said.

1. On April 28, 1997, Reuters published an article describing the shift in Compaq's business model paradigm:

In its current business model, Compaq ships a certain number of PCs to its distributors and resellers in configurations that it believes the market wants. Then, these resellers, based on orders from customers, sometimes have to add new parts or reconfigure the boxes themselves - for example, swapping a one gigabyte hard disk drive for a two gigabyte drive, or more memory chips. This second reconfiguration adds extra costs to the product.

Now, when a product isn't selling to forecast, Compaq cuts prices to help move the inventory out of the distribution channel, but it also has to pay its resellers and dealers for price protection, because they have already purchased the products from Compaq to be sold at the higher prices.

With fewer weeks of inventory on hand, Compaq's price protection payments will decline. Compaq's returns policy will also change so that it will only accept returns from its distributors of products that are dead on arrival.

Mason said that the lower prices will not lead to lower overall profits at Compaq, because the drop in prices will also fuel strong demand for its products. "We will have the most competitively priced products and that will create a tremendous pull out of the channel," he said, adding that the current model is somewhat like a "bulldozer pushing all its products" to its resellers.

Many Wall Street analysts are concerned that Compaq's re-engineering will cause a big shake-up in its business, and that its lower prices will hurt profits. Mason said that he believes Wall Street does not fully understand what Compaq is doing and that its plan, plus increased sales of higher margin products such as servers and networking products, will fuel margin growth.

Currently, Compaq's gross profit margins are among the highest in the PC industry, at 24.5 percent of revenues in Q1. "My guess is you will see us rewrite our 10Q," Mason said, referring to Compaq's quarterly filing with the Securities and Exchange Commission, where the company targets margins in the 23 to 25 percent range. "When you see this thing go over 25, you will see us rewrite the 10Q," he said, but he declined to be more specific.

Compaq's New Sales Model Worries The Channel

1. From its outset, the ODM program faced serious difficulties. Unlike Dell's build-to-order model, which was based on direct sales to end users, Compaq's plan was extremely cumbersome; the Company had to include the channel in the process or risk alienating its chief revenue source. Of course, these channel partners needed to be compensated. Thus, Compaq was forced either to charge more for its products than Dell to compensate its dealers and distributors or accept lower profit margins. In addition, since Compaq's business model put it at the mercy of its dealers, it was not in a position to sell directly to customers without dealer boycotts or other defensive tactics by dealers. Furthermore, Compaq was up against the channel mentality of always maintaining sufficient supply for all potential customers. Distributors and dealers use excess inventory to fulfill unexpected increases in orders and as leverage to secure pricing concessions from manufacturers. Although defendants convinced the market that this switch in business strategies to the ODM could be effectuated seamlessly, they had a much more difficult time convincing the channel.

1. Indeed, as the official launch of Compaq's program drew near, resellers wondered aloud whether Compaq was not just moving to build-to-order, but to direct selling. According to an article appearing in The New York Times on May 5, 1997:

But many analysts and industry executives doubt that Compaq can match the efficiency of the direct sellers without going direct itself. For example, when customers go to Dell's Web site, they can order a computer to their specifications in minutes. At Compaq's site, customers are directed to the nearest Compaq dealer.

"Unless they actually build a direct business, they still end up with a significant disadvantage versus Dell and Gateway," said Michael Kwatinetz, a PC hardware and software analyst at Deutsche Morgan Grenfell in New York.

But that move would risk souring Compaq's relations with dealers. Many resellers became alarmed last month when reports emerged that Compaq had been negotiating to buy both Gateway 2000 and Micron Electronics. Neither Compaq nor Gateway executives will comment on the discussions, but Micron Electronics issued a statement on April 11 confirming that takeover talks with Compaq had occurred, though Micron said no actual offer was made.

"This arouses very intense emotion among distributors," Mr. Raymund of Tech Data said. "Dell and Gateway 2000 are the enemy."

If Compaq alienates its dealers, they could easily switch their allegiance to rival suppliers. I.B.M. itself tried to sidestep dealers a few years ago only to reverse course after it began losing market share.

It is now courting dealers assiduously. It is ahead of Compaq in its ability to ship partly built machines to resellers for final assembly and is rapidly regaining share.

Mr. Schraith of Compaq said the company currently made 99.6 percent of its sales through third parties and had no intention of forsaking its partners. "Press stories have misinterpreted our actions and created some false hysteria in the marketplace," he said.

Several dealers said that despite being relieved by Compaq's reassurances, they remained wary. "I am kind of rooting for Compaq to solve their cost problems and giving them the benefit of the doubt that they won't betray the channel," Mr. Anderson of CompuCom Systems said, referring to the network of dealers.

1. The dichotomy between the Dell and Compaq business model was further described in an article appearing in the May 18, 1997 edition of The Fort Worth Star-Telegram:

Compaq and Dell both sell most of their computers to corporations and government agencies. The difference lies in how those computers are distributed. Compaq typically moves its merchandise the same way General Motors distributes cars - through a network of middlemen, who mark up the price and sell it to the end user.

Dell goes the direct route, selling its products directly to the corporate customer. Dell also builds it products "to order," which means that it doesn't have already-manufactured inventory sitting around in warehouses waiting to be sold. Thus, it can both undercut Compaq, (there is a 10 percent to 20 percent price gap between Compaq's retail prices and those of the direct sellers) and maximize its own profits.

The Wall Street Journal reported last week that Compaq intends to hire 2,000 sales people this year who will act as direct representatives of the company's big corporate clients. And the company intends to manufacture more and more of its PCs "to order," just like Dell.

Compaq will have to walk a fine line during the transition. As long as some of its computers are still sold in the traditional fashion, it will need a supportive network of middlemen - known in the computer business as value-added resellers.

"If I was a small reseller, I'd be worried," said Gene Ramirez, who follows Compaq for Dallas-based Southwest Securities. "Compaq needs to transition slowly but surely."

(Emphasis added.)

1. According to a story appearing in The New York Times on June 16, 1997, Compaq's plan would also change certain of the price protections it had offered dealers:

Now, Compaq will guarantee the prices of a dealer's inventory for only two weeks. And it will not take back any computers unless they simply do not work. As dealers work down their warehouse stockpiles, Compaq hopes by year-end to have a lean two weeks' worth of dealer inventory across its entire product line.

Earl Mason, Compaq's chief financial officer, who was recently put in charge of putting the new distribution strategy into effect, believes that it will enable Compaq to save $1 billion or more a year.

The ROIC As Measure of Performance

1. The June 16, 1997 article in The New York Times also explained that defendant Mason had been instrumental in getting the Company to focus on ROIC as an indication of performance:

By getting the company to concentrate on using its assets more efficiently rather than looking only at income and profits, Mr. Mason increased Compaq's cash hoard from $700 million to nearly $5 billion in one year. The company's return on invested capital - - which is after-tax operating profit divided by operating assets - - has doubled to 50 percent from 25 percent in that period, Mr. Mason added, and he predicted that it would soon be at triple digits.

"Our stock is tremendously undervalued," Mr. Mason said. "All this re-engineering is going to do nothing but force our profits up."

1. Mason was responsible for changing Compaq's compensation plan so that performance was measured by ROIC. According to a Dean Witter report dated January 7, 1998, "when Earl Mason joined CPQ in May 1996, the Company began looking at return on invested capital (ROIC). At this time, it created employee incentive goals related to ROIC." In fact, the Company changed its Executive Compensation plan so that performance goals hinged on ROIC. As stated in Compaq's schedule 14A filed with the SEC on or about March 7, 1997, "much of an officer's compensation depends on Compaq's financial performance. . . . Performance in 1996 placed Compaq at about the 80^th percentile in the peer group based on an evaluation of return on invested capital and revenue growth, which are highly correlated with long-term stockholder value creation." (Emphasis added.)

Defendants Continue To Raise The Expectations Of

The Investment Community Prior To The Class Period

1. On June 18, 1997, the Merrill Lynch analyst following Compaq issued a report summarizing the events of a Merrill Lynch hosted dinner with senior management of Compaq, including defendant Mason, on June 16, 1998. Among other things:

Earl Mason Senior Vice President and Chief Financial Officer effectively put to rest (yet again) a number of stories, speculations, and general skepticism surrounding the fundamental health of the business and the industry which has recently resulted in dramatic volatility for the PC stocks.

1. The report also listed the following highlights: (1) The June quarter is in great shape; (2) gross margins are improving and should continue to move up consistently; and (3) "the Build-to-Order/Configure-to-Order manufacturing transition is progressing very well. July will mark an important step up in this strategy, but so far, so good."
2. Wasserstein Perrella Securities Inc. similarly issued a positive report with a "Strong Buy" rating on June 25, 1997. Among other things, the report noted Compaq's intention to reduce channel inventories to two weeks by the end of the year. The report also noted that Compaq intended to change the price protection it offered channel partners in the new build-to-order program:

Compaq will be introducing its build-to-order system coincident with the announcement of new models in the DeskPro 2000 and 4000 family, the low and middle points of the commercial computer line, on July 14^th. With this announcement Compaq will be providing 5-day delivery for most of the orders received from dealers. Dealers will thus be able to drop their inventories sharply. As a dealer incentive, Compaq will be giving only a two week price protection, versus virtually unlimited price protection today. Returns, other than for defective system, will not be allowed.

Last year price protection and other reserves cost Compaq over 12% of revenues. By cutting this figure down substantially as they move to the build-to-order systems and with the resulting shift in dealer terms, there is the potential for significant savings. We believe that most of this will be translated into lower prices, with the aim of boosting market share. While the 12%-plus figure is an overall result, Compaq may be more aggressive in selective competitive segments of the market, resulting in more than a 12% lowering of specific product prices.

1. On June 23, 1997, as reported by Dow Jones, Compaq announced that it had agreed to acquire Tandem Computers Inc., a maker of high-end server computers and software, for $3 billion in Compaq stock. In connection with the deal, defendant Pieper, then Tandem's Chief Executive Officer, was to become a Senior Vice President of Compaq. As reported by Dow Jones, defendant Pfeiffer highlighted Tandem's sales force as one of the "motivating factors" behind the acquisition. Compaq's sales force was scheduled to double from 4,000 to 8,000 after the acquisition.

Defendants See The Writing On The Wall

1. By July 10, 1997, the beginning of the Class Period, defendants knew that despite all the hoopla, the ODM program was not working and that they were continuing to lose ground to Dell. Despite months of private meetings with resellers and other channel participants in an attempt to quell fears, and a massive publicity campaign designed to convince the market of Compaq's reliance on and agreements with the channel, Compaq had met with resistance from the channel from the very outset of the program. Not only were channel participants not keen on the idea of build-to-order, they feared that Compaq was simply attempting to shift to a direct seller model and abandon the channel altogether.
2. This fear was well founded, because Compaq soon found that it could not cut prices as deeply as it hoped unless it adopted a direct sales model. However, it knew that to do so was tantamount to corporate suicide since 90% of its sales were through the channel. Also, Compaq had not come close to meeting its goal of 5-day delivery for product under the new build-to-order model. Thus, by the time it officially launched ODM, Compaq knew that the plan would take years, not months to work itself out and would be, in the short term at least, a failure.

Defendants' Motivations For Postponing The Inevitable

1. For several reasons, defendants were determined to postpone the disclosure of any negative news about the ODM, and the erosion of market share and disappointing earnings that would be a consequence thereof. First, defendants sought to postpone disappointing earnings results for as long as possible so that they could keep the price of Compaq stock inflated as long as possible while they cashed in their personal holdings. Indeed, as alleged in detail below, defendants collectively unloaded over $120,000,000 worth of their stock during the Class Period, i.e., while the stock was artificially inflated. Second, defendants sought to keep the price of Compaq stock inflated as long as possible so that they could use that stock as currency to acquire other companies. Indeed, while the Company's stock price was artificially inflated, defendants acquired two companies, Tandem and DEC, with billions of dollars worth of the Company's stock. Third, defendants' compensation was in large part based on the Company's return on invested capital, or ROIC. To avoid disappointing results, as further alleged below, defendants factored receivables and were thereby able to show a higher ROIC and increase their bonuses. Fourth, defendants were hoping against hope that if they bought some time they could somehow convince the channel to get behind the new sales model. This hope, as alleged herein, would of course require no less than a miracle given the channel's intransigence, of which defendants were fully aware. (Another keen motivation, although not a financial one, was the personal hubris of defendant Pfeiffer, who could not tolerate failure and, in effect, losing to arch rival Michael Dell.)

1. On July 10, 1997, the first day of the Class Period, the Company announced the following results for the second quarter as reported on BusinessWire:

Worldwide sales [were] $5.0 billion for the second quarter ended June 30, 1997, an increase of 25 percent compared to the second quarter of 1996 and a 42 percent unit growth for the same period. Net income increased by 58 percent to $422 million or $1.48 per share, excluding a $208 million or $.73 per share non-recurring charge for purchased in-process technology in connection with the Microcom acquisition. Net income after the non-recurring charge for purchased in-process technology was $214 million or $.75 per share.

"These results reflect an excellent second quarter for Compaq, our customers and shareholders," said Eckhard Pfeiffer, President and Chief Executive Officer, Compaq Corporation. "We continue to accelerate our market groups while increasing profitability."

"We're very pleased with the consistency of our financial progress, especially with the improvements in earnings and the growth of gross margins to 25.3 percent in the second quarter," said Earl Mason, Compaq Senior Vice President and Chief Financial Officer. "Our on-going focus on asset management increased inventory turns from 7.1 to 10.4, and decreased Days Sales Outstanding from 60 to 39 days. Taken together, these operational improvements lifted our cash balance 165 percent from the previous year to $5.1 billion. These excellent results more than doubled Economic Value Added (EVA) to $345 million at the end of the second quarter, providing a continued increase in shareholder value."

(Emphasis added.)

1. Also on July 10, 1997, Bloomberg reported that the Company's earnings "got a boost from increased sales of expensive servers and computer networking equipment." The same Bloomberg article stated that the Company "reported gains in efficiency by reducing inventory and speeding up the collection of cash from customers." The article continued, "Compaq's efficiency moves helped boost its cash balance to $5.1 billion from about $2 billion a year ago."
2. In addition to announcing second quarter results on July 10, 1997, defendants also touted the progress of the ODM program. An article appearing in BusinessWire reported as follows:

Outlook

"Our outlook continues to call for a strong second half," said Pfeiffer. "We're confident that Compaq's new business model will accelerate market share gains and improve profitability. We are now implementing the first phase of optimizing our entire distribution model from design to manufacturing and delivery. This first phase, known as Build-to-Order, will result in substantial customer benefits. These include a shortened manufacturing cycle time, greater product availability and predictability, lower channel inventory and reduced product costs. Customers will continue to receive Compaq quality and innovation at the most compelling prices and lowest total cost of ownership. In fact, we expect our new distribution model to enable the industry's most satisfying buying and ownership experience as well as the most efficient, cost effective and comprehensive fulfillment process."

(Emphasis added.)

1. Also on July 10, 1997, Compaq executives, including defendants Pfeiffer and Mason, hosted a press conference to outline the new build-to-order strategy. As reported by ZDNN:

In a press conference here, Compaq officials went over details of how the system would work and gave details on 13 new systems designed specifically for this method of distribution. The new Deskpro 2000 and Deskpro 4000 lines have been redesigned to be more modular than normal Compaq system, to reduce assembly costs. There are also fewer systems in the lines than in Compaq's norm, which reduces inventory levels.

Although analysts have said Compaq won't see the cost savings until later this year, Compaq officials told analysts that the savings, combined with less expensive component costs, would prevent margins from eroding.

The company has been working on inventory management in preparation for the build-to-order move, and its work showed. Its yearly inventory turns increased from 7.1 to 10.4, and the number of days receivables are outstanding dropped from 60 to 39 year over year.

(Emphases added.)

1. The July 10, 1997 Bloomberg article, referred to above, also reported on the build-to-order program. Bloomberg quoted defendant Mason as stating in response to questions about price cuts and margins as follows: "we have a strategy to grow the Company substantially and the gross margin is only a piece of it. We're not going to do that at the expense of shareholders, we're going to delight our shareholders along the way." Bloomberg also reported that Compaq was "beefing up its corporate sales staff and starting to build computers to order to better compete with direct-sales companies. Compaq has sold 100,000 build-to-order PCs so far and hasn't had any major problems adopting the new strategy to its dealer network, Mason said." (Emphasis added.) The Bloomberg article also reported that Compaq unveiled significant price cuts "designed to stimulate demand." As Ashok Kumar, an analyst at Southcoast Capital, explained in that same article, "Compaq's price cuts could take a toll on profit margins and its stock price if the Company can't increase sales enough to overcome the falling per unit revenue."

Defendants' Scheme To Hide The Failure Of The ODM --

Stuffing The Channels and Factoring Receivables

1. The statements cited above regarding the ODM were false and misleading. The Company intentionally misled the market concerning the extremely weak start-up of the ODM by stuffing its distributor channels to give the appearance of greater sales and to overcome the falling per unit revenue. This channel stuffing directly contradicted its stated goal to "lower channel inventory."
2. Although "stuffing the channel" temporarily increases a company's sales figures, it only provides a short term increase and eventually causes numerous problems, such as clogged channels and lessened price and product flexibility. Here, the Company "stuffed the channel" to make quarterly results for the last three quarters of 1997 more attractive. Defendants deliberately and fraudulently mischaracterized Compaq's quarterly results and failed to inform the market of the true reasons for these results. Defendants knew that their practices were unsustainable and would ultimately catch up to them leading to price reductions for the products already in the channel which Compaq would be forced to absorb, lower product sales at the beginning of 1998, reduced earnings, and consequently, a deflated price for Compaq shares. Defendants were essentially increasing one quarter's results by borrowing from future quarters' profitability. Plaintiffs and other members of the Class were kept in the dark as to defendants' practices and the inevitable impending dire consequence of these practices that would, and did, become apparent in future quarters. At the same time, the Individual Defendants, armed with these facts, were selling Compaq shares at an unprecedented rate and amount.

1. "Channel stuffing" has consequences beyond merely increasing the amount of product inventory at distributors. High product inventories reduce a PC maker's flexibility in that it reduces its ability to change pricing and adapt to new technology and new products from competitors. If the distributor channels are clogged with a company's product, that company has limited flexibility to react to market changes. An article in The Wall Street Journal of March 16, 1998, explained that "[W]ith new components always emerging, the value of a finished unit declines about one percentage point a week." This in turn hands over price control to the dealers or distributors who may need to reduce prices in the event of a fall off in the popularity or currency of a product held in inventory. These inventory problems are the very problems that the Company was seeking to avoid by moving over to the Dell, inventory-free, "build to order" business model.
2. An article appearing in Fortune Magazine on September 29, 1997, entitled "Shipping Bricks and Other Tricks: Accounting Scams of Silicon Valley," explained that channel stuffing also raises accounting issues because a manufacturer may book sales as soon as product leaves the factory for a distributor, even if sell-through is not expected for weeks because of excess inventory at the distributor. As explained in the article:

With Computer equipment there's often no way to know how quickly a product will become obsolete. When business is booming, that's usually not a problem for companies that book revenue on sales to distributors. "But when things get harsher," Steel says, it can be tempting to "stuff the channel" by persuading distributors to take more product than they really need or want. Such deals are usually struck toward the end of a lousy quarter, and they help earnings look better than they really are.

1. The article implicated Compaq when it explained that "earlier this year Vanstar, a computer distributor, was approached by several computer companies (it wouldn't name names, but Vanstar distributes for Compaq and IBM) to sell additional merchandise. CEO William Taucher told analysts that Vanstar cooperated, and the companies made their quarters."
2. The story further explained that when a company engages in channel stuffing, it "is gambling that its troubles will be temporary." It also explained that "if channel stuffing is excessive, it can show up in financial statements" because receivables grow faster than sales.
3. A company's "channel stuffing" is, in the normal course, detectable by analysts and the investment community through an examination of that company's receivables. However, Compaq was able to mask its "channel stuffing" by factoring its receivables at a discount, i.e., by selling its bills payable by customers to third parties at discounted prices, thus giving the impression that not only was the product moving through its channels efficiently but also that its customers were providing a quick payment turnaround or Days Sales Outstanding. (Factoring receivables is highly unusual for a large company with significant cash in the bank, for the simple reason that it hurts the bottom line because of the significant discount received by the factor as compensation for purchasing the receivables.) The factoring of receivables by defendants prevented the market from learning that the ODM was suffering from major start-up problems, including channel resistance, and ensured healthy compensation for executives, which compensation was tied to increased ROIC. The practice of factoring receivables gave the false impression of increased sales, uncluttered distribution channels, increased demand for the Company's products, reduced Days Sales Outstanding, and increased ROIC.

1. The Company also increased its factoring of receivables for other reasons. It needed extra cash to mask the assistance it was giving to its Asian distributors and/or end customers during the Asian financial collapse. The March 2, 1998 edition of The High-Tech Strategist reported that the Company's Asian clients were in particular need of assistance and the Company acted as a banker to certain Asian distributors who were too small to afford the financial instruments necessary to protect them against currency swings. The Company also required extra cash flow to pay for the incentives it was providing distributors to accept more products during the process of "stuffing the channel." The Company found this cash flow through its increased factoring of its receivables.
2. Thus, defendants' statements on July 10, 1997, regarding Compaq's second quarter results were false and/or misleading because, contrary to defendants' representations, the Company's increased sales and profitability did not "reflect an excellent second quarter," were not driven by "gains in efficiency," and were not due to "operational improvements." Rather, the reported financial results were due to the short term, unsustainable and undisclosed practice of factoring receivables.
3. Defendants' failure to reveal the existence of the above-described practices of channel stuffing and factoring receivables to the public acted as a fraud upon plaintiffs and the Class because plaintiffs and the Class were left in the dark as to the following inevitable consequences of defendants' actions:
1. sales would eventually decline because they were only being maintained at their high levels through defendants' channel stuffing;
2. the factoring of receivables at a discount, though temporarily raising the Company's ROIC, would ultimately affect the Company's profitability and reduce the ROIC in later periods; and
3. the practice of channel stuffing would eventually catch up with the Company -- although not before the Individual Defendants dumped $122 million worth of their own Compaq stock -- and lead to: (i) clogged channels; (ii) reduced inventory turns; (iii) reduced sales; (iv) reduced market share; (v) the need to offer expensive incentives to stimulate sell through of obsolete inventory in the channel; (vi) lessened flexibility to react to market changes such as the release of new, and perhaps more attractive products by its competitors; and (vii) lessened price flexibility.
4. Moreover, defendant Mason's statement, cited in the July 10, 1997, Bloomberg article, that there were no "major problems" with the channel was patently false. Not only were channel partners dismayed at the build-to-order plan, they were balking at the reduction in return policies and price protection being forced on them by Compaq. The 5-day delivery time was proving unattainable and dealers were preoccupied with concern over Compaq's shift to direct sales. Moreover, because of the channel stuffing, there was so much excess inventory at the dealer levels that nobody was interested in moving new Compaq products - - they wanted to first get rid of the old products.
5. Certain of the Individual Defendants, including defendants White, Cabello, Heil, Lay and Mason, took advantage of the fraud perpetrated on the market through defendants' July 10 misstatements by collectively selling over 130,000 shares of Compaq stock (or 260,000 shares measured after the 2-for-1 stock split that occurred later during the Class Period) for total proceeds of more than $6,700,000, between July 14 and July 16, 1997.

Defendants' Misrepresentations Continue

1. Merrill Lynch issued another report on July 15, 1997, based, in part, on the extensive conference calls and press briefings conducted by Compaq on July 10, 1997, stating that Days Sales Outstanding declined from 60 in the second quarter of 1996 to 39 in the second quarter of 1997. The report further explained that "[t]he company's two key financial measurements also improved during the quarter. ROIC, return on invested capital, jumped from 25.4% in 2Q96 to 69% this quarter, and improved from 54.2% sequentially."
2. As explained above, however, these figures were only achieved through the factoring of receivables in the second quarter, a practice that was not disclosed until February 1998, and which enabled defendants to reap rich financial rewards in 1997.
3. Similarly on July 16, 1997, Credit Suisse First Boston Corp., another analyst following Compaq, issued a report explicitly based on the July 10, 1997 press conference and a separate meeting in New York on that same date during which Compaq made a slide presentation concerning price parity between Compaq and Dell:

Compaq is reinventing itself yet again. . . . In migrating to a build-to-order model, Compaq will emulate the direct sellers, such as Dell, who have been conspicuously successful selling directly to corporations. In addition, the ODM initiative will eliminate a significant portion of the costs of selling through the indirect channel. Furthermore, by providing dealer markups even on shipments directly to customers, Compaq will retain the local presence and relationships of its 100,000 dealers around the world - - a community not open to the direct sellers.

On July 10, Compaq unveiled its well-publicized optimized distribution model, or ODM, with which it hopes to reap the benefits of both the direct and indirect PC distribution models. Compaq has promised to deliver these orders up to five days after their receipt.

Compaq will ship customized orders directly to large accounts, mostly in the corporate sector. The resellers responsible for these accounts will continue to receive a markup on these sales. The company anticipates that 30% of its sales will eventually be fulfilled through direct shipments. Finally, on a portion of its sales, it will authorize a select group of resellers to configure Compaq computers in the channel. The details of this program will be announced later this month.

1. The report also emphasized Compaq's inventory reduction which it purportedly was able to achieve through "aggressive pricing":

The company hopes to reduce channel inventory to two weeks by year-end. As it rolls out ODM, Compaq will reduce dealer price protection from three months to 30 days and eventually to two weeks, creating a strong incentive for its resellers to participate in the program.

ODM will significantly enhance Compaq's competitive position in the market. This can be quantified through the reduction in contra fund items [cost of price protection and returns]. These items represented 12.3% of sales in the fourth quarter of 1996, declining to 10.2% in the second quarter of 1997. The company hopes to reduce contra items to 6.5-7.0% of sales by the fourth quarter. In dollar terms this would translate into hypothetical savings of $1.3 billion on projected 1997 revenues and would add almost 6 points to Compaq's gross margin, raising it to over 30%.

1. These statements about build-to-order, which came directly from Compaq itself, were false and misleading for failing to explain the problems Compaq was having in launching the new program, and most significantly that the Company's build-to-order program was meeting with resistance from the channel. Fearing that Compaq intended to move to a direct sales model, channel partners were slow to accept the change that Compaq was formulating and were not happy with the change in return policy thrust upon them by Compaq.
2. In fact, on July 16, 1997, Dow Jones reported that Richard Snyder, who was to be the backbone of this new program after being hired away from Dell to implement it, had resigned after only nine months as Compaq's Senior Vice President for World-Wide Sales, Marketing, Service and Support. Snyder was responsible for implementing the transition to build-to-order. According to Dow Jones, tensions between product and marketing groups led to his departure. Snyder said "there was a lack of clear alignment about what the role should be."
3. Snyder denied that the channel's fear of being cut out of the process by Compaq, based on his past relationship with Dell, played a role in his departure. However, an article appearing in The Wall Street Journal on January 12, 1998, attributed Snyder's resignation to "difficulties in changing Compaq's distribution and tension in its management structure." (Emphasis added.) Thus, it appears clear that as of July 16, 1997, Compaq was having more difficulty than it cared to acknowledge in even getting its new strategy off the ground.
4. On July 24, 1997, the Company filed its quarterly report on Form 10-Q with the SEC for the second quarter ended June 30, 1997, which was signed by defendant Mason. The 10-Q Report repeated the sales and earnings results announced in Compaq's July 10 Press Release. Defendants stated that "sales increased 25% and 20% in the second quarter and first half of 1997, respectively, over the comparable periods of 1996, primarily as a result of increased unit and option sales." This statement was false and/or misleading because it failed to disclose that the increased sales were due to the Company's practice of channel stuffing, not the "result of increased unit and options sales."
5. The Company also made the following statement regarding inventory in its second quarter 1997 10-Q Report:

Inventory. We anticipate that inventory turns, which were 10.4 at the end of the second quarter 1997, will continue to increase in 1997. The increases result from improved product cycle management and other efficiencies accompanying the re-engineering of certain internal processes.

However, contrary to this statement, the Company was encountering extreme problems in improving inventory turns. As defendant Pfeiffer would later admit to The Wall Street Journal, in an article dated March 16, 1998, the Company's inventory "process changes" were not increasing "inventory turns," but were rather being met with "technical problems and cultural resistance in the Company." Pfeiffer's admission of March 16, 1998, makes clear that the Company knew it was losing the battle with its chief competitor Dell as soon as the battle began in earnest. Moreover, neither "improved product cycle management" nor "other efficiencies" were behind the Company's purported inventory turn increases. Rather, it was the undisclosed practices of factoring receivables and channel stuffing that led to the reported increases.

1. Similarly, defendants' statement that "accounts receivable decreased to $2.2 billion at June 30, 1997, compared to $3.2 billion at December 31, 1996, reflecting Compaq's continued emphasis on receivables management," was false. Rather, the reduction was a direct result of defendants' as yet undisclosed practice of factoring receivables. In fact, as defendants would later admit in February 1998, the Company had factored more receivables than usual in the second quarter of 1997.
2. On July 29, 1997, as reported by Bloomberg, Compaq unveiled the second prong of its ODM strategy when it announced the nine computer resellers who will finish building computers for Compaq before they are sent to customers:

Compaq will ship its Deskpro PCs that are partly built to large resellers such as Inacom Corp., MicroAge Inc. and others. Once there, the resellers will install the memory, hard disk drives and other components, as well as the system software based on customers' orders. . . . "The net results for us are lower costs which we pass on in lower prices" to customers, said Jim Schraith, head of Compaq's North American division.

(Emphasis added.) The other resellers that were to be part of phase two included CompuCom Systems Inc., Electronic Data Systems Corp., Entex Information Services Inc., GE Capital Information Technology Solutions, Ingram Micro Inc., Tech Data Corp., and Vanstar Corp. The article further reported that in the fourth quarter Compaq would announce step three of the ODM.

1. On August 25, 1997 and September 8, 1997, a series of articles appeared in Computer Reseller News stating that the build-to-order plan was not able to meet demand. According to the August 25 story, Jim Schraith explained the backlog problem as follows: "With the announcement of BTO and new pricing, [reseller orders] are exceeding supply by a wide margin. In this quarter we are producing 33 percent more desktops than we did in the second quarter. In the first two weeks of August, we have built 50 percent more desktops than we did in the first two weeks of July." Scraith explained that Compaq was hiring more personnel to meet demand. "We're adding 20 people per week," he said according to the September 8, 1997 story.
2. By the end of September, Compaq made it appear that it had solved its efficiency problems. On September 24, 1997, Bloomberg reported that Compaq had cut prices on desktop PCs by "as much as 15 percent, citing cost savings by shifting to a build-to-order system similar to that used by rival Dell Computer Corp." According to the story, Compaq cited "significant gains in efficiency" in moving to build-to-order instead of building up inventory to meet expected demand. (Emphasis added.)
3. On October 15, 1997, according to Bloomberg, Compaq confirmed the fears that resellers had when the build-to-order program was first introduced, by announcing at The Wall Street Journal's technology conference in New York that it had started selling computers over the World Wide Web: "the company in the last month began offering three models of its Presario computers that it said aren't widely available in stores. . . . Compaq President and Chief Executive Eckhard Pfeiffer said the company had to be cautious in the way it sells directly to consumers to avoid undercutting its retail partners." What defendants failed to disclose, however, was that the shift to direct sales was due to the fact that the cumbersome build-to-order program through the reseller channel was simply not working and had not been working since its earlier introduction.
4. On October 16, 1997, the Company, as reported on BusinessWire, announced:

[R]ecord worldwide sales of $6.5 billion for the third quarter ended September 30, 1997, an increase of 31 percent compared to the third quarter of 1996 and a 56 percent unit growth for the same period. Net income increased by 54 percent to a record $562 million or $.71 per share, excluding a $44 million or $.06 per share non-recurring charge for merger related costs. Net income after the non-recurring charge for the merger related costs was $517 million or $.65 per share.⁽⁴⁾

1. According to defendants, these results were directly tied to the ODM model, thereby assuaging any remaining market concerns that may have been raised by the Computer Reseller News stories of August and September:

"These results reflect record performance for Compaq, our customers and shareholders," said Eckhard Pfeiffer, Compaq's President and Chief Executive Officer. "Our new distribution focus has enabled Compaq's volume to grow more than three times the industry's rate while increasing profitability."

"Compaq continues to demonstrate solid financial progress, as shown by earnings growth which are above revenue growth," said Earl Mason, Compaq's Senior Vice President and Chief Financial Officer. Our ongoing focus on asset management increased inventory turns from 8.8 to 10.1, and decreased Days Sales Outstanding from 60 to 40 days. These and other operational achievements lifted our cash balance 83 percent from the previous year to $6 billion. These record results more than doubled Economic Value Added to $441 million, providing a continued increase in shareholder value.

Outlook

"Our outlook continues to call for a strong fourth quarter performance, with a healthy outlook for 1998," said Pfeiffer. "We're confident that Compaq's new business model will continue to accelerate market share gains and improve profitability. The progress in implementing the new model to optimize our entire distribution process (ODM) is on target. This work is enabling the industry's most satisfying buying and ownership experience."

(Emphases added.)

1. Again, defendants' statements that these results "reflect record performance," and were the result of a "distribution focus," "focus on asset management" and other "operational achievements" were false because defendants failed to reveal the following:
1. sales again had increased through their practice of "channel stuffing" and not from a "new distribution focus";
2. Days Sales Outstanding had been reduced as a consequence of factoring receivables at a costly discount in order to increase ROIC which had a direct impact on year-end bonuses;
3. the Company's cash balance had increased as a result of its practice of factoring receivables;
4. defendants were engaging in practices that were unsustainable and that provided improved short-term financial results only by borrowing against future profitability;
5. the Company was suffering from severe inventory problems and its transition to a new distribution process was proving to be singly unsuccessful; and
6. the ODM plan was meeting with resistance from channel partners who were concerned about the change in price protection and return policies and who worried that ultimately Compaq was moving to a direct sales model which would leave them out in the cold.
2. Compaq's Chief Financial Officer, defendant Mason, was quoted in a Bloomberg article dated October 16, 1997, as stating that, "[U]nit sales of consumer oriented PC's more than doubled in the third quarter from year ago levels." Mason continued, "[W]hile these units generally carry lower selling prices, Compaq's profitability didn't suffer." What defendants failed to reveal was that sales had not increased to end users and only increased by virtue of defendants' unsustainable practice of "stuffing the channel."
3. The same Bloomberg article reported, based on an interview with defendant Mason, that the Company's "cash on hand" at September 30, 1997, as increasing 83 percent from year ago levels. Mason, however, did not explain that Compaq's increased "cash on hand" was achieved in substantial part through "channel stuffing", combined with the factoring of these bloated receivables. Both practices could only reap short term gains and would eventually come back to haunt the Company. Had Compaq's channel stuffing and factoring practices been disclosed, the price of Compaq shares would have plummeted at that time.
4. On or about October 31, 1997, Compaq filed with the SEC its Report on Form 10-Q for the third quarter ended September 30, 1997, which was signed by defendant Mason. The 10-Q Report reiterated the financial results contained in the Company's October 16 Press Release and Mason's interview with Bloomberg. Defendants revealed (in an isolated reference in the third quarter 10-Q Report) that in the third quarter, accounts receivable were reduced, in part, through the "sale" of $735 million of receivables. They failed to explain, however, the connection between the sale of receivables and the ongoing undisclosed practice of channel stuffing at Compaq.
5. Also on October 31, 1997, Merrill Lynch Capital Markets issued a report on Compaq based on a conference call with defendant Mason the previous day. Among other things, Merrill Lynch reported that "Compaq confirmed business is indeed strong"; "Compaq's consumer business achieved triple digit ROIC in 3Q"; "Compaq's business is on track to grow at 3 times the market rate (in unit terms) in 4Q/97"; "Channel inventory is in good shape. Compaq is on track to achieve its 15+ goal and 2 weeks of channel inventory by year end" (emphasis added); and "Overall, the call was positive and informative. The quarter is off to a very good start." (Compl. ¶¶ 114-115.)

Defendants Take Advantage Of Inflated Prices To Unload

$55 Million Of Their Own Company Holdings In One Month

While plaintiffs and the Class were being kept in the dark regarding Compaq's problems, Company insiders, including defendants White, Stearns, Perkins, Heil and Pieper, sold 769,000 shares of their own Compaq stock in October 1997, for record proceeds of over $54,600,000, just after the Company's stock price reached an all time high. According to a November 11, 1997 Washington Service report, Heil's sales represented over 95% of his Compaq holdings, Perkins sold over 30% of his total Compaq stock, Pieper sold 100% of his holdings, Stearns sold over 93% of his holdings, and White sold over 80% of his holdings. Defendants' insider selling continued in early November, with defendants Rose, White, Winkler, Heil, Petsch, and Pieper selling over 234,000 shares of Compaq stock for total proceeds of more than $14,400,000 between November 3 and November 20, 1997. Defendants Petsch and Pieper sold 95% and 100% of total holdings respectively, defendant Winkler sold 75% of his holdings, and defendants Heil and Rose sold nearly half of their holdings according to a December 9, 1997 report by the Washington Service. (Compl. ¶¶ 117-118.) The the time period when executives are permitted to sell stock runs from mid-October to November 30, the first window since July when there was a week when stock could be sold. Defendants guaranteed themselves that this "selling window" would be a window of opportunity by timing their fraudulent and misleading statements so that the Company's stock price would be at artificially high prices when insiders were allowed to sell. The above-detailed fraudulent and misleading statements by defendants on October 16, 1997, and in the Company's third quarter Form 10-Q Report, were designed to coincide with defendants' selling window. Defendants' insider sales during the entire Class Period are listed in detail in the (Compl. ¶¶ 173-177.)

Defendants' Misstatements Continue

On November 17, 1997, defendant Pfeiffer gave the keynote address at the COMDEX trade show in Las Vegas. The address focused on the future of the PC business in general but defendant Pfeiffer also promoted his own company, stating: "When Compaq introduced the optimized distribution model, or ODM, earlier this year, we leveled the playing field in terms of product and distribution cost and in doing so, we have literally destroyed the direct vendor's price advantage. Our third-quarter volume gains of 56 percent and the related financial performance clearly demonstrate this point." The statement was false and misleading for several reasons: First, because of fees to resellers and dealers, Compaq's price cuts were eating into its own margins. Second, Compaq still had significant costs in terms of price protection that were not part of the direct sales equation. Third, sales in the third quarter and Compaq's financial performance in general were based on channel stuffing and factoring of receivables and not on true sales to end users. (Compl. ¶¶ 120-121.)

In a Bloomberg reposition on December 8, 1997, and in a press release on December 9, 1999, Compaq reported extraordinary gains in market share. (Compl. ¶¶ 122-123.) Compaq, however, did not disclose to plaintiffs and the other members of the Class that the above-detailed extraordinary gain in market share from the second quarter to the third quarter was achieved by defendants' "channel stuffing", not by actual sales to end-users. Compaq, in fact, through the Individual Defendants, instructed its Investors Relations department to express comfort with securities analyst estimates and confidence in the build-to-order and inventory reduction program. For example, on December 16, 1997, in an e-mail response to questions posed by Mindy Aber (one of the plaintiffs herein) concerning fourth quarter 1997 and full year 1998 earnings estimates, Tien Le of Compaq's Investor Relations Department stated that "Compaq is comfortable with analyst consensus at $.83 for the fourth quarter" and that "our outlook for 1998 is strong and we are comfortable with analyst consensus at $3.40 for 1998." In addition, in response to Mindy Aber's question about the build-to-order program, Le stated as follows:

Build-to-Order (BTO), the first program in our Optimized Distribution Model, is going on plan. It is fully implemented across all commercial products in Europe, and in almost all commercial products in the U.S. By the end of 1997, BTO will be implemented in all of our commercial products in the U.S.

Here are some measurements that tell us BTO is working:

(1) Channel inventory at the beginning of 1997 was well above 10-12 weeks. Now channel inventory is less than half of that.

(2) Product predictability, which allows us to accurately predict what products customers want, has more than doubled.

(3) Cycle time, which measures the time we receive an order to the time we deliver, has been more than halved.

These statements were false and misleading since inventory was increasing dramatically, particularly in December, because defendants were actively stuffing the channel to make year-end numbers. Also, contrary to Compaq's statements, the ODM program was failing because of severe problems gaining the support of the channel, as alleged above. (Compl. ¶¶ 125-127.)

On January 9, 1998, Bloomberg reported that defendant Pieper and Jim Schraith had resigned from Compaq. Both positions were filled in the interim by defendant Heil. According to a story appearing in Austin 360 Tech on January 20, 1998, the resignations of Pieper and Schraith "have fed speculation about problems at the company."

1. On January 21, 1998, the Company announced the following results for the fourth quarter ended December 31, 1997, over BusinessWire:

[R]ecord worldwide sales [were] $7.3 billion for the fourth quarter ended December 31, 1997, an increase of 23 percent compared to the fourth quarter of 1996. Net income increased by 37 percent to $667 million or $0.84 per share before the January 20, 1998, two-for-one stock split ($.42 per share on a post-split basis), compared to the fourth quarter of 1996.

Compaq's worldwide sales for 1997 grew to $24.6 billion, compared with $20.0 billion in 1996. Net income for 1997 increased by 60 percent to $2.1 billion or $2.69 per share ($1.35 post-split), excluding $252 million or $.32 per share ($.16 post-split) in non-recurring, non-tax deductible charges for purchased research and development and merger-related costs in connection with acquisitions. Net income after these non-recurring charges was $1.9 billion or $2.37 per share ($1.19 post-split).

"These results reflect an excellent fourth quarter and an outstanding year for Compaq," said Eckhard Pfeiffer, Compaq's President and Chief Executive Officer. "We continued to execute well across all areas of our business. Compaq's volume grew more than 2½ times the industry's rate while increasing profitability. This is remarkable growth for a $24.6 billion company."

"Compaq continues to demonstrate solid financial progress, as shown by improvements in earnings and the growth of gross margins to 27.6 percent in the fourth quarter," said Earl Mason, Compaq's Senior Vice President and Chief Financial Officer. "Our focus on asset management lifted our cash balance 66 percent from the previous year to $6.8 billion and increased our Return on Invested Capital from 49 percent to 90 percent for the fourth quarter."

1. These statements were also false and/or misleading because defendants failed to reveal the true reasons for the Company's 41% jump in its ROIC from 49% to 90%, between the third and fourth quarters of 1997. Contrary to defendants' representations, Compaq did not have "an excellent fourth quarter," nor did it "execute well across all areas of our business," nor did it "demonstrate solid financial progress." Rather, defendants achieved the above reported "record" sales results by "stuffing the channel" with product in the third and fourth quarters and then cashing out of what would have been extremely bloated receivables by factoring these receivables at a discount, thus masking the fact that its success in selling to end users was far less than the figures it touted and that in fact it was starting to suffer from indigestion at the distributor and retailer levels. The factoring of the receivables was intended to mask these problems and the fact that the build-to-order program had not been the success defendants had been touting.

Defendants Use Inflated Stock Price To Consummate The DEC Deal

1. On January 26, 1998, the Company announced the execution of an agreement to acquire Digital Equipment Corporation ("DEC"). The transaction, valued at approximately $10 billion provided that DEC shareholders would receive $30 in cash and 0.945 shares of Compaq common stock for each share of DEC common stock. Compaq had been speaking to DEC since 1995 and was interested in consummating a transaction. Defendants were desperate to reach an agreement with DEC, as they saw its acquisition, and other potential acquisitions, as a means to increase the Company's market share and diversify its products in order to continue to better compete with Dell and, more importantly, diversify away from Dell by going into those parts of the computer business in which Dell was not involved. Because the DEC transaction consideration included approximately 150 million shares of Compaq stock, as well as cash, defendants were motivated to maintain the Company's stock price at a high level in order to get maximum value from their transaction currency, i.e., Compaq stock. This was accomplished through the fraudulent activities detailed herein.

The Individual Defendants Unload More Compaq Stock

1. Immediately following the announcement of fourth quarter earnings on January 21, 1998, and the announcement of the DEC deal on January 26, 1998, certain of the Individual Defendants again sold tens of millions of dollars worth of their own Compaq stock in order to profit from the artificially inflated prices caused by defendants' misstatements. Defendants White, Stearns, Winkler, Perkins, Cabello, Heil, Rosen and Schrock collectively sold over 970,000 shares of Compaq stock between January 28, 1998, and February 12, 1998, for total proceeds of more than $34,000,000.

The Truth Begins To Slowly Emerge

1. Although a reference to the Company's sale of receivables in the third quarter was buried in the Company's third quarter 10-Q Report, the market first began to note the consequences of those transactions in February 1998 when it began to question whether the Company had pushed its obsolete inventory from its warehouses onto distributors and dealers. For example, the February 9, 1998 edition of Barron's discussed the factoring of receivables by the Company and questioned whether the high level of factoring had become necessary as a result of channel stuffing:

In short, Compaq gets paid a smaller sum, sooner; whoever buys the payment stream gets paid more, later. Compaq has been selling receivables in a big way -- $735 million in the third quarter, or about 11% of revenues, and $1.07 billion, or about 15% of revenues, in the fourth quarter. One analyst we talked to theorized that Compaq might be doing this as a way of reducing currency exposure, selling nondollar-denominated receivables for dollars. A less pleasant explanation would be that Compaq really has been "stuffing the channel, " and has become concerned about slow payment from some of its customers.

(Emphasis added.)

1. The Barron's article further reported that questions about channel stuffing remained unanswered by the Company:

Several analysts who listened to Compaq's post-earnings conference call note that Compaq CFO Earl Mason refused to answer questions about inventories in the dealer channel. Reportedly, Mason said he wouldn't talk about that particular subject at the request of large institutional shareholders. Compaq spokesman Jim Finlaw notes that channel inventories are hard to accurately pinpoint, limiting the usefulness of comment on the topic. Finlaw declined to give details on its receivable sales, or explain the reasons for them, other than "better asset management."

While you're trying to figure out what all of this means, keep this in mind: Compaq released its fourth-quarter earnings just days before it announced its deal with Digital Equipment, an acquisition Compaq will be making partially in stock. Suspicious persons might conclude that Compaq stuffed the channel so as to hit Street estimates, so the stock wouldn't drop ahead of the disclosure of the acquisition.

(Emphases added.)

1. Similarly, on February 12, 1998, an article in The Wall Street Journal ("WSJ") reported on the suspiciousness of Compaq's factoring transactions:

The transactions raised red flags in the minds of some investors and analysts not only because they are unusual for a personal computer maker but also because they lowered Compaq's costs for the period. The two transactions also raised the company's "return on invested capital," which is simply a fancy name for profitability that takes into account the costs of carrying receivables.

In a recent report to clients, Donaldson, Lufkin & Jenrette analyst Kevin McCarthy told clients that without the receivables deals, Compaq's return on invested capital "would have been essentially flat over the past three quarters instead of posting sequential improvement." With the factoring in the second half of 1997, Mr. McCarthy said, "Compaq arguably inflated its improvement" in return on invested capital, or ROIC, and another financial measure, days sales outstanding, which is the average time it takes to be paid for a product. "This apples to oranges comparison of these key yardsticks has some investors crying foul," the DLJ analyst observed.

(Emphasis added.)

1. The same WSJ article reported that "in an interview yesterday, Earl Mason, the Company's chief financial officer, acknowledged the transactions helped profitability. 'It helps ROIC,' he said. 'Otherwise we would not do it.' Mr. Mason also said the Company factored more receivables in the second, third, and fourth quarters of last year than it normally does." (Emphasis added.)
2. The WSJ article continued:

Wall Street has been following Compaq's return on invested capital closely because the company has said it is one of the best measures of its attempts to cut costs. Last summer, Compaq told analysts it would cut its costs of doing business so much that return on invested capital would climb from 50% to "triple digits." But without the factoring transaction, Compaq would not have even come close to that goal according to Mr. McCarthy.

1. It was now, for the first time, revealed to the investing public that the Company was not achieving its increased level of ROIC through cost cuts, or through any other efficiencies or process changes, but rather through the expensive combination of channel stuffing and factoring of receivables, including during the second quarter. Moreover, still unbeknownst to the public at this time, defendants' factoring of receivables was the necessary outgrowth of channel stuffing. Defendants' short term practice was essentially borrowing and discounting from future profitability by handing over to a factor a percentage of its receivables income as consideration for the factors' purchase of Compaq's receivables.
2. The same WSJ article of February 12, 1998 reported how defendant Mason had promised, in the summer of 1997, higher ROIC and a reduction in the number of weeks of inventory carried from 10 to 3. The same WSJ article also reported how the Company had been rumored to be "stuffing the channel" in the second half of 1997 and that the Company strongly denied those rumors. These denials, as it turned out, were false.

1. The full extent of the Company's deceit was yet to be revealed, however, and defendants Rose and Barth, on February 17 and 18, 1998, took advantage of their superior knowledge of Compaq's business by collectively selling 345,000 shares of Compaq stock for total proceeds of more than $12,000,000 at artificially inflated prices.
2. The following day, on February 19, 1998, Compaq filed its Report on Form 10-K with the SEC, which was signed by defendants Pfeiffer, Mason, Rosen, Lay and Perkins, among others. Defendants reported on the Company's year end results as follows:

Compaq reinforced its position as the largest supplier of personal computers in the world in 1997. It increased its market share of the expanding worldwide PC market from approximately 10% to approximately 12% by focusing its business activities on expanding sales to new customers while augmenting sales to its existing customer base.

The significant increase in sales in 1997 stemmed primarily from an increase in the number of units sold and an increase in sales of options associated with CPU products. In 1997, Compaq's worldwide unit sales increased 43% while they increased 23% in 1996. The 1997 increase included a 35% expansion in unit sales of commercial CPU products, a 62% increase for consumer CPU products and a 65% increase for enterprise CPU products. According to third-party estimates, worldwide unit sales of personal computers increased approximately 15% to 16% in 1997, in contrast to a 16% to 18% increase in 1996. Competition continues to have a significant impact on prices of our products, especially those aimed at the consumer market, and additional pricing actions may occur as we attempt to maintain our competitive mix of price/performance characteristics. We attempt to mitigate the effect of any pricing actions through implementation of design-to-cost goals, the aggressive pursuit of reduced component costs, manufacturing efficiencies and control of operating expenses.

1. The above statements regarding sales were false and/or misleading because defendants still failed to explain that the Company's reported sales results were based on channel stuffing. Similarly, defendants' statements about how the Company "mitigates" the effect on pricing of competition failed to explain that the Company's inventory-on-hand business model was no longer working in the face of competition from build-to-order manufacturers, in particular, Dell.

1. Defendants Mason and Pfeiffer were continuing to express comfort with analyst estimates for the first quarter of 1998 despite the channel stuffing activity that was sure to catch up to Compaq eventually. On February 23, 1998, nearly two-thirds of the way through Compaq's 1998 first quarter, PaineWebber Inc. disseminated an analyst report, explicitly based on a conference call with management, including Mason, that trumpeted the first quarter as follows:

We would characterize the fourth quarter as a very good performance in a somewhat difficult environment. Management's commentary on the results and outlook bode well for continued healthy earnings growth over the next 12-18 months. Management's comfort with consensus forecasts for both the first quarter (March) and full year seems to quell concern over a possible reduction/shortfall in near-term earnings tied to such issues as channel inventories, lower ASPs and exposure to the soft trends in the Asia Pacific markets.

(Emphasis added.)

1. Under the heading "conference call highlights," the PaineWebber analyst commented on the Company's inventory efforts, as follows:

Regarding inventories in the distribution channel, Compaq backed away from giving specific numbers in each geography (a smart move, we believe). However, while the company failed to meet its aggressive two-to three-week worldwide goal (which had been expected), it has made progress from last year - - notable given that last year's inventories were double the current number of weeks. More important, despite the widespread reports of special incentives to the major channel resellers in December (which we hear are selling throughout), management believes that overall inventory levels are in good shape and will not have a negative impact on results in the March quarter. Also, now that investor expectations of the timing of the company's manufacturing and distribution reengineering plans have been properly recalibrated (to mid-1998-ish), the benefits to margins and the company's P/E multiple have yet to accrue.

Relative to the balance sheet, it appears that Compaq now fully understands (and is executing well) today's new "earns times turns" business model in the PC market, placing as much emphasis on managing the balance sheet as the income statement. Favorable signs include an exit rate in the quarter of inventory turns approximating 14x (versus about 10x in the September period) and a further improvement in DSOs to about 35 days. This helped drive a further increase in cash to $6.76 billion from $5.96 billion last quarter and $4.0 billion a year earlier. As a result of these favorable trends, ROIC increased to 90% (138% excluding Tandem) versus 49% a year ago. The large cash position gives Compaq a good deal of financial flexibility, which will be used to help fund the acquisition of Digital Equipment. We note that Tandem was once again additive to earnings last quarter, illustrating management's success in making positive acquisitions.

(Emphasis added.)

1. That same day, February 23, 1998, Computer Reseller News published an interview with defendant Mason concerning ODM, the channel, investor relations and future goals, among other things. Mason stated:

Our goal for the year 2000 is $50 billion in revenue, half of which is made up of enterprise revenues. The challenge to the channel and to ourselves is to expand the size of what I'll call our distribution planes so the growth profile we need is delivered.

1. Mason also talked about how the return on investment capital measurement system has been a big part of his plans for Compaq:

When I got here at the end of May in 1996, we changed measurements of the company to return on investment capital. Literally, this team in one month implemented a complete change of measurement across the world for all of our subsidiaries like I've never seen before in my business career.

The key thing you have to understand is that the measurement system, the return on investment system, I believe, spurs a lot of the right re-engineering efforts and behaviors we've seen played out with our channel partners.

For example, the ODM program is a key effort that came out of some of the ROIC thinking to reduce our cost structure so we could share some of those things with our customers and some of them with our shareholders. The key programs under ODM include build-to-order, configure-to-order, and the channel configuration programs. Those are key re-engineering efforts with our channel partners right now that are taking costs out of the channel and taking the cost out of Compaq. And the winner is our shareholders and our overall customer base.

We've improved our predictability since we started implementing our overall ODM program. We've more than doubled our predictability by the company. We've improved this significantly. We're not finished yet. We have a lot more efforts to go with our channel partners to get predictability up so that when a customer wants it, they can get it very rapidly from Compaq.

In April of last year, Eckhard [Pfeiffer] asked me to take leadership over our overall ODM [Optimized Distribution Model] efforts. We did that and those efforts led to a lot of work with our channel partners around BTO [build-to-order], CTO [configure-to-order], and our channel configuration efforts. That's an example of an operational effort, what I call a horizontal team to re-engineer some of our distribution, manufacturing, and sales throughout the world.

1. When asked to characterize Compaq's relationship with the channel, Mason responded as follows:

Our relationship with the channel partners right now are excellent. We certainly consider them a part of our extended team at Compaq and we know many of them consider us part of their team.

1. Finally, Mason explained his financial responsibilities for Compaq:

There is usually a fair amount of Wall Street activity throughout the day. I work with our investor relations organization and talk to different large shareholders. When you're helping manage a large, growth organization, there are always questions about what's going to happen the very next day. So we try to keep our shareholders and the analysts informed as much as possible about what our actions are going to be. That allows them to make the proper judgments on their stock ownership. So we're focused on growing the company, so there are always a lot of product reviews and strategy reviews that take place in the Company and that involves my time.

1. The February 23, 1998 statements in the PaineWebber report and Mason interview were false and misleading for a number of reasons. First, the ODM had hardly been a success. Costs were still high to Compaq, price protection was cutting into profits since the channel never accepted the two weeks initially demanded by Compaq, and resellers were still balking at the BTO concept as would be revealed at the end of the Class Period. Second, the 1998 first quarter financial results were not going to be good in light of the extensive channel stuffing at the end of 1997, and defendants knew or at least should have known this because the first quarter was two-thirds over. Third, the increased ROIC repeatedly touted by Mason was the outgrowth of the factoring receivables, not of an improved business model. Fourth, because of defendants' channel stuffing, inventories were much higher than represented by defendants.

1. On February 26, 1998, the truth began to emerge about how severe the Company's inventory problems were, how the Company had been "stuffing the channel" to give the appearance of increased sales, and how all of this was impacting the Company's bottom line. A Bloomberg article dated February 26, 1998, reported that:

Compaq Computer Corp. shares fell 3.3 percent in heavy trading on concern that the computer maker has too much inventory and will have to forego several weeks of sales while existing inventory sells through. . . .

Compaq has been struggling to reduce its inventory because high inventory means it can't react to lower costs and price cuts as quickly as rivals like Dell Computer Corp., who carry almost no inventory because they sell directly to customers. Excess inventory could force price cuts and also hurt earnings and revenue because Compaq won't be able to sell more, analysts said. . . .

The Houston-based computer maker had $1.57 [billion] worth of inventory at the end of December, up from $1.27 [billion] at the end of 1996, and down from $2.0 [billion] at the end of September. The Company has said it was working to reduce its inventories to about three weeks worth of product. . . .

Salomon Smith Barney Inc. analyst Richard Gardner cut his rating on the stock to "neutral" from "outperform," citing concern about increased inventory levels.

"The higher the level of Compaq inventory in the channel, the greater the probability of a disruption in revenue and earnings when the company attempts to reduce channel inventories," Gardner said in a report. He said inventories at distributors and resellers, known as the channel, are still at about five weeks. (Emphasis added.)

Buy-Ins

Gardner said in his report that Compaq has begun negotiating so-called buy-ins, which is a practice of selling more into the channel at the end of the quarter to get rid of product. That has started earlier than usual, which Gardner said indicates that inventory could rise as high as six to eight weeks.

Analysts said Compaq made a similar move in December and that its channel customers could stop buying until inventory levels come down.

"They pushed a lot of inventory into the channel in December," said analyst Dan Niles of BancAmerica Robertson Stephens, who in December cut his rating to "long term attractive" because of rising inventories. "You can only do that for so long before the channel starts refusing to take the product."

Another problem with excess inventory is that Compaq gives price protection to its customers, which means that if the products sit in inventory too long, Compaq will have to slash the price that it charged to reflect the lower value of the product.

(Emphasis added.)

1. Upon the release of the above devastating news, the Company's stock price tumbled from $34.00 per share on February 25, 1998, to a close of $27-1/8 per share on March 5, 1998. However, this was not the end of the assault on the Company's stock price as Compaq had more bad news in store.
2. In the March 2, 1998 edition of The High-Tech Strategist, more accusations of Compaq's channel stuffing surfaced:

In looking at Compaq's balance sheet the past couple of quarters, I couldn't understand why the channel stuffing that I knew was occurring was not showing up in the receivables balances. This month we got the answer: over $1 billion of receivables in the last quarter were factored. Factoring receivables is essentially selling them to another party at a discount. No large company with cash in the bank ever sells receivables, because the discount to the financial intermediary (to account for profit and risk) hurts the bottom line.

1. The article further explained that the Company was unable to provide any sound business reasons for the factoring:

Compaq spokespeople came up with some incredibly lame excuses for the factoring, but it sure looks like Compaq was trying to hide the channel stuffing that they have previously denied. Up until this revelation, Compaq had insisted that it had been making progress in its stated goals to reduce inventories (and thus lower the channel's competitive cost disadvantage versus Dell).

(Emphasis added.)

1. On March 6, 1998, the Company confirmed the rumored problems with inventories in conjunction with its announcement that its first quarter sales would be flat with the prior year and that it would have no first quarter earnings, rather than $500 million as projected by analysts based on guidance by defendant Mason. Defendant Pfeiffer stated that:

We looked closely at our market and business plan once it became clear that sales out of our North American commercial channels were not meeting our expectations. We are putting in place price reductions and aggressive promotions in the first and second quarter to reduce these channel inventories and accelerate the implementation of our Optimized Distribution Model (ODM).

(Emphasis added.)

With these actions, we are attempting to achieve channel inventories that support ODM by the end of the second quarter.

1. That same day, Dow Jones reported that Kevin Hause, an analyst at International Data Group, said that "the major issue is that Compaq's inventories are double what they were six months ago," adding that Compaq "stuffed the channel" at the end of 1997 to push up market share and make its annual results look better. The article further explained that demand in the computer industry was not down from prior years stating, "witness Dell Computer Corp. which continues to do well and which distributes its machines directly so it is not hampered by inventories at distributors, Hause said."
2. On the release of these devastating revelations, the Company's stock price dropped from a high of $28-3/8 per share on March 6, 1998, to open at $24-3/4 per share on Monday, March 9, 1998, on the resumption of trading after the weekend.
3. In the days that followed, the market began to get wind of defendants' misconduct. A Bloomberg article dated March 9, 1998, reported that:

Compaq loaded up distributors with much inventory at the end of last year and got stuck with a lot of product early this year, a traditionally slow sales time. Now, corporate demand has waned and the company has to slash prices to help dealers sell those personal computers. It could be months before the company is able to show profit.

The Bloomberg article also quoted analyst John Rutledge of Loomis, Sayles & Co., as saying that, "They were supposed to be getting out from under this problem. This raises the issue of credibility." (Emphasis added.)

1. Defendant's fraudulent practices were neatly summarized by analyst Rick Schutte of Goldman Sachs & Co. on March 9, 1998:

In our view, Compaq's pre-release does not confirm a slowing demand environment but rather a consequence of inventory build up in each of the last three quarters, overstating sales and demand in the prior quarters. Simply put, it's payback time.

1. A report by CIBC Oppenheimer on March 9, 1998, similarly commented on Compaq's "shockingly low revenue outlook" as follows:

In the past two weeks concerns over Compaq's first-quarter margin outlook had been growing, but, based on conversations with the company, we thought demand had remained within expectations. Management's preannouncement after Friday's close crushed that expectation - - dramatically - - saying 1Q revenue would be roughly flat year over year at $5.3 billion, a full $1 billion below our model, and gross margins would be below target, for a break-even quarter (we had estimated $0.36). We were prepared for a miss of a few cents on weaker margins, but nothing, not even Intel's 1Q preannouncement, prepared us for such a dramatic change in guidance; remember that last year, Compaq and other vendors survived Intel's weakening results through continued market-share gains.

(Emphasis added.)

1. After the revelations of March 6, 1998, defendants showed the extent of their inventory problems by engaging in drastic measures to stimulate sell through in the channels. On March 16, 1998, the WSJ reported that the Company would be giving away free monitors valued at about $300 each with purchases of its desktop personal computers and extending a promotion offering to double the installed memory of certain products. The same article reported that defendant Pfeiffer said that the Company's inventory "process changes have met technical problems and cultural resistance in the Company and with dealers." (Emphasis added.) The same article quoted analysts as estimating that Compaq's products remain in dealers hands from 7 to 16 weeks and that Computer Reseller News reported that Compaq had approximately 250,000 desktop units on dealers shelves, as compared to 58,000 units for International Business Machines and 40,000 units for Hewlett Packard.

The Market's Backlash

1. According to a Bloomberg article dated April 15, 1998, "Compaq Computer Corp.'s first-quarter profit plunged 96 percent as the world's largest personal computer maker slashed prices to clean out inventory. Net income fell to $16 million, or 1 cent a diluted share, from $414 million, or 27 cents diluted, a year earlier." The Company also announced worldwide sales of $5.69 billion for the first quarter, nearly $1 billion less than projected according to a survey of analysts by IBES International Inc. This difference represents the amount that was stuffed into the channel at the end of 1997. Compaq's stock price closed at $25-15/16 per share the following day.
2. In an attempt to bolster its sagging stock price, Compaq announced, on April 23, 1998, that it had begun a stock repurchase program to acquire up to 100 million shares of its common stock. According to Bloomberg, Compaq had not instituted a repurchase program since 1992.
3. In reporting on the buyback, Bloomberg, on April 23, 1998, stated, "the $3 billion buyback comes as first-quarter earnings at the world's biggest personal computer maker skidded to a penny a share and its stock dropped 18 percent in two months. Weak demand from corporations left PCs sitting in warehouses, with little relief from the buildup expected until the second half." Bloomberg noted that "the buyback may soothe investors for a time," but that Compaq had bigger problems to address. Noting that a buyback is but a "temporary" fix, analyst Vadim Zlotnikov of Sanford Bernstein & Co. was quoted as saying, "while this will help, they need to do something much more fundamental." The announcement had its intended short-term result, however, as the price of Compaq shares climbed to over $30 per share by early May 1998.
4. The problem was so extreme at Compaq that, according to a May 1, 1998 Dow Jones report, "[i]n an unprecedented move, Compaq closed its North American factory during the first two weeks of April in an effort to reduce its inventories."
5. Further commenting on the woes that beset Compaq as a result of its channel stuffing, Bloomberg reported on April 27, 1998, that "Compaq saw 55 percent growth in shipments to distributors in the U.S.," according to International Data Corp. ("IDC"), but that "most of that hasn't been sold to users and represents the inventory that Compaq is now trying to get rid of with fire-sale prices and free monitors."
6. The article continued:

While the total growth in shipments appears strong, the numbers don't track demand from end users. Excess inventory caused by weaker-than-expected PC demand forced Compaq to slow shipments last month and shut down North American production in the first two weeks of April. The company's first-quarter profit fell 96 percent as it slashed PC prices to alleviate the glut.

"Compaq looks like it's in the most beautiful shape, but it's only a smoke screen covering the inventory levels," said analyst John Brown of IDC. "Although the growth looks very high, the underlying story won't be out until next quarter."

(Emphasis added.)

1. Further commenting on Compaq's channel stuffing, the May 2, 1998 edition of The High-Tech Strategist reported that "in March, Mike Pocock, Compaq's vice-president of North American channel sales admitted to Computer Reseller News that 'this model we're under, channel stuffing, whatever you want to call it -- we need to bite the bullet. We need to get out of it altogether.'" That same High-Tech Strategist article reported, however, that even in the first quarter of 1998, Compaq was stuffing the channel. According to Ed Anderson, CEO of CompuCom, a Compaq customer, "we tolerated the inventory stuffing as a favor to an OEM supplier of ours to help them out. Compaq didn't have the [first] quarter they wanted to have, so they asked for help, and we agreed."
2. The editor of the High-Tech Strategist, Fred Hickey, continued:

I feel bad for Anderson. He's an honest guy. I have no such fond feelings for Compaq's management, however. They've been selling this same line of baloney for a long time now. Up until this March, business was always booming. In January during the Q4 conference call, Compaq's management told analysts that even though Q4 revenue growth came in less than forecast, they expected to grow more than twice as fast as the industry overall in 1998. The stock market cheered, sending Compaq's stock up 8.2% on the day (and encouraging a big tech stock rally overall). Nobody seemed to mind that Compaq CFO Earl Mason refused to answer questions about channel inventories. Few wanted to challenge the lame excuses given for the massive receivables factoring which came to light at that time.

1. Even as late as December 1998, the market was still questioning Compaq's integrity in light of the Company's 1997 transgressions. An article appearing in the December 11, 1998 edition of The Wall Street Journal, based in part on a conversation with PaineWebber analyst, Don Young, explained that investors were upset because they felt Compaq had mislead them:

To be sure, Compaq isn't yet out of the doghouse with investors. Its credibility has been suffering since the end of its March quarter, when an excess inventory at Compaq's distributors caused it to miss quarterly earnings expectations. The problem was a big sore spot with investors, since management had denied the problem for months, saying it was bringing inventory levels down, when the opposite was true, Mr. Young said.

"A lot of people don't know if they trust what the company is saying these days. That's what I hear from a lot of clients," said Mr. Young, who now believes the company is again walking the straight-and-narrow with investors.

(Emphasis added.)

Defendants Knew During The Class Period That The ODM Was Failing

1. Defendants knew, prior to the beginning of the Class Period, that Compaq was losing the battle to Dell for dominance in the PC market, that Compaq's inventory-on-hand strategy was becoming too costly to compete with Dell's build-to-order business and that Compaq would have to switch strategies rather than continue to fight Dell in what was a losing battle. Compaq thus announced and promoted its own version of a build-to-order system of sales. From the outset, however, as alleged above, the Individual Defendants, who were running the Company and aware of the progress of the ODM, knew that serious difficulties with the channel were hindering Compaq's ability to implement the ODM and compete with Dell's direct sales model. Defendants knowingly misled the market about the ODM program, realizing that a public admission of failure would depress Compaq's price.

Defendants' Knowledge Of Factoring And

Channel Stuffing During The Class Period

1. As alleged herein, defendants acted with scienter in that they knew that the Company was engaging in "channel stuffing" and factoring receivables at a discount which were the real reasons for the Company's increased sales, increased ROIC and profitability. As set forth elsewhere herein in detail, by the end of the Class Period, defendants admitted, and it was otherwise revealed, that Compaq had been engaging in these undisclosed practices throughout the Class Period. In fact, on February 12, 1998, defendant Mason admitted that in the second quarter the Company had factored receivables at an unusually high rate. Nevertheless, the second quarter 10-Q Report, disseminated to the public on July 24, 1997, made no mention of that practice. Because the Individual Defendants were running the Company, they knew that these practices were occurring and, therefore, they knew or had to know that their representations about Compaq's financial progress were false.

Resignation Of Key Employees

1. The resignations of Richard Snyder, defendant Pieper and Jim Schraith, all key figures in implementing the ODM system, further support the inference that Compaq knew its ODM plan was not working. Snyder, who publicly supported the ODM and was brought in from Dell as Compaq's chief architect of the plan, resigned on July 16, 1997, citing conflicts with Compaq's marketing department. In January 1998, however, it was revealed that he quit because of problems convincing the channel of the viability of the ODM system. Schraith was also publicly very bullish on the ODM program until his sudden departure in January 1998. As for Peiper, although slated to have a major role in the ODM program, he bailed from Compaq's sinking ship only four months after his arrival, but just after managing to sell over $21,000,000 worth of Compaq stock. Taken together, these abrupt and suspicious departures, combined with the other allegations of the complaint, raise an inference of scienter here.

Defendants Had Several Clear Motives to

Postpone Bad News, Further Supporting Scienter

Insider Selling

1. Defendants were motivated to perpetrate their fraud by their desire to push Compaq's stock price to record levels in the short term, while exercising options and cashing out of their stock. Indeed, during the Class Period, while Compaq's top insiders were issuing favorable statements about the Company, the Individual Defendants collectively sold nearly 2.5 million shares of Compaq stock (and far more if measured after the 2-for-1 stock split in January 1998), for more than $120,000,000.00 in total proceeds, personally profiting from the artificial inflation in Compaq's stock price which their fraudulent scheme had created. Most of the proceeds generated by defendants' stock sales represented pure profit to defendants, who executed their sales by exercising options at prices ranging from $2.25 per share to $25.16 per share and then selling their stock at prices ranging between $30.25 per share and $74.13 per share. The timing of these sales, particularly in light of the fact that they occurred during the height of the Company's practices of channel stuffing and factoring of receivables detailed above, were highly suspicious. As explained in a March 10, 1998 Bloomberg article, "Compaq Computer Corp. officers sold some 1.2 million shares [nearly half of the insider's Class Period sales] in February, about a month before a company earnings forecast that startled the industry." Questioning whether the defendants saw "potential problems" on the horizon when they dumped their stock, Jerry Dodson, portfolio manager at Parnassus Fund in San Francisco which owns 450,000 shares of Compaq stock, stated, "They may have sensed that there was weakness and the stock wasn't going to do well in the next six to nine months. It concerns me." In addition, these sales were unusual because of their sheer magnitude. The $54,600,000 worth of sales in October 1997 alone, for example, was a "record" for the Company.
2. Notwithstanding their access to confidential information as a result of their status as directors, and/or officers of the Company, and their corresponding duty to disclose adverse material facts before trading in Compaq stock, the Individual Defendants sold massive amounts of Compaq shares at artificially inflated prices in order to profit from the fraud, and did so while in possession of material non-public information. Each and every sale of Compaq stock by the Individual Defendants during the Class Period is detailed below, with the pertinent information, including the date sold, the number of shares, the price per share, the total proceeds from the sales and the average cost basis for the stock sold:

* Reflects prices paid prior to a two-for-one stock split as of January 21, 1998.

The Tandem And DEC Transactions

1. A further motive for deferring negative earnings announcements to a later quarter was to maintain the Company's stock price at artificially inflated levels in order to facilitate the merger transactions whereby the Company's stock would be used as the transaction currency. Indeed, during the Class Period, Compaq used billions of dollars of its stock to acquire both Tandem and DEC. With respect to the DEC transaction, as explained in the February 9, 1998 edition of Barron's:

Compaq released its fourth-quarter earnings just days before it announced its deal with Digital Equipment, an acquisition Compaq will be making partially in stock. Suspicious persons might conclude that Compaq stuffed the channel so as to hit Street estimates, so the stock wouldn't drop ahead of the disclosure of the acquisition.

Compaq's Executive Compensation Plan Was Tied To The ROIC

1. A further motive for keeping Compaq's stock price as high as possible was to increase the ROIC, and thereby bonuses, to the Individual Defendants. According to the 1998 Proxy, "the compensation mix for executive officers consists of base salaries, bonus, and stock option awards. As a result, much of an officer's compensation depends on Compaq's financial performance." The 1998 Proxy further explained that 1997 compensation was based, in large part, on the Company's ROIC and its sales growth, two financial measurements that were directly inflated by defendants' factoring of receivables and channel stuffing. In fact, defendant Mason admitted that factoring of receivables helps ROIC, "otherwise we would not do it." The 1998 Proxy explained that defendant Pfeiffer's bonus, which included $3,250,000 in cash and options to purchase 1,750,000 shares of Compaq stock, valued at potentially $102,000,000, were based on "Mr. Pfeiffer's direction of Compaq's operations in 1997 [which] resulted in record-setting financial performance, including an annual sales increase to $24.6 billion from $20.0 billion in 1996, an increase in earnings per share to $1.19 from $.87 in 1996, and an improvement in gross margins to 27.6% by the fourth quarter of 1997." Thus, Pfeiffer, Mason and the other Individual Defendants, who all received compensation in 1997 tied to increased ROIC and record sales, had a motive to inflate these figures through factoring receivables and channel stuffing.

1. As indicated by the allegations above, Compaq is followed by securities analysts employed by brokerage houses and/or broker/dealers which issue reports and make recommendations concerning Compaq common stock to their clients. Among the securities firms that followed the Company during the Class Period were: Oppenheimer & Co. Inc.; Morgan Stanley Dean Witter, Merrill Lynch, Wasserstein Perella Securities Inc., Lehman Brothers Inc., Bear Stearns & Co., Inc., The Robinson-Humphrey Co., Inc., Credit Suisse First Boston Group., CIBC Oppenheimer, BT Alex Brown, and PaineWebber Inc. As described above, defendants successfully deceived these analysts, along with the rest of the market, with respect to Compaq's financial condition during the Class Period. In addition, defendants also in many instances used these analysts as conduits to promote the Company and are therefore responsible for many of the statements made by analysts.
2. As set forth above, defendants used their communications with analysts to assure them that their estimates of Compaq's business were accurate and that the Company was on track to achieve its stated expectations. In writing their reports, the analysts relied in substantial part upon these communications as well as information provided to them privately by the Company, and assurances by defendants and the Company that information in the analysts' reports did not materially vary from the Company's internal knowledge of its operations and prospects.
3. Indeed, prior to and during the Class Period, it was the Company's practice to have its top officers and key members of its management team, including defendants Pfeiffer and Mason, communicate with securities analysts at the firms identified above (and others), on a regular basis, to discuss, among other things, the Company's operating results and anticipated revenues and to provide detailed "guidance" to these analysts with respect to the Company's business and anticipated revenues and earnings. These communications included, but were not limited to, conference calls, meetings, dinners, and analyst briefings where defendants discussed relevant aspects of the Company's operations and financial prospects.
4. Compaq's consistent contact with and guidance to analysts throughout the Class Period is demonstrated by, inter alia, the following: (1) a February 16, 1998 article in Computer Reseller News noting that "Mason is credited with wooing the financial industry and rallying its support."; (2) Senior Management of Compaq, including Mason attended a dinner hosted by Merrill Lynch according to a June 18, 1997 Merrill Lynch report; (3) Compaq held a meeting for analysts in New York on July 10, 1997, during which it made a slide presentation, according to a July 16, 1997 Credit Suisse First Boston Corp. report; (4) another Credit Suisse report, dated October 21, 1997, noted that defendant Mason makes "pronouncements at institutional investor's conferences, which he attends with great regularity"; (5) according to an October 31, 1997 report by Merrill Lynch, Merrill hosted a conference call with defendant Mason on October 30, 1997; (6) according to the May 2, 1998 edition of the High-Tech Strategist, in November 1997 the Merrill Lynch's computer analyst held a conference call with defendant Mason, Compaq made representations about channel inventories at a Deutsch Morgan Grunfell conference in the fourth quarter of 1997, and Compaq held an analyst conference call in the third quarter of 1997; and (7) in an interview by Computer Reseller News on or about February 23, 1998, defendant Mason explained that: "I work with our investor relations organization and talk to different large shareholders. . . . [W]e try to keep our shareholders and the analysts informed as much as possible about what our actions are going to be."
5. Therefore, any reports by securities analysts may properly be attributed to defendants, whether the reports explicitly say so or not, because of defendants' systematic use of analysts as conduits for information. Defendants knew that by participating in regular and periodic direct communications with analysts, the Company could disseminate information to the investment community and that investors would rely and act upon such information (i.e., make purchases of Compaq common stock). The Individual Defendants communicated with analysts in order to cause or encourage them to issue favorable reports, recommendations and forecasts concerning Compaq - - which the analysts did - - and defendants used these communications to falsely present the operations and allegedly successful prospects of Compaq to the marketplace in order to artificially inflate the market price of Compaq common stock.
6. Despite their duty to do so, the Individual Defendants failed to correct these statements (of which they were the sources or which they had caused or facilitated) during the Class Period. The Individual Defendants also had the ability to correct misstatements of others, as evidenced by a press release issued over BusinessWire on March 9, 1998, where Compaq "disavowed a press release distributed last week by Hand Technologies. Compaq does not have a direct relationship with Hand Technologies nor do the two companies have a co-marketing agreement." During the Class Period, however, the Individual Defendants never disavowed an analyst report, further supporting the notion that defendants agreed with and adopted the reports circulated by securities analysts following Compaq during the Class Period.
7. The investment community relied and acted upon the information communicated in these analyst reports, which proclaimed that appreciation in Compaq's stock price could be expected and recommended that investors purchase Compaq shares.

FIRST CLAIM FOR RELIEF AGAINST ALL

1. Plaintiffs repeat and reallege each and every allegation contained in the above paragraphs as if fully set forth herein.
2. During the Class Period, the defendants engaged in a course of conduct, described above, pursuant to which they knowingly or recklessly engaged in acts, transactions, practices and a course of business which operated as a fraud upon plaintiffs and the other members of the Class; made various untrue statements of material facts and omitted to state material facts necessary to make statements made, in light of the circumstances under which they were made, not misleading to plaintiffs and the other Class members; and employed manipulative and deceptive devices and contrivances in connection with the purchase of Compaq securities.
3. The purpose and effect of the defendants' plan, scheme and course of conduct was to artificially inflate the price of Compaq common stock and then artificially maintain the market price of the stock.
4. The Individual Defendants, through their positions as directors and officers of the Company, had actual knowledge of the material omissions and/or the falsity of the statements set forth above, and intended to deceive plaintiffs and the other members of the Class or, in the alternative, acted with reckless disregard for the truth when they failed or refused to ascertain and disclose in the aforementioned documents the true facts to plaintiffs and the other members of the Class.
5. Defendant Compaq had actual knowledge of the material omissions and/or the falsity of the statements set forth above, and intended to deceive plaintiffs and the other members of the Class or, in the alternative, acted with reckless disregard for the truth when it failed or refused to ascertain and disclose in the aforementioned documents the true facts to plaintiffs and the other members of the Class.
6. The statements made by defendants during the Class Period regarding, inter alia, the success of ODM, the state of Compaq's channel inventories, its ROIC, its cost cutting efforts, its sales, and its operations were materially false and misleading when they were made since, at the time they were made, the defendants were aware, or recklessly disregarded, the fact that Compaq was experiencing major difficulties with its resellers and distributors and its ODM program in general, that inventory levels were not decreasing, that it was "stuffing the channel" which led the Company to maintain its ROIC at a high level through the costly exercise of factoring its receivables.
7. Throughout the Class Period, in knowing and reckless disregard for the truth and/or as part of their common plan and on-going efforts to continue the illusion of Compaq's business success, expected substantial profitability and future business prospects, the defendants continued to issue, and/or participated in the issuance of, materially false and misleading statements to the investing public as particularized above. Moreover, defendants failed to correct said statements and omissions when, during the Class Period, defendants knew, or absent recklessness, should have known, that the statements they previously made or disseminated had become materially false and misleading.
8. Pursuant to their aforesaid plan and scheme, defendants made or issued, among others, statements that were materially misleading when made for the reasons set forth above and, in that they failed to disclose the aforementioned material, adverse facts about Compaq's business, financial condition and future business prospects, which were known to and/or recklessly disregarded by defendants.
9. As a result of the foregoing, the market prices of Compaq securities were artificially inflated during the Class Period. In ignorance of the materially false and misleading nature of the misrepresentations made by defendants, and the deceptive and manipulative devices and contrivances employed by the defendants, plaintiffs and the other members of the Class relied, to their detriment, on the integrity of the market prices in purchasing Compaq securities. Had plaintiffs and the other members of the Class known of the material adverse information not disclosed by defendants, they would not have purchased Compaq securities at the artificially inflated prices that they did.
10. Plaintiffs and the other members of the Class have suffered substantial damages as a result of the wrongs alleged herein.
11. By reason of the foregoing, defendants have violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder in that they: (a) employed devices, schemes and artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary to make the statements made not misleading; and (c) engaged in acts, practices and a course of business which operated as a fraud or deceit upon plaintiffs and the other members of the Class in connection with their purchases of Compaq securities during the Class Period.

1. Plaintiffs repeat and reallege each and every allegation set forth in the above paragraphs as if set forth fully herein.

1. The Individual Defendants, by virtue of their offices, directorships and specific acts, were, at the time of the wrongs alleged herein, controlling persons of Compaq within the meaning of Section 20(a) of the Exchange Act. The Individual Defendants had the power and influence and exercised the same to cause Compaq to engage in the illegal conduct and practices complained of herein by causing the Company to disseminate to the public, or through securities analysts, the materially false and misleading information referred to above.
2. The Individual Defendants' positions made them privy to and provided them with actual knowledge of the material facts concealed from plaintiffs and the other members of the Class by defendants during the Class Period.
3. By reason of the conduct alleged in the First Claim for Relief, the Individual Defendants are liable for the aforesaid wrongful conduct and are liable to the plaintiffs and the other members of the Class for the substantial damages which they suffered in connection with their purchases of Compaq securities during the Class Period.

1. The 20A Plaintiffs repeat and reallege each and every allegation set forth in the above paragraphs as if set forth fully herein.

1. The 20A Plaintiffs assert this Count for violations of Section 20A of the Exchange Act against the Individual Defendants, each of whom sold Compaq common stock contemporaneously with the 20A Plaintiffs' purchases of Compaq stock during the Class Period.
2. The Individual Defendants collectively sold over 2,400,000 shares of Compaq common stock, realizing proceeds of more than $122,000,000 during the Class Period, while in the possession of material adverse non-public information as set forth above.
3. During the time the Individual Defendants sold Compaq common stock while in the possession of material non-public information, the 20A Plaintiffs, and other members of the Subclass, contemporaneously with the sale of Compaq stock by these defendants purchased securities of the same class sold by the Individual Defendants.
4. By virtue of the foregoing, the Individual Defendants violated section 20A of the Exchange Act.
5. As a result of the foregoing, the 20A Plaintiffs and the Subclass have suffered damages.

WHEREFORE, plaintiffs, on their own behalf and on behalf of the other members of the Class, pray for judgment as follows:

1. Declaring this action to be a proper class action, certifying the plaintiffs as Class representatives and their counsel as Class Counsel, and certifying the 20A Plaintiffs as representatives of the Subclass;
2. Declaring and determining that the defendants violated the federal securities laws by reason of their conduct as alleged herein;
3. Awarding money damages against the defendants, jointly and severally, in favor of the plaintiffs and the other members of the Class for all losses and injuries suffered as a result of the acts and transactions complained of herein, together with pre-judgment interest on all of the aforesaid damages which the Court shall award from the date of said wrongs to the date of judgment herein at a rate the Court shall fix;
4. Awarding plaintiffs their costs and expenses incurred in this action, including reasonable attorneys', accountants' and experts' fees; and
5. Awarding such other relief as may be just and proper.

Dated: March 16, 1999

HOEFFNER, BILEK & EIDMAN, L.L.P.

Thomas E. Bilek - TBA 02313525

440 Louisiana, Suite 720

Houston, TX 77002

(713) 227-7720 Telephone

(713) 227-9404 Facsimile

Plaintiffs' Liaison Counsel

WOLF HALDENSTEIN ADLER

FREEMAN & HERZ LLP

Daniel W. Krasner

Michael Jaffe

Neil L. Zola

270 Madison Avenue

New York, NY 10016

(212) 545-4600

STULL STULL & BRODY

Jules Brody

6 East 45th Street

New York, NY 10017

(212) 687-7230

Plaintiffs' Co-Lead Counsel

CHITWOOD & HARLEY

Martin Chitwood

2900 Promenade Two

1230 Peachtree Street N.E.

Atlanta, GA 30309

(404) 873-3900

Plaintiffs' Executive Committee

MANN & JUST

Joshua J. Just

50 Broad Street, Suite 1000

New York, NY 10004

(212) 425-1999

BARRY PINKOWITZ, ESQ.

112 Madison Avenue

8h Floor

New York, NY 10016

(212) 725-4700

LAW OFFICES OF CURTIS V. TRINKO, LLP

Curtis V. Trinko

16 West 46^th Street, 7^th Floor

New York, NY 10036

(212) 490-9550

BERNSTEIN LIEBHARD & LIFSHITZ

Sandy Liebhard

10 East 40th Street - 22^nd Floor

New York, NY 10016

(212) 779-1414

SMITH, MACKINNON, GREELEY,

BOUDOIN & EDWARDS, P.A.

Ted B. Edwards

255 South Orange Avenue

Suite 800, Citrus Center

Orlando, FL 32801

(407) 843-7300

KOHN, SWIFT & GRAF, P.C.

Joseph C. Kohn

Denis F. Sheils

1101 Market Street, Suite 2400

Philadephia, PA 19107-2924

(215) 238-1700

BRIAN M. FELGOISE, ESQ.

1494 Old York Road, Suite 200

Abington, PA 19001

(215) 576-5077

LEONARD L. CAMPBELL, ESQ.

6523 Harvey Avenue

Pennsauken, NJ 08109

(609) 662-8923

WEISS & YOURMAN

Joseph H. Weiss

551 Fifth Avenue

New York, NY 10017

(212) 682-3025

FINKELSTEIN, THOMPSON, LOUGHRAN

Burton H. Finkelstein, Esq.

The Foundry Building

Suite 601

1055 Thomas Jefferson

Street, N.W.

Washington, D.C. 20007

(202) 337-8000

MUCH SHELIST FREED DENENBERG

AMENT & RUBENSTEIN, P.C.

Joseph D. Ament

200 North LaSalle, Suite 2100

Chicago, Illinois 60601

(312) 346-3100

HAROLD B. OBSTFELD, P.C.

260 Madison Avenue

New York, New York 10016

(212) 696-1212

WIRTZ & ASSOCIATES

D. Joshua Staub

16161 Ventura Blvd., #669

Elcino, CA 91436

(310) 576-7770

IANELLI AND MOLDER

Michael Molder

325 Chestnut Street, Suite 903

Philadelphia, PA 19106

(215) 627-3394

LAW FIRM OF HARVEY GREENFIELD

60 East 42nd Street, Suite 2001

New York, New York 10165

(212) 949-5500

GOFORTH, LEWIS & WILLIAMS, L.L.P.

2200 Texaco Heritage Plaza

1111 Bagby

Houston, TX 77002

(713) 650-0022

Attorneys for Plaintiffs

1. Some of those shares do not reflect to the Company's 2-for-1 stock split that occurred on January 21, 1998. Therefore, in current numbers, defendants sold well over 2.5 million shares of stock.

2. The stock prices referred to herein are adjusted for stock splits occurring during the Class Period.

3. A Credit Suisse market analysis indicates that Dell's market share relative to the "Fab Four," which includes Compaq, rose from an approximate share of 10% in the 4th Quarter of 1994, to 15% in the 4th Quarter of 1996, while Compaq's relative market share declined from approximately 40% to 37% during the same period.

4. These per share figures reflect the 5-for-2 stock split that occurred on July 29, 1997.