UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION ALLAN ZISHKA and GERALD R. DAILEY, ) Civ. No. 98CV0660-D On Behalf of Themselves and All ) [filed Mar. 10, 1998] others Similarly Situated, ) COMPLAINT - CLASS ACTION ) Plaintiffs, ) ) vs. ) ) AMERICAN PAD & PAPER COMPANY, BAIN ) CAPITAL, INC., BAIN VENTURE ) CAPITAL, TYLER CAPITAL FUND, L.P., ) COMPLAINT FOR VIOLATION OF TYLER MASS., L.P., TYLER ) THE SECURITIES EXCHANGE ACT INTERNATIONAL, L.P. II, BCIP TRUST ) OF 1934 ASSOCIATES, L.P., BCIP ASSOCIATES, ) GREGORY M. BENSON, JONATHAN S. ) LAVINE, RUSSELL M. GARD, MARC B. ) WOLPOW, CHARLES G. HANSON, III, ) ROBERT C. GAY, KEVIN W. McALEER, ) SCOTT R. WATTERSON, MORGAN STANLEY ) & Co., INC., ALEX. BROWN & SONS, ) INC., BANKERS TRUST NEW YORK ) CORPORATION, BT SECURITIES CORP. ) and CREDIT SUISSE FIRST BOSTON, ) INC., ) ) Defendants. ) Plaintiffs Demand A ____________________________________) Trial By Jury ------------------------------------------------------------------------ SUMMARY OF ACTION 1. This is a suit on behalf of purchasers of American Pad & Paper Company ("American Pad" or the "Company") stock between 7/2/96 and 12/17/97 (the "Class Period"), alleging violations of §§ 10b) and 20(a) of the Securities Exchange Act of 1934 ("1934 Act") and SEC Rule 10b-5. This action complains of a scheme by American Pad, its controlling shareholders and top insiders, its lending bank and its securities underwriters (which included its lending bank) to escape from a failing leveraged buyout ("LBO") of American Pad by misrepresenting American Pad's business, financial results and future prospects to accomplish a $234 million initial public offering ("IPO") of American Pad stock. Defendants represented that the new and restructured American Pad was a growth company in a growth industry which had competitive strengths and advantages, was uniquely well positioned to benefit from the consolidation occurring at the retail distribution level of office paper products, had significant purchasing advantages and had implemented policies that insulated its profits from any adverse impact of fluctuations in paper prices and thus American Pad would achieve strong earnings per share ("EPS") growth of at least 20% per year over the next several years. These misrepresentations artificially inflated the price of American Pad's stock, enabling defendants to take American Pad public, selling 16.2 million shares of American Pad stock at $15 per share, raising $243 million.1 American Pad received $172.8 million from the IPO, which it used to repay and restructure its crushing bank debt, paying Bankers Trust ____________________ 1 Includes shares sold in the over-allotment. - 1 - ------------------------------------------------------------------------ New York Corporation ("Bankers Trust"), American Pad's main lender, $175 million owed under a bank credit agreement and under senior subordinated notes arranged by Bankers Trust. The IPO also allowed Bain Capital, Inc., including Bain Venture Capital (collectively "Bain Capital") -- American Pad's controlling shareholder, which had arranged the 1992 LBO of American Pad -- to sell off 3.4 million of its American Pad shares pocketing $49 million. The huge amounts of cash raised in the IPO also replaced American Pad's negative ($66 million) stockholders' equity with an $88.9 million positive shareholders' equity -- boosting the book value of the 10 million American Pad shares Bain Capital continued to own after the IPO by $13.45 per share -- a $135 million windfall for it -- and also boosting the book value of the 2 million shares owned or subject to option by Charles G. Hanson, III ("Hanson"), American Pad's Chairman and CEO, and Russell M. Gard ("Gard"), American Pad's COO -- a $27 million windfall for them. This large IPO rescued the American Pad LBO that by 1995 was on the verge of failure, exposing Bain Capital and Bankers Trust to huge losses. Defendants' false and misleading statements not only facilitated the $234 million IPO, but also drove American Pad stock to as high as $26-1/2 per share and allowed American Pad's two top officers (Hanson and Gard) to later sell off 100,000 shares of their American Pad stock, pocketing $1.3 million in illegal insider- trading proceeds. Although American Pad's stock fell sharply in 1/97 when American Pad revealed its 1stQ 97 results would be lower than forecast, defendants represented this quarterly shortfall was due to mechanical, short-term factors which American Pad was over- coming, that American Pad's competitive advantages and growth - 2 - ------------------------------------------------------------------------ prospects were intact and it would still achieve strong EPS growth going forward. When American Pad reported better-than-expected 2ndQ 97 results its stock recovered to $24-15/16 per share. But then in 9/97, when American Pad revealed sharply weakening demand for its products, the lack of growth in its business and that its 3rdQ and 4thQ 97 EPS would decline -- American Pad's stock collapsed from $24-3/8 to $11-1/2 and then to just $7-3/4 per share, when it admitted in 12/97 it would suffer a huge 4thQ 97 loss and a loss for all of 97, due to major accounting adjustments which showed it had been falsifying and artificially inflating its net income and EPS. 2. American Pad sells paper writing products, including legal pads, telephone message pads, index cards and envelopes. Prior to 1992, American Pad operated as a subsidiary of Mead Corporation ("Mead"). In 92, Hanson, Gard (who ran American Pad for Mead) and Bain Capital (a leveraged buyout firm) purchased American Pad in an LBO with short-term financing from Mead. They invested only $3 million of their own capital, borrowing almost all the funds necessary for the buyout from Mead which left American Pad saddled with a huge acquisition debt. However, after the LBO, during 94-95, American Pad's business lost over $22 million from its operations, and remained burdened by its huge debt which American Pad could barely service and could never repay from its loss-ridden operations. 3. By mid-95, Bankers Trust became, intimately involved with American Pad -- acting as its and Bain Capital's financial advisor and loaning American Pad the millions it needed to repay Mead so it could stay afloat. By then Bain Capital and Bankers Trust knew the - 3 - ------------------------------------------------------------------------ American Pad LBO was in danger of failing. As of mid-95, American Pad had accumulated a negative shareholders' equity of $66 million and the book value of Hanson's, Gard's and Bain Capital's shares of American Pad stock was a negative ($17.06) per share. American Pad was also losing millions from its operations and was burdened by a huge buyout debt which it could not repay Mead, and which Mead was demanding be paid. By mid-95, Bain Capital, Hanson, Gard and American Pad realized that if the collapse of American Pad's floundering LBO was to be avoided, they needed to raise cash to pay down and/or refinance American Pad's oppressive LBO debt. In 10/95, American Pad brought in Bankers Trust who was willing to loan the Company $230 million and arrange for the sale of $200 million in senior subordinated notes, provided that the Company quickly carry out an IPO to pay off the loans and pay down the notes. American Pad's insiders, controlling shareholders and Bankers Trust knew that an IPO of American Pad stock was the only way to salvage the LBO and pay off Bankers Trust, as only an IPO could raise the huge amount of cash American Pad needed to reduce its burdensome debt and interest payments, boost its shareholders' equity and the book value of the stock owned by them -- and thus bail themselves out of a dangerous financial situation. Secondly, an IPO would create the trading market in American Pad's stock they needed to be able to do a follow-on stock or convertible debt offering to raise more cash to further reduce American Pad's debt burden after the IPO and to have a ready non-cash currency to make the acquisitions which were indispensable to American Pad growing its business by diversifying and increasing its profitability. - 4 - ------------------------------------------------------------------------ 4. Pulling off a huge public offering of a company that sold paper pads, index cards, message pads and envelopes presented a tremendous challenge. By the 90's, the office paper products industry was viewed by many to be, at best, a very slow growth industry and, at worst, a "dead" industry from an investment viewpoint -- an industry plagued by commodity products and pricing, intense competition, slow revenue growth and poor prospects for net income and EPS growth. This negative industry outlook was exacerbated by the burgeoning use of computers in the office place, which was resulting in the use of less paper in offices and some believed was even leading to the so-called "paperless office." American Pad seemed to manifest these negative characteristics, and in fact, Mead had sold American Pad to Bain Capital, Hanson and Gard in 92 because of the poor performance of, and poor prospects for, American Pad's business. After being sold by Mead in 92 to Bain Capital, Hanson and Gard, American Pad continued to suffer losses, losing $7 million in 94 and $15 million in 95, due, in part, to increasing paper prices which posed a significant risk to its business as, due to competition and other factors, it was very hard for American Pad to pass along these increases to its customers. In order to pull off the kind of huge IPO that American Pad and its controlling shareholders needed to raise the millions necessary to save the America Pad LBO, they knew that they, would have to make it look as though, due to macroeconomic industry changes and a restructuring of American Pad's business, American Pad was now in an industry with growth prospects, its own ongoing operations were profitable and American Pad was now positioned to - 5 - ------------------------------------------------------------------------ deliver strong profitable growth over the next several years, i.e., it was a "growth" company in a "growth industry." 5. In preparation for American Pad's IPO and as part of the plan to make American Pad appear profitable, in 10/95 the American Pad LBO debt was restructured. Mead was paid off using funds loaned by Bankers Trust. Using monies loaned, or arranged, by Bankers Trust, American Pad also acquired Williamhouse-Regency of Delaware, Inc. ("Williamhouse"), a manufacturer of envelopes. As a result of the Williamhouse acquisition, American Pad was able to create "pro forma" financial statements, presenting its results as if Williamhouse had been a part of American Pad in the past, and thus make it appear that American Pad had 95 net income of $16.7 million and $.56 EPS, as opposed to the $14.6 million/$.91 EPS loss it had suffered from its own ongoing or historical operations. 6. As a result of the Williamhouse acquisition and the creation of its new "pro forma" financial statements for the year ended 12/31/95, American Pad was positioned to look like a profitable company. American Pad's reaching of apparent profit- ability created the opportunity for American Pad, its controlling shareholders, Bankers Trust and the high-powered investment bankers they recruited to take American Pad public. The defendants hurried to take American Pad public as soon as they could in 96, as they knew that the adverse facts concerning American Pad's business could not be concealed indefinitely and, if those facts became known, it would prevent an IPO at a high price, leave American Pad's controlling shareholders and Bankers Trust locked in their unfavorable and illiquid position, exposing American Pad's - 6 - ------------------------------------------------------------------------ insiders, controlling shareholders and Bankers Trust to the loss of their investment in or loans to American Pad. 7. To accomplish the IPO with the help of Bankers Trust and its investment banking subsidiary, BT Securities Corp. ("Bankers Trust/BT Securities"), American Pad and its controlling shareholders sought out high-powered investment bankers to help them with the IPO and follow-on stock/convertible debt offering they and Bankers Trust were planning. Thus, they contacted large investment banking firms capable of orchestrating a huge IPO -- Morgan Stanley & Co., Inc. ("Morgan Stanley"), Alex. Brown & Sons, Inc. ("Alex. Brown") and Credit Suisse First Boston, Inc. ("First Boston") (collectively with Bankers Trust/BT Securities, the "Underwriter Defendants"). They determined that in return for their share of the IPO proceeds they were willing to participate in the scheme by merchandising American Pad stock in the IPO, including orchestrating a nationwide pre-IPO "roadshow" to stimulate interest in the IPO, and by issuing favorable research reports on American Pad after the IPO to support American Pad's stock price (known as "booster shots") so American Pad could pull off a follow-on stock offering. 8. By late 95, as the Williamhouse acquisition was completed, defendants were already working on American Pad's IPO. However, the defendants realized that American Pad would face great difficulty in marketing its IPO, as American Pad was apparently profitable only because of its recent acquisition of Williamhouse, it remained very highly leveraged due to its large LBO debt and, even after the IPO, American Pad would still have a multi-million dollar debt. Moreover, Bain Capital wanted to raise the large - 7 - ------------------------------------------------------------------------ amounts of cash needed without unduly diluting its ownership of American Pad. To achieve these ends, they wanted to sell American Pad stock in the IPO at as high a price as possible. However, in order to create strong demand for American Pad's stock and justify a high price for American Pad's stock in the IPO, they knew they would have to make it appear that American Pad was not a slow growth company in a "dead" industry, but was, in fact, now a "growth" company in a "growth" industry, with significant competi- tive strengths and advantages, having transformed its business from a commodity office paper supply business into one that produced significantly higher profit margins than in the past and that, as a result, American Pad was now a higher profit margin growth company which would be able to achieve substantial EPS growth over the next several years. 9. In order to create intensive investor interest in the American Pad IPO, defendants organized a "roadshow" to take place prior to the IPO where American Pad's top executives (Hanson, Gard and Gregory M. Benson ("Benson"), American Pad's then Director of Strategic Planning and Acquisitions and Chief Financial Officer), in the presence of representatives of the Underwriter Defendants, made presentations about American Pad. During the roadshow presentations, in connection with American Pad's IPO, they stated: • Due to the restructuring of American Pad's business, the Williamhouse acquisition and changes in the distribution of office paper products, American Pad was now a growth company in a growth industry. • The office products distribution channel was undergoing a major consolidation into larger superstore outlets. American Pad was organized and uniquely positioned to capitalize on this trend. This would enable it to gain market share and achieve strong revenue and EPS growth over the next several years. - 8 - ------------------------------------------------------------------------ • American Pad was uniquely well positioned to increase its sales to office superstores, one of the most important and rapidly growing segments of the office products industry. • American Pad had de-emphasized the commodity nature and portion of its business by introducing new, value-added products which carried higher, more profitable prices and would contribute to strong revenue and EPS growth over the next several years. • American Pad would make several accretive acquisitions over the next few years which would contribute to strong profitable growth. • American Pad had implemented sophisticated cost control and accounting systems, which enabled it to effectively control its inventory levels and expense so that it would achieve profit gains that exceeded its revenue growth. • The Williamhouse acquisition was a tremendous success and was already being integrated into American Pad and was performing better than expected, resulting in substantial synergies and cost savings. • American Pad had competitive strengths and advantages, including purchasing advantages, which enabled it to secure lower prices for raw materials, which benefited its profitability. • American Pad had successfully implemented a pricing strategy to shield its gross dollar margins from the pricing volatility traditionally present in the paper business. This would enable American Pad to maintain its profit margins in the face of paper price increases or decreases going forward. • American Pad had achieved strong operating momentum which would lead to substantial revenue growth in the next several years. • American Pad expected 30% EPS growth in 97 and 98 and at least 20% ongoing EPS growth thereafter. 10. American Pad's 7/2/96 IPO Prospectus represented that it was now profitable, having achieved 95 EPS of $.59 and 1stQ 96 EPS of $.01. It presented American Pad's "growth strategy," stressing its "competitive strengths," which, provided "continued opportunities for growth and profitability," including new retail distribution channels which American Pad was "uniquely positioned" to exploit. It said American Pad's "purchasing advantages," - 9 - ------------------------------------------------------------------------ "innovative . . . higher value-added" products, low-cost manufac- turing operations and its plan to follow the Williamhouse acquisition with several more acquisitions would boost its growth. The Prospectus stated American Pad's new pricing policies would "minimize the impact of price volatility on dollar margins" which, combined with American Pad's new products and more diverse product mix, made it "less susceptible to paper price fluctuations." 11. Between 7/96 and 1/98, defendants stressed American Pad's "strong results" and that it had "achieved" and "continue[d] to meet [its] profitability goals," due to strong demand and retail sell-through, combined with American Pad's tight financial cost controls. Defendants represented that American Pad had been successful in implementing its new pricing policies to shield its profit margins from price fluctuations, that the Williamhouse acquisition had been a great success and had been successfully integrated, with acquisition synergies being realized and that American Pad's "acquisition pipeline remains full." American Pad said it was "on target" with "new product introductions" and "market penetration," and these factors plus American Pad's purchasing advantages, internal growth and planned acquisitions would lead to 30% EPS growth in 97-98 and 20% compound annual EPS growth thereafter with 97 EPS of $1.30-$1.40. Defendants represented that consolidation within the office retail market was a positive development for American Pad and would "strengthen" American Pad's competitive position, leaving American Pad "uniquely positioned to capitalize" on the ongoing consolidation trend at the retail level. When American Pad later acquired Shade-Allied, Inc. ("Shade-Allied"), defendants stated this acquisition would be - 10 - ------------------------------------------------------------------------ "immediately accretive" from "day 1" and boost American Pad's 97 and 98 EPS. As a result of these positive representations and forecasts, American Pad's stock moved to an all-time high of $26- 1/2 in late 1/97. 12. In late 1/97, American Pad's stock began to decline and continued to fall to $11-1/8 by 4/1/97, as American Pad revealed "slight" softness in its 4thQ 96 and 1stQ 97 results, and American Pad "modestly" reduced its 97 and 98 EPS forecasts. Defendants insisted this softness was due to transitory "mechanical" factors relating only to industry factors and customer reorder patterns. Defendants insisted that American Pad's "core business remain[ed] solid," there had been "no deterioration of [its] fundamentals," which were intact and American Pad's strong growth was still "on track." Defendants continued to represent that American Pad was still achieving its internal goals for revenue growth and profitability, was maintaining strong gross profit margins due to its pricing policies and thus was successfully passing along paper price increases in 97. According to defendants, American Pad was "on target" for more acquisitions, as "[o]ur acquisition pipeline is full" and "we will continue to realize exceptional growth" -- EPS growth in 97 to $1.25-$1.35 per share with 20% EPS growth going forward. American Pad later reported better-than-expected 2ndQ 97 EPS, assuring the markets that these results showed earlier negative market factors "ha[d] stabilized," that American Pad's "fundamentals" and "growth strategy [were] on track," that its increasing inventory levels were not a matter for concern or due to softening demand; but rather, were the result of a decision to "build up" inventories in anticipation of very strong second half - 11 - ------------------------------------------------------------------------ 97 revenue growth. Thus, defendants then forecast 3rdQ 97 EPS of $.44, 4thQ 97 EPS of $.47, 97 EPS of $1.15-$1.30 and 20% EPS growth going forward. 13. On 9/15/97, American Pad suddenly revealed that instead of the strong 3rdQ and 4thQ 97 growth defendants had been forecasting, American Pad was encountering flat revenues and would suffer a sharp decline in EPS. American Pad's stock fell sharply from over $24 on 9/15/97 to $11-1/2 per share over the next five trading sessions as investors reacted to these startling revelations. However, because defendants did not make full disclosure of the nature and extent of the adverse facts impacting American Pad's business, American Pad's stock continued to trade at inflated prices. American Pad continued to forecast to analysts that the Company would be profitable in the 4thQ 97 and achieve 97 EPS of $.48-$.52, while representing it would meet long-term growth. These statements were false, as American Pad would suffer losses in the 3rdQ 97 although it disguised and concealed these losses by falsifying its financial statements. In addition, due the severity of the problems impacting American Pad's business, there was no basis to forecast profitability in the 4thQ 97 or the full year 97 as, in fact, American Pad would suffer losses in those periods. 14. On 11/10/97, knowing that American Pad had been falsifying its financial results and this would shortly be exposed, Hanson and Gard each sold off 50,000 shares of their American Pad stock -- 20% of the stock they actually owned -- at $13 per share -- allowing them to pocket $1.3 million in illegal insider trading proceeds. A few days later, on 12/17/97, American Pad revealed it - 12 - ------------------------------------------------------------------------ would suffer a huge 4thQ 97 loss Of $.46-$.50 per share -- a loss so large that it would suffer a loss for the full year 97 as well. The loss was due, in part, to millions in accounting charges to increase American Pad's Last-in, First-out ("LIFO") reserve to reflect its paper price increases during 97 and adjustments to its cost of goods sold. American Pad's stock collapsed on these revelations to $7-3/4. As one analyst commented on 12/19/97: We are disappointed in AMPAD's inability to at least meet their own targeted expectations, let alone those of the investment community. We believe that it will take some time for the company's credibility to be restored, in view of their recent history. AMPAD will have to demonstrate that its business is once again on a growth curve before the stock can outperform the market. We believe this will take several months, if not longer . . . . 15. The positive statements by defendants about American Pad were each false and misleading when made, as the true facts were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations, and thus its business remained as exposed as ever to the adverse impact of such price fluctuations, which American Pad was concealing by manipulating and falsifying its financial statements, including its cost of goods sold, LIFO and inventory reserves as detailed in ¶¶116-138; (b) That during 96, American Pad's core operations and profitability were being adversely affected by paper price declines which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being disguised by American Pad's manipulation and falsification of its cost of sales calculations, especially in its Williamhouse Division as detailed in ¶¶116-138; - 13 - ------------------------------------------------------------------------ (c) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive advantages, including purchasing advantages over major competitors in that marketplace; (d) That during 97 paper price hikes from its major suppliers were having a material adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the manipulation of American Pad's LIFO reserve and thus falsification of its publicly reported financial results as detailed in ¶¶116-138; (e). That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products; its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had not succeeded; (f) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers; thus it was continuing to be exposed to all the negative forces present in a highly competitive commodity product business, including severe price competition and the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials and limited growth profits; - 14 - ------------------------------------------------------------------------ (g) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, appeared to be meeting those goals by manipulating and falsifying its financial statements as detailed in ¶116-138; (h) That American Pad's 1stQ, 2ndQ, 3rdQ, 4thQ 96 and 1stQ, 2ndQ and 3rdQ 97 financial statements issued were materially false and misleading as they were manipulated and falsified as detailed in ¶¶116-138; (i) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions; in fact, American Pad was incurring significant and persistent difficulties in integrating these operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (j) That the ongoing consolidation of the office products retail channel into larger superstores was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was increasingly negatively impacted due to the sophisticated inventory management practices of the larger retail stores which reduced their inventory carry; (k) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the - 15 - ------------------------------------------------------------------------ deliberate manipulation of Williamhouse cost of sales as detailed in ¶¶116-138; (l) That American Pad's core paper products business was suffering from persistently weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (m) That the increased amount of inventories of American Pad's products during the 1stQ and 2ndQ of 97 was not the result of a deliberate decision to "build out" more product in anticipation of strong growth and/or increased seasonal demand in the coming quarters, but rather, because American Pad had accumulated millions of dollars of excessive inventory due to weak retail sell through of its products, both in the Ampad (the division which manufactured writing pads, file folders, retail envelopes, machine papers, and other products) and Williamhouse Divisions, significant amounts of which inventories would have to be sold at unprofitable prices in the near-term; (n) That American Pad's acquisition pipeline was not full, nor was it actively pursuing any significant number of acquisitions which it had a reasonable probability of completing in the foreseeable future as, in fact, due to the increasingly series internal business problems of American Pad, its executives had neither the time nor the ability to pursue significant acquisitions in the near-term and no acquisition other than Shade-Allied would occur; (o) That in late 97, American Pad was not in discussions with its lending banks regarding revisions to its bank lending agreements to facilitate its growth in the near term as, in fact, - 16 - ------------------------------------------------------------------------ American Pad's business was not growing, but stagnating or contracting, and that the discussions with the lending banks resulted from a serious decline in American Pad's financial condition which placed it on the verge of violation of its bank lending covenants and which American Pad's insiders and the banks knew, given that American Pad's actual results from operations, i.e., losses rather than profits, meant that American Pad was already in violation of its bank lending covenants or soon would be and would require waivers from its lenders to continue operations; (p) That the Shade-Allied acquisition in late 96 would not immediately benefit American Pad's EPS as the acquisition would not be completed for several months after it was announced and even then, due consolidation issues and steps and weak sales of Shade- Allied products, would not significantly advance American Pad's EPS for several months; (q) That as a result of these negative factors which were negatively impacting American Pad's results from operations, defendants actually knew that the 97 and 98 EPS forecasts being made by and for American Pad were false when made, as they were unachieveable; and (r) That as a result of these negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew their forecasts of 15%-25% EPS growth for American Pad over the next three to five years were false and misleading when made, as such EPS growth could not be achieved by American Pad. 16. American Pad's poor performance during 96 and 97, with stagnant or declining revenues and EPS compared to the large - 17 - ------------------------------------------------------------------------ increases forecast during the Class Period, is highlighted by the table below: American Pad Corporation Quarterly & Annual Results (In thousands, except EPS) 1995 ---- 03/31/95 06/30/95 09/30/95 12/31/95 Year -------- -------- -------- -------- ---- Revenues $ 47,450 $ 44,772 $ 53,787 $111,151 $257,160 Net Income $ 589 $ 1,875 $ 4,850 $ 10,278*/** $ 17,592*/** EPS $.02 $.06 $.16 $.35*/** $.59*/** 1996 ---- 03/31/96 06/30/96 09/30/96 12/31/96 Year -------- -------- -------- -------- ---- Revenues $120,108 $114,099 $173,606 $176,046 $583,859 Net Income $ 133 $ 691 $ 6,925 $ 10,465 $ 18,214 EPS $.00 $.02** $.24** $.36 $.62** 1997 ---- 03/31/97 06/30/97 09/30/97 12/31/97 Year -------- -------- -------- -------- ---- Revenues $149,834 $167,160 $176,462 Net Income $ 3,988 $ 4,708 $ 1,647 LOSSES NOW FORECAST EPS $.14 $.16 $.06 * Excluding estimated effects of non-recurring compensation charge. ** Before extraordinary charge for extinguishment of debt. 17. The graphs below show the price action of American Pad's stock during the Class Period. The charts also illustrate the collapse of American Pad's stock as the previously concealed facts about American Pad's business emerged and the performance of American Pad's stock compared to an index of similar companies which shows that the action of American Pad stock was due largely to company-specific events and not market forces: // // // // // // // - 18 - ------------------------------------------------------------------------ American Pad & Paper Co. January 2, 1997 - January 2, 1998 Daily Stock Prices [Chart 1 of 3] American Pad & Paper Company vs. Proxy Peer Group July 2, 1996 - January 29, 1998 [Chart 2 of 3] - 19 - ------------------------------------------------------------------------ JURISDICTION AND VENUE 18. Jurisdiction exists via §27 of the 1934 Act, 15 U.S.C. §78aa. The claims asserted arise under §§10(b) and 20(a) of the 1934 Act, 15 U.S.C. §78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. §240.10b-5. Venue is proper in this District as many of the relevant acts occurred in this District. Defendants used the instrumentalities of interstate commerce and the facilities of the national securities markets. PLAINTIFFS 19. (a) Plaintiff Allan Zishka purchased 100 shares of American Pad stock on 10/l/97 at $12-3/4 per share, and was damaged thereby. (b) Plaintiff Gerald R. Dailey purchased 200 shares of American Pad stock on 7/l/96 at $15 per share, and was damaged thereby. DEFENDANTS 20. American Pad markets paper office products i.e., American Pad sells writing pads, file folders, index cards, envelopes and other office paper products. During the Class Period, American Pad's stock traded in an efficient market on the New York Stock Exchange. 21. (a) Charles G. Hanson, III ("Hanson") is Chairman and Chief Executive Officer of American Pad and a member of its Executive Committee. Hanson owned 250,000 shares of American Pad stock and options to purchase 840,000 shares. Hanson sold 50,000 shares of his American Pad stock for $650,000. (b) Russell M. Gard ("Gard") is Chief Operating Officer and a director of American Pad and a member of its Executive - 20 - ------------------------------------------------------------------------ Committee. Gard owned 250,000 shares of American Pad stock and options to purchase 798,000 shares. Gard sold 50,000 shares of his American Pad stock for $650,000. (c) Gregory M. Benson ("Benson") was Executive Vice President and Director of Strategic Planning and Acquisitions, and a director of American Pad through 96 when he resigned. Benson was American Pad's Chief Financial officer through 8/96. Benson is a Managing Director of Bain Capital. (d) Kevin McAleer ("McAleer") was Vice President-Finance of the Company through 8/96 and its Chief Financial Officer thereafter, until he resigned in 11/97. (e) Robert C. Gay ("Gay") has been a director of the Company and a member of its Executive Committee since 92. Gay has been a Managing Director of Bain Capital since 93, and since 89 a general partner of Bain Venture Capital, the Tyler entities (as defined in ¶23), BCIP Associates ("BCIP") and BCIP Trust Associates, L.P. ("BCIP Trust"). (f) Jonathan S. Lavine ("Lavine") has been a director of American Pad since 95. Lavine has been a principal at Bain Capital since 95 and a general partner of BCIP and BCIP Trust. Lavine was one of two members of American Pad's Audit Committee in 95 and 96. Lavine previously worked in mergers and acquisitions at Drexel Burnham Lambert ("Drexel") -- a firm criminally convicted for violations of the federal securities laws. (g) Marc B. Wolpow ("Wolpow") has been a director of American Pad since 95 and a member of its Executive committee and was a member of its Audit Committee in 95 and 96. Wolpow has been a Managing Director of Bain Capital since 95 and a general partner - 21 - ------------------------------------------------------------------------ of BCIP and BCIP Trust. Wolpow previously worked in the corporate finance department at Drexel -- a firm criminally convicted for violations of the federal securities laws. (h) Scott R. Watterson ("Watterson") has been a director of American Pad since 12/96 and a member of its Audit Committee in 97. 22. The defendants identified in ¶21(a)-(h) are the Individual Defendants. Except Watterson and McAleer, they signed American Pad's IPO Registration Statement. Because of their positions, they each knew the adverse non-public information about the business of American Pad as well as its finances and future business prospects via access to internal corporate documents (including its operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations with other corporate officers and employees, attendance at management and/or Board of Directors' meetings and committees thereof and via reports and other information provided to them in connection therewith. During the Class Period, each Individual Defendant participated in the issuance of statements which they knew were false and/or misleading. 23. Defendant Bain Capital (which includes defendant Bain Venture Capital) is a controlling shareholder of American Pad. At the time of the IPO, Bain Capital owned 13.4 million shares of American Pad -- 90% of its stock. It also had four representatives, who were its employees, agents and controlled persons, on American Pad's Board of Directors, including two members of American Pad's four-member Executive Committee and two members of American Pad's two-member Audit Committee during 95-96. - 22 - ------------------------------------------------------------------------ After the IPO, Bain Capital continued to own 38.5% of the outstanding stock of American Pad and had four representatives on American Pad's Board, as well as members of its Executive and Audit Committees. Bain Capital's shares of American Pad were owned by the "Bain Capital Funds," i.e., defendants Tyler Capital Fund L.P., Tyler Mass. L.P., Tyler International L.P. II (collectively the "Tyler entities"), BCIP and BCIP Trust, which Bain Capital controlled and which sold their shares pro rata in the IPO. Through a management advisory contract, Bain Capital provided consulting and other financial advisory and support services to American Pad. Because of Bain Capital's representation on American Pad's Board, it knew the adverse non-public information about the business of American Pad, as well as its finances and future prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to its representatives in connection therewith. During the Class Period, Bain Capital participated in the issuance of statements which it knew were false and/or misleading for the purpose of selling American Pad securities. 24. The defendants identified in ¶¶20-23 are the "American Pad Defendants." As officers, directors and/or controlling persons of a publicly-held company and/or as sellers of American Pad stock, the American Pad Defendants had a duty to disseminate accurate and truthful information promptly with regard to American Pad and to correct any previously issued statements that had become untrue and - 23 - ------------------------------------------------------------------------ to disclose any adverse trends known to them that would materially affect the operating results of American Pad, so that the market price of American Pad's stock would be based upon truthful and accurate information. 25. The American Pad Defendants controlled the contents of American Pad's SEC filings, reports and releases. Each of the American Pad Defendants participated in preparing American Pad's reports, releases and SEC filings alleged to be misleading. Because of their access to material non-public information, each of these defendants knew that the adverse facts specified herein were being concealed from the public and that the positive represen- tations which were being made were then false and misleading. Thus, each of the American Pad Defendants is legally responsible for the falsifying of American Pad's reports, financial statements and releases as "group-published" information. 26. Defendants Bain Capital, Hanson, Gard, Benson, Lavine, Wolpow and Gay, by reason of their executive positions with American Pad, their Board membership and their ownership of American Pad stock, were controlling persons of American Pad and had the power and influence, and exercised the same, to cause American Pad to engage in the conduct complained of herein. Bain capital also controlled its employees, partners and agents, Benson, Lavine, Wolpow and Gay. 27. Defendants Morgan Stanley, Alex. Brown, Bankers Trust/BT Securities and First Boston are investment banking firms which specialize, inter alia, in underwriting public offerings of securities. These firms served as co-lead underwriters of American Pad's 7/2/96 IPO in which they sold millions of shares of American - 24 - ------------------------------------------------------------------------ Pad stock to the public at an artificially inflated price and for which they received a significant portion of the money raised in the IPO. Each of these firms was also a marketmaker in American Pad stock and subsequent to the IPO purchased and sold American Pad stock on a daily basis. To get the underwriting business for American Pad's IPO, Morgan Stanley, Alex. Brown, Bankers Trust/BT Securities and First Boston each agreed to participate in the scheme to inflate American Pad's stock, including promising to issue positive research reports on American Pad after, but in connection with, the IPO known as "booster shots," to help artificially inflate American Pad stock in the aftermarket, in part because they knew American Pad was planning a follow-on offering of stock or convertible debt securities to raise millions more in equity capital to further reduce its remaining LBO debt. Because of their close association with American Pad, the Underwriter Defendants had constant access to American Pad's internal corporate information, including the adverse information concealed by defendants. 28. Defendant Bankers Trust is a large New York-based bank providing lending, financial services and, through its subsidiary defendant BT Securities Corp., investment banking activities. In mid-97, Bankers Trust acquired Alex. Brown, which also now operates as a subsidiary of Bankers Trust. Bankers Trust had special access to and information about American Pad due to its unique relationship with American Pad as its financial advisor, lender and placement agent. One very lucrative part of Bankers Trust's business specializes in making highly leveraged loans whereby it makes and/or places very high interest rate (and high risk) loans, - 25 - ------------------------------------------------------------------------ often to finance leveraged buyouts. Bankers Trust provided over $230 million in loans and acted as placement agent, i.e., investment banker to sell some $200 million of American Pad's subordinated notes to institutional investors, to finance the payoff of American Pad's LBO debt and fund the Williamhouse acquisition. As part of making those loans and placing these notes it was agreed that a subsequent IPO of American Pad in 96 to raise millions of dollars to repay the loans by Bankers Trust would be undertaken. It was imperative to Bankers Trust that the American Pad LBO not fail, not only so that its own huge loans could be repaid and it could thus avoid a major loss, but also so that American Pad could pay off a portion of the subordinated notes placed by Bankers Trust and be recapitalized and placed in a position to pay off the balance of those outstanding notes, as a default on those notes by American Pad would be a terrible embarrassment to Bankers Trust and would hurt its lucrative highly leveraged financing business. DEFENDANTS' SCHEME TO DEFRAUD 29. Each defendant is liable for making false statements and concealing adverse facts, and selling American Pad shares at artificially inflated prices as a participant in a fraudulent scheme which: (i) deceived the investing public; (ii) facilitated the IPO and caused Class members to purchase American Pad stock at inflated prices; (iii) permitted American Pad and Bain Capital to sell over 16 million shares of American Pad stock to the public in the IPO, raising over $243 million; (iv) permitted the Underwriter Defendants to pocket the lion's share of $13.4 million in underwriting fees taken out of the IPO proceeds; (v) permitted - 26 - ------------------------------------------------------------------------ American Pad to repay some $173 million in bank debt and senior notes arranged by or owed to Bankers Trust/BT Securities; (vi) permitted Bain Capital to pocket millions in fees from American Pad, in addition to selling off 3.4 million shares of its American Pad stock in the IPO, while it reduced its ownership exposure to American Pad from 90% to 38%; and (vii) permitted Hanson and Gard to later sell 100,000 shares of their American Pad stock at inflated prices for $1.3 million in illegal insider-trading proceeds. 30. The defendants each had strong economic motives to inflate American Pad stock. By mid-95, American Pad's LBO was in financial distress. The only way for American Pad to survive and to salvage the LBO was to take American Pad public. An IPO would allow Bain Capital to "cash out" of its investment in American Pad, provide American Pad with the financial ability to pay millions in fees per year to Bain Capital going forward and raise cash to pay down American Pad's debt to Bankers Trust. Once having established a trading market in American Pad's stock, if American Pad's stock price could be pushed up and maintained at higher prices, American Pad could do a follow-on stock or convertible debt equity offering to further reduce its LBO debt, or American Pad could use its stock as currency to make acquisitions of other, more profitable companies. This plan to take American Pad public and raise millions of dollars from public investors was necessary because American Pad's controlling stockholder, i.e., Bain Capital, was not willing to make any additional investment in American Pad, due to the serious operating problems it faced. - 27 - ------------------------------------------------------------------------ 31. Prior to American Pad's IPO, the American Pad Defendants were "locked-in" an illiquid investment in a troubled company which could not even make a profit and could not repay its debt from its continuing business operations. Bankers Trust and made over $200 million in loans, which American Pad could not repay from its operations. However, the IPO cashed out Bain Capital (generating $49 million for it), boosted the book value of the 10+ million shares it continued to hold in American Pad by over $13 per share, and directly and indirectly generated almost $200 million for Bankers Trust/BT Securities to pay back its large loans. The American Pad Defendants sold some 16 million shares in the IPO, pocketing over $229 million in net proceeds, even though they knew that American Pad was falsifying its financial results and its IPO Prospectus was false as American Pad was then experiencing serious, undisclosed problems which adversely impacted American Pad's business and EPS growth prospects. 32. The artificial inflation of the trading price of American Pad stock was a key to defendants' scheme, as it: (a) permitted American Pad to raise $172.8 million in net proceeds from its IPO which enabled American Pad to pay down its huge debt to Bankers Trust, pay millions in fees to Bain Capital and refinance its bank credit agreement, then, using millions from that new credit agreement, to pay off more of its current loans to Bankers Trust, funneling out of or as a result of the IPO almost $200 million in total to repay Bankers Trust and to redeem notes arranged by Bankers Trust; (b) enabled Bain Capital to pocket $49 million by selling off 3.4 million shares of its, American Pad stock, while - 28 - ------------------------------------------------------------------------ boosting the book value of the 10 million shares it continued to own by $13-45 per share -- a $135 million windfall for it -- and to be paid millions in consulting/advisory fees by American Pad; and, (c) enabled Hanson and Gard to later each sell $650,000 worth of their own American Pad stock in the open market at artificially inflated prices, just a few weeks before the stock crashed by 50% when American Pad revealed it had suffered huge losses and accounting irregularities, to further profit from their deliberate and dishonest acts. 33. American Pad's controlling shareholders (Bain Capital, Hanson and Gard) personally profited from this fraudulent scheme. Bain Capital salvaged its investment in American Pad and the floundering LBO, but American Pad's $15 per share IPO also eliminated American Pad's negative ($66 million) shareholders' equity and replaced it with an $88.9 million positive shareholders' equity, raised enough cash to pay off the Bankers Trust debt which increased the book value of their American Pad stock from negative ($17.06) to ($3.61) -- a $13.45 per share increase or a $160 million windfall for Bain Capital, Hanson and Gard, who owned or had options to purchase some 12 million shares. 34. Bain Capital also wanted to take American Pad public to improve American Pad's financial condition so that American Pad would be able to pay millions of dollars to it for so-called "advisory fees," thus permitting Bain Capital to continue to plunder American Pad. According to American Pad's Proxy Statement: In October 1995, the Company entered into a ten-year Management Advisory Agreement (the "Advisory Agreement") with Bain Capital to replace Bain Capital's prior agreement with the Company. In connection with the Company's IPO, the Company and Bain Capital amended and - 29 - ------------------------------------------------------------------------ restated the Advisory Agreement to provide for an initial term of four years . . . . Under the Amended Advisory Agreement, the Company will pay Bain Capital an annual cash advisory fee of $2.25 million, plus out-of-pocket expenses . . . and a transaction fee in connection with the consummation of each acquisition, divestiture or financing by the Company or its subsidiaries in an amount equal to 1% of the aggregate value of such transaction. For the year ended December 31, 1996, the Company paid Bain Capital fees of $7,140,619, plus expenses of $225,706, under the Advisory Agreement. 35. In addition to their stock ownership and participation in the LBO, Hanson, Gard, McAleer and Benson each had other financial motives to bring about American Pad's IPO and falsify its financial results. The Compensation Committee of American Pad's Board -- which was composed of Gay and Wolpow (Bain Capital principals) -- authorized special one-time cash bonuses to them for completing the IPO -- Hanson got $116,500, Gard got $103,000 and Benson got $78,400. Also at the time of the IPO, these insiders got new employment contracts which substantially increased their salaries and provided that each of them was entitled to receive annual bonuses of 100% of their increased salaries but only if American Pad achieved certain annual net income targets. By falsifying American Pad's 96 results and falsifying American Pad's IPO Prospectus and participating in the false and misleading roadshow, these top insiders thus not only got their special one-time IPO "success" payments, but they also each received large year-end 96 bonuses as shown below, specifically because of the apparent excellent financial performance of American Pad in 96: NAME AND PRINCIPAL POSITION YEAR SALARY BONUS Charles G. Hanson, III 96 $407,239 $386,500 Chief Executive Officer 95 $250,000 Russell M. Gard 96 $360,905 $343,000 Chief Operating Officer 95 $225,000 - 30 - ------------------------------------------------------------------------ Kevin W. McAleer 96 $131,167 $141,000 Chief Financial Officer Gregory M. Benson 96 $210,000 $378,400 95 $175,000 These employment contracts also provided a motive for Hansen, Gard and McAleer to further falsify American Pad's 97 financial results, as they stood to receive 97 bonuses of 100% of their 97 salaries if they could make it appear that American Pad met its 97 EPS targets. 36. To accomplish their fraudulent scheme, American Pad's insiders worked closely with the Underwriter Defendants. After Bankers Trust helped recruit the Underwriter Defendants, Morgan Stanley, Alex. Brown, Bankers Trust/BT Securities and First Boston agreed they would help American Pad merchandise its common stock in the IPO by orchestrating "roadshows" in several cities to stimulate interest in the offering and assist in artificially inflating the price of American Pad shares subsequent to the IPO by having their analysts issue favorable research reports on American Pad after the IPO was completed. 37. However, before Morgan Stanley, Alex. Brown, Bankers Trust/BT Securities and First Boston would go along with this part of the fraudulent scheme, they extracted an illegal agreement from American Pad and Bain Capital that they would indemnify and hold them harmless from any liability under the federal securities laws. They also made certain that American Pad had purchased millions in directors' and officers' liability insurance. As American Pad and Bain capital were going to pocket over $234 million from the IPO, these proceeds, plus the directors' and officers' liability insurance coverage, would provide the Underwriter Defendants with a large financial buffer to protect them from any adverse - 31 - ------------------------------------------------------------------------ consequences of their illegal conduct, thus permitting them to participate in the fraudulent scheme with impunity. The Underwriter Defendants knew that American Pad and Bain Capital were going to get over $216 million from the IPO and that these funds, together with the directors' and officers' liability insurance they required American Pad to have to protect its officers and directors and American Pad's agreement to indemnify them, would provide the Underwriter Defendants with a large enough financial buffer to protect them from any adverse consequences of their illegal conduct, thus permitting them to directly and actively participate in the scheme with impunity. 38. The Underwriter Defendants were motivated to act as direct participants in the scheme by the prospect of earning millions of dollars in underwriting fees by selling American Pad's common stock at artificially inflated prices. Bankers Trust was especially motivated to complete the American Pad IPO and rescue the floundering LBO, as its loans to refinance the American Pad LBO (and Williamhouse acquisition) -- which totaled more than $230 million -- were very risky as American Pad could not repay those loans from its operations -- and could only repay them via the IPO. The Underwriter Defendants had the opportunity to commit the fraud complained of by virtue of their direct and active participation in the IPO process, the IPO roadshow, writing the IPO Prospectus, the drafting and dissemination of false and misleading analyst reports as detailed in this Complaint. 39. The Underwriter Defendants further sponsored the Company in the market after the IPO by having their securities analysts issue false favorable research reports on American Pad or make - 32 - ------------------------------------------------------------------------ other public statements about the Company to the financial press to help push American Pad's stock price higher and the Underwriter Defendants acted as marketmakers in American Pad stock after the IPO to help support the stock price. The Underwriter Defendants further orchestrated a multi-city roadshow prior to the IPO, during which they and certain of the Individual Defendants (Hanson, Gard and Benson) travelled to, inter alia, New York City, Boston, Chicago, San Francisco, San Diego and Los Angeles during late 6/96 and early 7/96 to meet with potential investors to present highly favorable information about the Company which was much more positive than that contained in the IPO Prospectus, including forecasts of strong revenue and profit growth through 97 and 98. 40. The Underwriter Defendants assisted American Pad in planning the IPO and purportedly conducted investigations into the business, operations, products and future business prospects of American Pad, known as a "due diligence" investigation, which was required of them in order to engage in the offering. During the course of their "due diligence," the Underwriter Defendants had continual access to confidential corporate information concerning American Pad's business, financial condition, products and future business plans and prospects. In addition to availing themselves of virtually unbridled access to internal corporate documents, the Underwriter Defendants also communicated with American Pad management, particularly Hanson, Gard, Benson and McAleer. As a result of those constant contacts and communications between the Underwriter Defendants' representatives and Hanson, Gard, Benson and McAleer, the Underwriter Defendants learned of American Pad's existing problems. - 33 - ------------------------------------------------------------------------ 41. As a consequence of their investigation and communica- tions with American Pad, the Underwriter Defendants (or their agents or counsel) met with representatives of American Pad, its accountants and counsel during the several months prior to the issuance of the 7/2/96 IPO Prospectus. During such meetings, including those known as "drafting sessions," representatives of the participants met to discuss the timing in terms of the offering and the contents of the Registration Statement and Prospectus, and devised, agreed upon and refined the actions necessary for the consummation of the offering. These parties, in part through their agents, discussed and reached understandings as to the timing and strategy to best accomplish the offering, the terms of the offering, the language to be used in the 7/2/96 Prospectus, what disclosures about American Pad would be made in the Prospectus, and what responses would be made to the SEC in connection with its review of the Registration Statement containing the Prospectus. 42. After the IPO, the Underwriter Defendants worked closely with Hanson, Gard, Benson and McAleer to publish highly positive internal advisories and public research reports concerning American Pad, creating the false impression that the restructuring of American Pad's business had proved highly successful, that American Pad had several competitive advantages and was now profitable and would achieve increasing revenues and EPS in 97 and 98, without disclosing the numerous problems which were then actually adversely impacting American Pad's business as more fully detailed in this Complaint. Based on the negative and adverse internal documents and reports of the Company's actual business performance, the Underwriter Defendants knew or recklessly disregarded that those - 34 - ------------------------------------------------------------------------ public statements, and those of their securities analysts for which they are responsible, were false and misleading when made and were inflating the price of American Pad's common stock. FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD 43. In order to generate investor interest in the American Pad IPO and sell the 15+ million shares of American Pad stock to be marketed, the defendants knew that a publicity campaign to distri- bute favorable information about American Pad's business and prospects was necessary. Thus, the Underwriter Defendants organized and scheduled a nationwide "roadshow" as detailed in ¶¶44-45. 44. During the roadshow presentations and in connection with American Pad's IPO, Hanson, Benson and Gard in the presence of representatives of the Underwriter Defendants stated: • Due to the restructuring of American Pad's business, the Williamhouse acquisition and changes in the distribution of office paper products, American Pad was now a growth company in a growth industry. • The office products distribution channel was undergoing a major consolidation into larger superstore outlets. American Pad was organized and uniquely positioned to capitalize on this trend. This would enable it to gain market share and achieve strong revenue and EPS growth over the next several years. • American Pad was uniquely well positioned to increase its sales to office superstores, one of the most important and rapidly growing segments of the office products industry. • American Pad had de-emphasized the commodity nature and portion of its business by introducing new, value-added products which carried higher, more profitable prices and would contribute to strong revenue and EPS growth over the next several years. • American Pad would make several accretive acquisitions over the next few years which would contribute to strong profitable growth. - 35 - ------------------------------------------------------------------------ • American Pad had implemented sophisticated cost control and accounting systems, which enabled it to effectively control its inventory levels and expense so that it would achieve profit gains that exceeded its revenue growth. • The Williamhouse acquisition was a tremendous success and was already being integrated into American Pad and was performing better than expected, resulting in substantial synergies and cost savings. • American Pad had competitive strengths and advantages, including purchasing advantages, which enabled it to secure lower prices for raw materials, which benefited its profitability. • American Pad had successfully implemented a pricing strategy to shield its gross dollar margins from the pricing volatility traditionally present in the paper business. This would enable American Pad to maintain its profit margins in the face of paper price increases or decreases going forward. • American Pad had achieved strong operating momentum which would lead to substantial revenue growth in the next several years. • American Pad expected 30% EPS growth in 97 and 98 and at least 20% ongoing EPS growth thereafter. These representations affected the demand for and the price of American Pad's stock on the IPO. 45. In the 30 days prior to the IPO and as part of the roadshow, Hanson, Bain Capital, Gard and representatives of the Underwriter Defendants visited privately with certain institutional investors to "pitch" American Pad stock to them in connection with the IPO, making the same presentations to them as set forth above. These institutional investors -- who later purchased American Pad stock in the IPO -- included: Number Shares Institution Purchased ----------- ------------- J. & W. SELIGMAN & CO., INC. 2,196,079 FIDELITY MANAGEMENT & RESEARCH 2,031,000 T. ROWE PRICE ASSOCIATES, INC. 1,662,500 MASSACHUSETTS FINANCIAL SERVICE 950,000 LAZARD FRERES ASSET MANAGEMENT 750,000 OPPENHEIMERFUNDS INC. 679,300 - 36 - ------------------------------------------------------------------------ EDGEMONT ASSET MANAGEMENT CORP 600,000 MORGAN GUARANTY TRUST COMPANY 525,800 PROVIDENT INVESTMENT COUNSEL INC. 503,800 TRAVELERS INVESTMENT MANAGEMENT 375,364 NICHOLAS-APPLEGATE CAPITAL MGMT 350,000 FOUNDERS ASSET MANAGEMENT, INC. 334,075 TRAINER WORTHAM & COMPANY, INC. 308,600 PUTNAM INVESTMENT MANAGEMENT 300,950 46. As a result of strong investor interest in the American Pad IPO generated by the roadshow presentation and other marketing efforts of the defendants, on 7/2/96 American Pad went public, selling 15,625,000 shares at $15 per share. American Pad sold 12.5 million shares and Bain Capital sold 3,467,148 shares (including over-allotment shares). American Pad netted $172.8 million. Bain Capital netted $49 million. The underwriters got almost $1 per share -- $13.4 million of the IPO proceeds -- for helping to pull off the IPO. American Pad's share of the IPO proceeds were used, inter alia, to pay off the huge Bankers Trust debt and pay fees to Bain Capital. 47. While the Prospectus showed that American Pad had lost $7.5 million and $14.6 million in 94 and 95 from its "historical operations," the Prospectus also presented American Pad as now being profitable on a "pro forma" basis, i.e., giving effect to the financial results of certain companies American Pad had recently acquired, the most important of which was Williamhouse: - 37 - ------------------------------------------------------------------------ Year Ended 12/31 Three Months Ended 3/31 Historical Pro Forma Historical Pro Forma 1994 1995 1995 1996 1996 ------------------------------------------------------------- (in thousands, except (unaudited) per share amounts) Income statement data: Net sales $120,443 $259,341 $617,167 $121,416 $149,735 Income (loss) from operations ($3,566) $ 1,350 $ 57,493 $ 12,503 $ 14,162 Net income (loss) ($7,548) ($14,686) $ 16,723 $ 128 $ 3,883 (Loss) per share ($.91) $.56 $.01 $.13 The Prospectus thus indicated that American Pad's business was profitable on an ongoing basis and had made a profit in the 1stQ 96. The Prospectus represented that these results fairly presented American Pad's results in conformity with Generally Accepted Accounting Principles ("GAAP"). 48. The Prospectus, while containing a list of "boilerplate" risk factors normally placed in IPO prospectuses today by underwriters and lawyers involved in the IPO process, was extremely positive about American Pad's business and its future growth, indicating that the Company had competitive advantages and was well positioned to implement a growth strategy which would lead to greater profitability than in the past, regardless of fluctuations in paper prices. The Prospectus stated: The Company is one of the largest manufacturers and marketers of paper-based office products . . . in the $60 billion to $70 billion North American office products industry. The Company offers a broad product line including nationally branded and private label writing pads, file folders, envelopes and other office products. Through its Ampad division, the Company is among the largest and most important suppliers of pads and other paper-based writing products, filing supplies and envelopes to many of the largest and fastest growing office products distributors. Acquired in October 1995, the Company's Williamhouse division is the leading supplier of mill branded, specialty and commodity envelopes to paper merchants/distributors. The Company's strategy is to grow by focusing on the largest and fastest growing office product distribution channels, - 38 - ------------------------------------------------------------------------ making acquisitions, introducing new product lines, broadening product distribution across its channels and maintaining its position among the lowest-cost manufacturers in the industry. . . . Since the mid-1980s, the office products industry has experienced significant changes in the channels through which office products are distributed such as the emergence of new channels, including national office products superstores, national contract stationers and mass merchandisers, and consolidation within these and other channels. . . . The Company has targeted and will continue to target those customers driving consolidation in the retail, commercial and paper merchant distribution channels and believes that it is uniquely positioned to meet the special requirements of these customers. . . . Furthermore, as these customers continue to grow and as they consolidate their supplier bases, the Company's ability to meet their special requirements becomes an increasingly important competitive advantage. . . . Competitive Strengths The combination of the Company's products, customers and national scale distinguishes it as a leading manufacturer and marketer of paper-based office products (excluding computer forms and copy paper) in North America. The Company attributes this position and its continued opportunities for growth and profitability to the following competitive strengths. Market Leader. The Company has achieved market leadership in core products sold to customers in the largest and fastest growing office products channels by offering one of the broadest assortments of high quality products in the industry. . . . Well-Positioned and Diversified Customer Base. The Company has substantial opportunities for growth within several distribution channels of the office products industry. The Company has focused on the largest and fastest growing office products channels. . . . The Company's Williamhouse division maintains particularly strong relationships with the largest and fastest growing paper merchants/ distributors in the market . . . . The Company also maintains strong customer relationships across all of the other office products distribution channels, including mass merchandisers, warehouse clubs, office products wholesalers and independent dealers. - 39 - ------------------------------------------------------------------------ National Scale and Service Capability. The Company's extensive product line, multiple brands and broad price point coverage provide significant advantages and economies of sale in selling to and servicing its customers. . . . * * * Innovation/New Products. The Company has introduced several innovative products as part of its marketing strategy to differentiate itself from other suppliers and enhance profitability. . . . The Company's brand recognition and presence with its national customers allows it to more easily introduce new or acquired product lines to those customers. Low-Cost Manufacturer. The Company believes it is among the lowest-cost manufacturers of paper-based office products in the industry. The Company ensures its low-cost manufacturing position through its paper purchasing and distribution advantages as well as its maintenance of modern and efficient manufacturing technology and a high quality workforce. . . . Purchasing Advantages. The Company has strong relationships with most of the country's largest paper mills . . . These relationships afford the Company certain paper purchasing advantages, including . . . favorable pricing arrangements. Proven Management Team With Successful Track Record. The Company's senior operating management team averages over 25 years each in the paper products industry. Management has succeeded in increasing sales and operating profitability by recognizing and acting on the transition to the fastest growing distribution channels, introducing higher value-added products . . . . Growth Strategy The Company's strategy is to maintain and strengthen its leadership position by focusing on the following: Focus on Rapidly Growing Customers. The Company serves many of the largest and best positioned customers in the office products market segment including national office products superstores, mass merchandisers and warehouse clubs, national contract stationers and national paper merchants/distributors. . . . Anticipating further consolidation in the office products industry, the Company expects that its national scope and broad - 40 - ------------------------------------------------------------------------ product line will be increasingly important in meeting the needs of its customers . . . . Continue to Introduce New Products. New, higher value-added products give the Company a greater selection to offer its customers and improve product line profitability for both the Company and its customers. The Company plans to differentiate itself from other suppliers and improve profitability through product innovation, differentiation and line extensions. Pursue Complementary Product Line and Strategic Acquisitions. The office products industry is highly fragmented despite continuing consolidation among its manufacturers. . . . The Company believes that there are significant opportunities to acquire companies in both its existing and complementary product lines. In addition, the Company intends to enter new office products markets through acquisitions of established companies in those markets. Broaden Product Distribution. The Company's market presence and distribution strengths uniquely position it to sell new or acquired product lines across its distribution channels, including national office products superstores, national contract stationers, office product wholesalers and mass merchandisers. As an important part of its growth strategy, for example, the Company has successfully introduced the envelope product lines acquired in the [Williamhouse] Acquisition, previously distributed primarily through paper merchants/distributors, to the Ampad division's distribution channels under the Ampad and private label names. The company estimates that this market opportunity is approximately $350 million in annual net sales. Continue to Reduce Costs. The Company has identified and is in the process of implementing cost reductions in connection with the Acquisition that are expected to result in approximately $7.4 million of annualized cost savings. In addition, management plans to implement further identified cost reductions beyond 1996. 49. Elsewhere, the IPO Prospectus presented American Pad as a restructured company whose previous losses were not representa- tive of its future results and represented that it had now - 41 - ------------------------------------------------------------------------ successfully protected its profitability against fluctuations in paper prices: The Company believes that its future operating results will not be directly comparable to its historical operating results because of its strategic acquisitions and the expected cost savings from integration of the [Williamhouse] Acquisition. * * * Paper Prices. Paper represents a majority of the Company's cost of goods sold. While paper prices have increased by an average of less than 1% annually since 1989, certain commodity grades have shown considerable price volatility during that period. This volatility negatively impacted the Company's earnings in 1994, particularly in the fourth quarter, as a result of the company's inability to implement price changes in many of its product lines without giving its customers advance notification. Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. The Company believes that it is now able to price its products so as to minimize the impact of price volatility on dollar margins. In addition, as a result of acquisitions and new product introductions, the Company offers a broader and more diverse product mix which is less susceptible to paper price fluctuations. 50. The positive representations and statements made about American Pad by the defendants in the Prospectus and in the pre-IPO roadshow and private presentations to institutional investors, as pleaded in ¶¶44-49, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations; thus its business remained as exposed as ever to the adverse impact of such price - 42 - ------------------------------------------------------------------------ fluctuations, which American Pad was concealing by manipulating and falsifying its financial statements, including its cost of goods sold as detailed in ¶116-138; (b) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products; its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had not succeeded; (c) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers; thus it was continuing to be exposed to all the negative forces present in a highly competitive commodity product business, including sever price competition and the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; (d) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, appeared to be meeting those goals by manipulating and falsifying its financial statements as detailed in ¶¶116-138; (e) That during 96, American Pad's core operations and profitability were being adversely affected by paper price declines which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being disguised by American Pad's manipulation and - 43 - ------------------------------------------------------------------------ falsification of its cost of sales calculations, especially in its Williamhouse Division as detailed in ¶¶116-138; (f) That American Pad's financial statements in the Prospectus, including its 1stQ 96 results, were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (g) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions; in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (h) That the ongoing consolidation of the office products retail channel into larger superstores was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was increasingly negatively impacted due to the sophisticated inventory management practices of the larger retail stores which reduced their inventory carry; (i) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive advantages, including purchasing advantages over major competitors in that marketplace; (j) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those - 44 - ------------------------------------------------------------------------ products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the deliberate manipulation of Williamhouse's cost of sales as detailed in ¶¶116-138; (k) That American Pad's core Ampad paper products business was suffering from persistently weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (l) That American Pad's acquisition pipeline was not full nor was the Company actively pursuing any significant number of acquisitions which it had a reasonable probability of completing in the foreseeable future as, in fact, due to the increasingly serious internal business problems of American Pad, its executives had neither the time nor the ability to pursue significant acquisitions in the near term; (m) That as a result of the foregoing negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the earnings growth forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (n) That as a result of the foregoing negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew the forecasts of 20% EPS growth for American Pad over the next three-five years were false and misleading when made, as such EPS growth could not be achieved by American Pad. - 45 - ------------------------------------------------------------------------ 51. On 7/29/96, American Pad reported its 2ndQ 96 results -- sales of $114 million, net income of $691,000 and EPS of $0.02 (before extraordinary item) and pro forma sales of $140 million, net income of $5.1 million and EPS of $.17. American Pad's release referenced "the successful acquisition of Williamhouse" and stated: "We are very pleased with the strong sales and earnings growth," said Charles G. Hanson, III, the company's chairman and chief executive officer. "We achieved our profitability goals and are on target with new product introductions and market penetration to our fast growing key customers: national contract station- ers, office supply super stores, mass merchants and paper merchants. Our costs savings programs continue to yield results." American Pad included these financial results in its 2ndQ 96 Form 10-Q later filed with the SEC and signed by McAleer. 52. On 7/29-30/96, American Pad's top executives had conversations with large American Pad shareholders, money and portfolio managers, securities analysts, brokers and stock traders to discuss its 2ndQ 96 results. During those conversations, Hanson, Benson and McAleer stated: • American Pad's financial results were on plan due to strong demand for its products and American Pad's tight cost controls. American Pad's business momentum was strong. • The growth of the superstore retail office products distribution channel was a very positive development for American Pad and American Pad was uniquely well-positioned with competitive advantages to benefit from this important industry trend. • American Pad had identified several potential accretive acquisitions which it would complete during the next few years and which would help boost its EPS growth rate going forward. • The Williamhouse acquisition had been a tremendous success. Williamhouse (and Niagara) were being successfully integrated into American Pad's business and important synergies and cost savings were being realized. - 46 - ------------------------------------------------------------------------ • Williamhouse sales were growing strongly, which was boosting Williamhouse's profitability as its operating costs were being reduced at the same time. • American Pad was continuing to successfully introduce distinctive new innovative value-added products which were helping to boost its profits. • American Pad had successfully implemented its new pricing strategy which would shield its earnings from the volatility of paper prices. In fact, American Pad had achieved its outstanding 2ndQ 96 results in the face of paper price volatility because of this new and successful pricing strategy. • American Pad's special relationships with paper mills continued to provide it with important purchasing advantages. • American Pad was forecasting 97 EPS of $1.30-$1.40 and a 20%-30% EPS growth rate after that. 53. Shortly following American Pad's IPO, the Underwriter Defendants began to flood the market with extremely positive reports on American Pad, which were issued in connection with American Pad's IPO. These reports are known as "booster shots" in the securities business and were reports with which to get the IPO underwriting business which the Underwriter Defendants had promised the American Pad Defendants they would issue to help push American Pad's stock price higher in the aftermarket. 54. For instance, on 8/7/96 Alex. Brown issued a "booster shot" report on American Pad, written by Christopher Vroom, in connection with the IPO with a "strong buy" recommendation. Prior to issuing this report, Vroom had discussions with Hanson, Benson and/or McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by American Pad from Hanson, Benson and McAleer and this report was based on and repeated information provided him by them in the 7/29-30/96 conversations and other discussions with them - 47 - ------------------------------------------------------------------------ during the IPO process, including the roadshow presentations. Vroom provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could review it for accuracy. They reviewed the report before it was issued and assured Vroom it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. This report forecast 97 EPS of $1.33 and a three-five year EPS growth rate of 20% for American Pad, stressing the Company's "long-term growth prospects" and "above-trendline near-term earnings momentum." The report stated: Management has established an enviable track record of solid sales and earnings gains both through internal growth and intelligent acquisitions and we see the changes that are unfolding within the retail channel driving continued strong gains through the end of this decade. * * * • Innovative marketing and merchandising have positioned the Company well to grow with the rapidly expanding superstore and contract stationer segments. • Strategic acquisitions serve to expand and augment the product line while helping drive substantial cost leverage. • Solid revenue gains and expense leverage are expected to drive better than 40% net income growth in FY 1996; close to 30% gains in both FY 1997 and FY 1998. • Longer-term, we believe better than 20% compound annual EPS growth is sustainable. • Given the Company's strong growth prospects, we find these shares extremely attractive . . . and recommend current purchase. AMERICAN PAD & PAPER IS POISED TO GROW WITH THE OFFICE PRODUCT INDUSTRY -- ONE OF THE MOST ATTRACTIVE SEGMENTS WE COVER. The office products segment, estimated to be a $90-100 billion segment at retail, continues to experience rapid consolidation as a handful of highly efficient operators (office product superstore retailers, contract stationers and mail order operators) - 48 - ------------------------------------------------------------------------ take share from the great majority of inefficient operators in this highly fragmented segment. The top five operators account for under 17% of industry revenues at retail in 1995; we believe 50-60% of the U.S. market will eventually come to be controlled by a small number of operators. Revenues of the leading office product superstore (OPS) retailers and contract stationers are estimated to expand at a CAGR of 20-25% over the next several years. As a key supplier to many of the leading operators in this segment, AP&P is poised to grow with these leaders . . . . INNOVATIVE MERCHANDISING AND MARKETING MAKE INCREASED PENETRATION LIKELY. Recognizing the powerful growth in the channels, AP&P's management began several years ago to aggressively target and cultivate relation- ships with the leading operators. Value-added products have been developed with input from the Company's largest clients, resulting in a number of differentiated, high- quality items that suit the needs of the retailer. . . . STRATEGIC ACQUISITIONS EXPAND THE OFFER. AP&P has made 5 acquisitions since 1992, which have afforded it a greater number of products and brands, increased manufacturing capacity and greater access to customers, in some case. Expanding and augmenting the product line is critically important to AP&P's approach, especially given the widening end-user demand for single-source supply. The most significant of the acquisitions was the October 1995 addition of Williamhouse, marking the Company's entry into the envelope business. The June 1996 acquisition of Niagara, also an envelope manufacturer, set the stage for operating improvements and increased scale and distribution capabilities in that product line. The Company . . . expects envelopes to make an important contribution to increased penetration at retail in 1996. We expect AP&P to continue to be active on the acquisition front, having identified at least 30 potential candidates. . . . SOLID REVENUE GAINS AND EARNINGS GROWTH FUEL OUR EXPECTATION FOR EPS TO GROW AT A 20% CAGR FOR SEVERAL YEARS TO COME. In 1996, we expect . . . net income growth of greater than 40% before special charges related to early extinguishment of debt. In 1997 and 1998, we anticipate EPS growth exceeding 30% and 20%, respectively, fueled by top-line growth of 12-13%. Longer term, we believe compound annual earnings growth of 20% is sustainable. Expense leverage will help drive the gains as recent acquisitions come to be operated more efficiently and revenues grow. . . . Moreover, management has been successful in implementing a pricing strategy to shield earnings from the volatility characteristic of the paper business. - 49 - ------------------------------------------------------------------------ Thus, in the just-ended 2Q 1996, despite volatile paper prices, gross profit dollars were well-managed and came in on plan. 55. On 8/16/96, in connection with American Pad's IPO, First Boston issued a "booster shot" report on American Pad, written by Martin Romm. Prior to issuing this report, Romm had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by American Pad from Hanson, Benson and McAleer and this report was based on and repeated information provided him by them, in the 7/29-30/96 conversations and other discussions with them during the IPO process, including the roadshow presentations. Romm provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could review it for accuracy. They reviewed the report before it was issued and assured Romm it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report called American Pad a "growth story within a growth industry" and forecast 97 EPS of $1.40, a three-year EPS growth rate of 30% for American Pad, and stated: We are initiating coverage of American Pad & Paper Company . . . . Since AGP's formation approximately four years ago, the company has emerged as a market leader with a diversified product line positioned to grow within the office products business. We believe that AGP is capable of showing rapid earnings growth as it focuses on expanding market share in the mass merchandisers, office superstores and contract stationers. . . . American Pad & Paper not only maintained strong relationships with its customers but also has conducted with the largest paper mills in the U.S. which has afforded it purchasing advantages. . . . - 50 - ------------------------------------------------------------------------ TARGETED GROWTH STRATEGY . . . AGP's growth strategy to drive revenues and enhance earnings growth encompasses five principle areas. These include: growth from rapidly expanding customers; expansion of its product line through high value- added products; pursuit of strategic acquisitions, particularly of complimentary products; expansion of market share; and cost reductions to enhance earnings. The execution of this growth strategy, in our view, should result in a substantially larger revenue base that will grow through a combination of internal expansion and supplemented by acquisitions. Earnings should increase significantly in the next several years as AGP integrates recent acquisitions . . . . * * * Since the IPO of American Pad & Paper on July 2, the company reported strong second quarter earnings results which we believe should give investors confidence that AGP has maintained excellent operating momentum leading into the second half of the year. The company is tracking with our 1996 full year estimates. Our projections call for earnings of $1.00 per share in 1996 . . . . Further, as the company gears up to increase its market share in the envelope business as well as grow with the mass merchandisers, we believe that 1997 should shape up as another year of significant progress in both revenues . . . and earnings per share. Our projections call for 1997 earnings per share of $1.40 on revenues of $769.5 million . . . . Accordingly, we believe that AGP is a growth story within a growth industry. The company is uniquely positioned to be the primary source of paper based products to the office product market. With the company's production and distribution scale, AGP is positioned to be the preferred supplier of its core products. 56. On 8/23/96, Bankers Trust/BT Securities issued a "booster shot" report on American Pad written by P.M. Iossa, which was issued in connection with the American Pad IPO. Prior to issuing - 51 - ------------------------------------------------------------------------ this report, Iossa had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Iossa from Hanson, Benson and McAleer and this report was based on and repeated information provided him by them in those conversations, the 7/29-30/96 conversations and also in the pre-IPO roadshow. Iossa provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could review it for accuracy. Hanson, Benson and McAleer reviewed the report before it was issued and assured Iossa it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report recommended purchase of American Pad securities and stated: American Pad & Paper Company ("APP") has undertaken several initiatives in the past twelve months. . . . With these changes, the Company has de-levered consider- ably and solidified its position as a market leader in the envelope and paper office products industry. . . . . . . Synergies from the acquisitions have begun to contribute to performance and are expected to continue going forward. In addition, new products continue to increase top-line growth. * * * APP has focused its business primarily on the office products channels, i.e., superstores . . . . These markets have had the greatest growth rates in recent years . . . . In addition, the number of office product distributors has declined almost 50% since 1989. The consolidation that has occurred among companies in this segment has created great opportunities for APP. These large retailers require vendors who provide multiple product lines and maintain a national presence. Centralized, electronic ordering systems and efficient national distribution allows the superstores to simplify ordering and minimize their costs. Strength in each of these areas allows APP to be a market leader. * * * - 52 - ------------------------------------------------------------------------ Key considerations * Cost savings implemented At the time of the WH [Williamhouse] acquisition, APP had identified approximately $7.4MM of cost savings relating to SG&A activities. . . . All of the savings that were identified at that time, which are estimated to be annual amounts, have been implemented. * * * One of the main drivers of APP's purchase of WH was that WH could benefit from cross-selling envelopes to Ampad's customers. . . . At the time of the acquisition, the firm had estimated that as a result of these sales, WH could generate additional revenues of approximately $40MM at full run rate; this has already reached $50MM. Additionally, the increased sales allow WH to lower its manufacturing costs by running its plants more efficiently. 57. On 8/28/96, Morgan Stanley issued a report on American Pad. Prior to issuing this report, analyst R.F. Runkle had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Runkle from Hanson, Benson and McAleer and this report was based on and repeated information provided her by them, both in those discussions and during the pre-IPO roadshow. Runkle provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could review it for accuracy. Hanson, Benson and McAleer reviewed the report before it was issued and assured Runkle it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report forecast 97 EPS of $1.36, 4thQ 96 EPS of $.40, and a five-year EPS growth rate of 20+% for American Pad. The report also stated: - 53 - ------------------------------------------------------------------------ The company is ideally positioned, we believe, to benefit from the fastest growing distribution channels -- namely, retail and contract stationers. . . . We forecast sustainable five-year internally generated earnings growth of 20-25%, with earnings rising from $22 million in 1995 to $31 million, $40 million, and $50 million in 1996, 1997, and 1998, respectively. . . . At the revenue line, we believe AGP can grow between 12% and 14% internally as it continues to introduce innova- tive new products and leverage existing ones into the fast-growing retail and contract stationer channels. * * * Market Leader with Broad Product Offering AGP is a market leader and is the only national supplier (manufacturer) of a broad range of paper-based office products. AGP is one of the largest suppliers of writing products and is one of the top three providers of filing supplies. In addition, as a result of the Williamhouse (1995) and Niagara (1996) acquisitions, the company now has the No. 1 position in envelopes sold through the paper merchant channel, as well as an emerging retail envelope business. * * * New Products + Innovation = Margin The ability to provide new, innovative products is another competitive advantage in this rapidly consoli- dating industry, we believe. * * * Cost Control at All Levels Is Key . . . AGP also enjoys purchasing and distribution cost advantages due to its scale of the acquired company, improving AGP's operating efficiencies. On the purchasing front, AGP management has been doing business with several of the nation's largest paper mills for decades. The company is one of the largest purchasers of the principal paper grades in the U.S. Although these relationships are not contractual, to date they have provided the Company with such purchasing advantages as stable supply in tight markets and favorable pricing arrangements. * * * "A" Is for Accretive Acquisitions - 54 - ------------------------------------------------------------------------ . . . [W]e believe acquisitions are likely to remain a significant part of AGP's growth potential. Experienced and Insightful Management Team CEO Charles Hanson and COO Russ Gard each have more than 30 years of industry experience. Since purchasing AGP in 1992, this team, along with Bain Capital, has increased sales and net income dramatically through internal growth and several successful acquisitions. . . . [W]e expect it to continue to demonstrate its savvy over the next several years. * * * Exposure to Paper Prices AGP's principal raw material is paper, averaging about 50% of cost of goods sold in any given year. Since 1989, paper price increases averaged less than 1% annually -- however, prices on several grades, specifi- cally commodity, have fluctuated considerably during that time frame. In 1994, price volatility negatively affected the company's earnings, as it was unable to pass changes in paper prices through to its customers in a timely manner. Beginning in 1995, however, the company implemented a pricing policy that enabled it to set prices of its product consistent with the prevailing market price of paper at time of shipment. To date, this policy has been accepted by its customers and has allowed the company to manage its margin dollar in a fluctuating pricing environment. * * * Financial Projections * * * Beyond 1996, our forecast calls for net revenue growth of 12-14% over the next several years . . . . * * * . . . Translates into Significant Earnings Growth Coupled with the IPO deleveraging, improved operations should result in impressive earnings and earnings per share growth over the next several years. For 1996, we forecast pro forma net income growth of 41%, to $30.6 million. For 1997 and 1998, we project growth of 31.2%, $40.1 million, and 25.9%, to $50.5 million, respectively. - 55 - ------------------------------------------------------------------------ 58. The positive representations and statements made about American Pad by the defendants between 7/29/96 and 8/28/96, as pleaded in ¶¶51-57, were each known to be, or were recklessly disregarded by defendant as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations and thus its business remained as exposed as ever to the adverse profit margin impact of such price fluctuations, but American Pad was concealing this by manipulating and falsifying its financial statements, including its cost of goods sold as detailed in ¶¶116-138; (b) During 96, American Pad's core operations and profitability were being adversely affected by price cuts which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being disguised by American Pad's manipulation and falsification of its cost of sales calculations, especially in its Williamhouse Division, as detailed in ¶116-138; (c) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products, as its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had failed; - 56 - ------------------------------------------------------------------------ (d) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive advantages, including purchasing advantages, over major competitors in that marketplace; (e) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers and thus was continuing to be exposed to all the negative forces present in a highly competitive commodity product business, including the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; (f) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, was apparently meeting those goals by manipulating and falsifying its financial statements as detailed in ¶116-138; (g) That American Pad's 1stQ and 2ndQ 96 financial statements were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (h) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; - 57 - ------------------------------------------------------------------------ (i) That the ongoing consolidation of the office products retail channel into larger superstores was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was increasingly negatively impacted due to the sophisticated inventory management practices which the larger retail stores were able to bring to their businesses and which reduced their inventory carry; (j) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which was being concealed by the deliberate manipulation of Williamhouse cost of sales as detailed in ¶¶116- 138. (k) That American Pad's core Ampad paper products business was suffering from weak demand and sell through at the retail level, and its actual results were persistently weak and below American Pad's internal budgets or forecasts; (l) That American Pad's acquisition pipeline was not full nor was it actively pursuing a number of acquisitions which had a reasonable probability of completion in the foreseeable future as, in fact, due to the increasingly serious internal business problems of American Pad, its executives had neither the time nor the ability to pursue significant acquisitions in the near-term; - 58 - ------------------------------------------------------------------------ (m) That as a result of the foregoing negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the 97 EPS forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (n) That as a result of the foregoing negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew their forecasts of 20% EPS, growth for American Pad over the next three-five years were false when made, as such EPS growth could not be achieved by American Pad. 59. On 9/4/96, Staples and Office Depot, two of American Pad's largest customers, announced they would merge. This created some uncertainty regarding American Pad's business as it was a supplier to both of these companies, and some members of the investment community feared this could hurt American Pad's growth. In order to reassure analysts, investors and the market that this was not an adverse development for American Pad, but rather a positive development, Hanson, Benson and McAleer had discussions with analysts on 9/4 and 9/5/96 during which they told them: • The merger was a very positive development for American Pad. • The merger would strengthen American Pad's competitive position as it was uniquely positioned to sell to and service these superstores. • American Pad was reaffirming its EPS forecasts for 96-97. 60. On 9/5/96, Morgan Stanley issued a report on American Pad, written by Runkle, which again forecast 96 and 97 EPS of $1.03 and $1.36, 4thQ 96 EPS of $.40 and a five-year EPS growth rate of - 59 - ------------------------------------------------------------------------ 20+%, for American Pad. Prior to issuing this report, Runkle had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Runkle from Hanson, Benson and McAleer and this report was based on and repeated information provided her by them. The report stated: -- Two of American Pad & Paper's largest retail/ contract stationer customers, Staples and Office Depot, announced a definitive agreement to merge yesterday morning. -- While no one knows how specific merger-related issues will pan out for American Pad & Paper -- the merger is a positive event for the company, in our opinion. -- While increased pricing pressure is a possibility, we continue to believe AGP's high-quality and service capabilities will drive its growth. In fact, the merger presents AGP an opportunity to increase its product penetration and also increases the company's relative competitiveness, in our opinion. * * * -- Given AGP's strong competitive position, superior execution, and Potential for continued growth, we believe the shares of AGP will outperform the market over the next 12 months. 61. On 9/27/96, Morgan Stanley issued another report on American Pad, written by Runkle, which continued to forecast 96 and 97 EPS of $1.03 and $1.36, 4thQ 96 EPS of $.40 and a five-year EPS growth rate of 20+%, for American Pad. Prior to issuing this report, Runkle had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Runkle from Hanson, Benson and McAleer. The report stated: -- . . . We recently spoke with management . . . our confidence in the feasibility of AGP's strategy and in management's ability to execute continues to grow. We - 60 - ------------------------------------------------------------------------ believe new retail envelope sales and additional acquisitions are likely over the next six-months and we remain comfortable with our recommendation. -- We are keeping our 1996 EPS estimate of $1.03 . . . and our 1997 estimate of $1.36 . . . . 62. On 9/27/96, Alex. Brown issued a report on American Pad, written by Vroom, entitled "BUY THIS STOCK TODAY." Prior to issuing this report, Vroom had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Vroom from Hanson, Benson and McAleer and this report was based on and repeated information provided him by them. Vroom provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could review it for accuracy. Hanson, Benson and McAleer reviewed the report before it was issued and assured Vroom it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report forecast 96, 97 and 98 EPS of $1.02, and $1.33 and $1.70, including 4thQ 96 EPS of $.43 for American Pad. The report also stated: Our enthusiasm for the Company rests on our conviction that AP&P's management has established a firm basis for driving exceptional internal growth while benefiting from the consolidation of the vendor channel through judicious acquisitions. We like the stock too, [with] our 1997 EPS estimate despite 20% long-term growth and greater projected near-term gains. We think that increased investor awareness of the Company's solid story and favorable fundamental developments regarding acquisitions will help drive these shares higher and thus we recommend prompt new commitments to the stock. . . . HIGHLIGHTS -- CURRENT BUSINESS MOMENTUM REMAINS STRONG. - 61 - ------------------------------------------------------------------------ -- STAPLES/OFFICE DEPOT MERGER SHOULD BENEFIT AP&P WHILE SPURRING CONSOLIDATION WITHIN THE VENDOR CHANNEL OF THE OFFICE PRODUCTS INDUSTRY. -- ACQUISITIONS INCREASE THE POTENTIAL FOR UPSIDE EARNINGS SURPRISE IN 1997. -- EARNINGS PROGRESSION IS SOLID. * * * ANALYSIS: CURRENT BUSINESS MOMENTUM IS STRONG. Management has made excellent progress at broadening the offer through both discount store and superstore segments and has increased penetration on items such as file folders and envelopes . . . . [W]e nevertheless expect accelerating sales momentum through the 2H. AP&P IS POSITIONED TO BE A BENEFICIARY OF THE MASSIVE CONSOLIDATION AT RETAIL. We see an important opportunity for AP&P to pick up additional market share through the merger of the two superstore leaders. . . . Thus, while many see the SPLS/ODP merger as negative for AP&P, we point out that this Company was formed precisely to benefit from increased concentration. ACQUISITIONS WOULD PROMPT REVISION TO OUR EARNINGS PROJECTIONS. AP&P management has done an excellent job acquiring and integrating other office products manufac- turers and we sense heightened urgency with respect to the acquisition process. We expect these potential purchases to be accretive to earnings and none are reflected in our 1997 forecast. 63. On 10/22/96, Alex. Brown issued another report on American Pad, written by Vroom, which repeated the forecasts for American Pad contained in its 9/27/96 report and again stated "BUY THIS STOCK TODAY." Prior to issuing this report, Vroom had discussions with Hanson, Benson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Vroom from Hanson, Benson and McAleer and this report was based on and repeated information provided him by them. Vroom provided a draft of this report to Hanson, Benson and McAleer before it was issued so they could - 62 - ------------------------------------------------------------------------ review it for accuracy. Hanson, Benson and McAleer reviewed the report before it was issued and assured Vroom it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. This report stated: Contrary to recent investor concerns, we view the ongoing consolidation of the office products industry as quite positive for sophisticated, national manufacturers such as American Pad and Paper (AP&P). In fact, we see American Pad & Paper as benefiting from increased concen- tration at retail. This Company was formed specifically to take advantage of such industry dynamics . . . . Our enthusiasm for the Company rests on our conviction that American Pad & Paper's management has established a firm basis for driving internal growth . . . . We think that increased investor awareness of the Company's solid story and favorable fundamental developments regarding acquisitions will help drive these shares higher . . . . * * * • Current business momentum remains strong, propelled by accelerated new product introduction and increased penetration of existing accounts. • Earnings progression is solid . . . . • The recently announced merger of Staples, Inc. and Office Depot should benefit American Pad & Paper, in our view . . . . • The acquisition pipeline is full, increasing the potential for upside earnings surprise in 1997. * * * ANALYSIS: Current Business Momentum Is Strong. Management has made excellent progress in driving revenues . . . . The Company's progress in this regard illustrates the competitive advantages accruing to those singular manufacturers that recognize the changing reality at retail. . . . The financial consequences of sharp merchandising and marketing skills have been impressive across the board as the Company has gained market share within existing lines while successfully leveraging new products across diverse channels of distribution. . . . - 63 - ------------------------------------------------------------------------ Expect Solid Earnings Progression Driven by Three- Pronged Revenue Growth Strategy. AP&P's management has wisely developed three distinct and high potential growth vehicles. First, revenues are expected to rise consistent with the sales gains enjoyed by the fastest- growing channels of distribution -- many of which are AP&P's fastest-growing customers. These include the office products superstore, contract stationer and discount segments. In aggregate, we project annual revenue growth of 20%, 24% and 12%, respectively, for these segments, which represented about 30% of AP&P's 1995 pro forma revenues. (The top five retailers in the office products segment still account for only 17% of industry revenues at retail, and we believe that share can eventually grow to 50-60%.) Second, we expect AP&P to increase its penetration of those key accounts by 10- 15% annually via introduction of new products and categories. And third, AP&P is poised to make additional acquisitions . . . . . . . For the full year, we estimate EPS of $1.02, or a gain of 40%, followed by a greater-than-30% rise in 1997. We project 20% compound annual earnings growth for the next 3-5 years, driven by topline gains in the midteens. American Pad & Paper Is Positioned To Be A Benefi- ciary Of The Massive Consolidation Both At Retail And In The Supply Channel. We see an important opportunity for AP&P to pick up additional market share through the merger of the two superstore leaders, Office Depot and Staples. . . . Potential increased revenues from the merger could be quite significant and are not currently reflected in our model. 64. On 10/24/96, American Pad reported its 3rdQ 96 results -- sales of $173.6 million, net income of $6.9 million and EPS of $.24 (before an extraordinary item) and pro forma net income of $8.9 million and EPS of $.30. The release stated: "We are very excited about the strong results we have been able to achieve to date in 1996," said Charles G. Hanson, III, the company's chairman and chief executive officer. "We . . . continue to meet our profitability goals while increasing market penetration to our fast growing key customers." * * * "Within the superstore market channel the merger of Staples and Office Depot has created a unique opportunity for a supplier with a full range of products and national - 64 - ------------------------------------------------------------------------ distribution such as AP&P," added Hanson. "We are uniquely positioned to capitalize on the continuing consolidation and change in this industry." These financial results were later included in American Pad's 3rdQ 96 Form 10-Q filed with the SEC, signed by McAleer. 65. On 10/24/96, American Pad held a conference call for large American Pad shareholders, money and portfolio managers, securities analysts, brokers and stock traders. During that call, Hanson and McAleer made presentations and answered questions and told participants they would be available to the individuals for follow-up discussions. During the call and in follow-up one-on-one conversations with participants, Hanson and McAleer stated: • American Pad's financial results were on plan due to strong demand for its products and American Pad's tight cost controls. • The growth of the superstore retail office products distribution channel was a very positive development for American Pad and American Pad was uniquely well positioned with competitive advantages to benefit from this important industry trend. • American Pad had identified several potential accretive acquisitions which it would complete over the next few years and which would help boost its EPS growth rate going forward. • The Williamhouse acquisition had been a tremendous success. Williamhouse (and Niagara) had been successfully integrated into American Pad's business and important synergies and cost savings were being realized. • Williamhouse sales were growing strongly, which was boosting Williamhouse's profitability as its operating costs were being reduced at the same time. • American Pad was continuing to successfully introduce distinctive new innovative value-added products which were helping to boost its profits. • American Pad had successfully implemented its new pricing strategy which would shield its earnings from the volatility of paper prices. In fact, American Pad had achieved its outstanding 2ndQ 96 results in the face of paper price volatility because of this new and successful pricing strategy. - 65 - ------------------------------------------------------------------------ • American Pad's special relationships with paper mills continued to provide it with important purchasing advantages. • American Pad was reaffirming its 97 EPS forecasts of $1.30-$1.40 and a 20+% EPS growth rate after that. 66. On 10/25/96, Bankers Trust/BT Securities issued a report on American Pad, written by Kanev, which was based on and repeated information provided him in the 10/24/96 conference call and follow-up conversations with Hanson and McAleer. The report forecast 96 and 97 EPS of $1.02 and $1.30 and a secular growth rate of $15+% for American Pad. The report also stated; Management expressed confidence in the street's current estimates for the fourth quarter and full year 1996 ($0.40 per share and $1.02 per share, respectively). It also has positive expectations for 1997, with growth being driven by the following: (i.) a stronger presence in the retail envelope sector resulting from the recent integration of the Niagara acquisition . . . [and] (iv.) management continues to pursue additional acquisition opportunities. 67. On 10/25/96, Alex. Brown issued a report on American Pad, written by Vroom, which was based on and repeated information provided him in the 10/24/96 conference call and follow-up conversations with Hanson and McAleer. The report forecast 96 EPS of $1.03, 97 EPS of $1.33 and 4thQ 96 EPS of $.42 for American Pad. The report also stated: American Pad & Paper reported strong 3Q96 operating results, validating our thesis that the Company is well positioned to increase penetration of and to grow along with certain rapidly expanding retail channels (office product superstores, contract stationers, mass merchants) in the consolidating office products segment. Important progress with key accounts through innovation and skilled merchandising continues to drive top-line gains, while leverage and acquisition-related cost reductions contribute to what we believe will be 20% compound annual EPS growth over the next 3-5 years. HIGHLIGHTS: - 66 - ------------------------------------------------------------------------ -- Pro forma gross profit rose 16% year-over-year, to $36 million; gross margin and gross profit dollars were ahead of our expectations. * * * -- The Company continues to make excellent progress penetrating large accounts in the fastest-growing segments of the office products industry. * * * AP&P IS WELL-POSITIONED TO GROW WITH THE FAST- GROWING RETAIL CHANNELS. The Company has made excellent progress penetrating its large accounts in the fast- growing channels; office product superstores, contract stationers and mass merchants . . . . As the retailers grow, scale, mix and geographic reach all become increasingly more important; these are just the attributes that we believe give AP&P its competitive advantage. 68. On 11/4/96 and again on 11/8/96, First Boston issued reports on American Pad, written by Romm, which were based on and repeated information provided him in the 10/24/96 conference call and follow-up conversations with Hanson and McAleer. Prior to issuing these reports, Romm also had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Romm from Hanson and McAleer. Romm provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured Romm it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report forecast 96 EPS of $1.00, 97 EPS of $1.40 and 4thQ 96 EPS of $.37 for American Pad. The report also stated: We believe AGP is on target to earn $1.00 per share for the full year suggesting excellent fourth quarter earnings comparisons. . . . - 67 - ------------------------------------------------------------------------ Consolidation in the office products business is accelerating with the announced merger of Staples and office Depot . . . . The creation of large superstores bigger office supply companies, and mass merchandisers will favor efficient suppliers like AGP who can meet these giant customer needs. We believe AGP continues to enjoy excellent opportunities for growth . . . . * * * Third Quarter and Nine-Month Results . . . [T]here has been an increase in uncoated free sheet paper costs that is being implemented by the mills. Under AGP's pricing strategy, the price increases on paper costs are passed through its customers at the time of shipment. . . . . . . We believe the company remains well positioned to capitalize on this continuing trend toward consolidation. 1996 Estimates/1997 Forecast . . . Based on our current forecast, we believe AGP revenues will be about $656.3 million with net income of approximately $29.4 million equal to $1.00 per share. . . . For 1997 we envision total revenues at $757.4 million and net income of $41.4 million. We believe AGP can earn $1.40 per share . . . . It should also be noted that AGP continues to successfully integrate recent acquisitions. The Niagara Envelope acquisition has been integrated with WilliamHouse, producing strong economies that had been projected with the combination of these two companies. AGP continues to be uniquely positioned to make additional acquisitions . . . . We remain confident that in the long term acquisitions will play a role in driving AGP's growth. . . . we . . . remain optimistic that AGP remains an excellent growth vehicle in the office products business. 69. The positive representations and statements made about American Pad by the defendants between 9/4/96 and 11/8/96, as pleaded in ¶¶59-68, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. - 68 - ------------------------------------------------------------------------ The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements-made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations and thus its business remained as exposed as ever to the adverse profit margin impact of such price fluctuations, but American Pad was concealing this by manipulating and falsifying its financial Statements, including its cost of goods sold, LIFO and inventory reserves; (b) That during 96, American Pad's core operations and profitability were being adversely affected by paper price declines which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being disguised by American Pad's manipulation and falsification of its cost of sales calculations, especially in its Williamhouse Division as detailed in ¶¶116-138; (c) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products as its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had failed; (d) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers and thus was continuing to be exposed to all the negative forces present in a highly - 69 - ------------------------------------------------------------------------ competitive commodity product business, including the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; (e) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive advantages, including purchasing advantages over major competitors in that marketplace; (f) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, was apparently meeting those goals by manipulating and falsifying its financial statements as detailed in ¶¶116-138; (g) That American Pad's 1stQ, 2ndQ and 3rdQ 96 financial statements were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (h) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (i) That the ongoing consolidation of the office products retail channel into larger superstores was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was - 70 - ------------------------------------------------------------------------ increasingly negatively impacted due to their sophisticated inventory management practices which reduced their inventory carry; (j) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive Competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact n American Pad's actual results of operations, which adverse impact was being concealed by the deliberate manipulation of Williamhouse cost of sales as detailed in ¶¶116-138; (k) That American Pad's acquisition pipeline was not full nor was American Pad actively pursuing a number of acquisitions which had a reasonable probability of completion in the foreseeable future as, in fact, due to the increasingly serious internal business problems of American Pad, its executives had either the time nor the ability to pursue significant acquisitions in the near term; (l) That American Pad's core Ampad paper products business was suffering from persistently weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (m) That as a result of these negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the 97 and 98 EPS forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (n) That as a result of these negative factors which were adversely affecting American Pad's results from operations, - 71 - ------------------------------------------------------------------------ the defendants actually knew their forecasts of 20+% EPS growth for American Pad over the next three-five years were false and misleading when made, as such EPS growth could not be achieved by American Pad. 70. On 12/16/96, Morgan Stanley issued a report on American Pad, written by Runkle, entitled "NOTES FROM MEETING WITH MANAGEMENT." Prior to issuing this report, Runkle had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Runkle from Hanson and McAleer. The report forecast 97 and 98 EPS of $1.36 and $1.72, 4thQ 96 EPS of $.40 and a five-year EPS growth rate of 20%+ for American Pad. The report also stated: -- We had the opportunity to talk with Charles Hanson, CEO, and Kevin McAleer, CFO, last week . . . . -- In a nutshell, the acquisition pipeline remains full and AGP continues to aggressively pursue accretive acquisitions . . . . * * * • Continuing to Make Inroads at Large Retailers. Management also discussed some of the inroads the company's products have made over the course of the past several months. * * * • Cautiously Optimistic about the 4th Quarter. Management's tone regarding the 4th quarter was cautiously optimistic . . . . To date, the quarter is progressing well and there are no indications of slowing down as we finish December. * * * For 1997, we consider $1.36 quite conservative . . . . Conservatively, in our opinion, acquisitions could add another $0.10 to our full-year 1997 estimate, penetration increases an additional $0.05-0.10. In other - 72 - ------------------------------------------------------------------------ words, we view $1.50 in earnings in 1997 as quite possible. 71. On 1/7/97, American Pad announced it would acquire Shade- Allied, a small manufacturer of paper-based office products. On 1/7-8/97, Hanson and McAleer spoke to analysts at Morgan Stanley, Alex. Brown, Bankers Trust/BT Securities and First Boston about this acquisition to present it as a very favorable development which would boost American Pad's revenue and EPS growth immediately, and thus American Pad was increasing its 97 and 98 EPS forecasts to $1.42-$1.50 and $1.70-$1.81, respectively, reaffirming its ongoing 15%-50% EPS growth rate forecast. 72. On 1/8/97, Morgan Stanley issued a report on American Pad which again forecast 4thQ 96 EPS of $.40 and raised the American Pad 97 EPS forecast from $1.36 to $1.42 and the 98 EPS forecast from $1.72 to $1.81, while maintaining the five-year EPS forecast of 20+% for American Pad. The information in the report was obtained by Morgan Stanley from Hanson and McAleer. The report stated: • . . . American Pad & Paper announced yesterday that it intends to purchase Shade-Allied, a manufacturer of machine papers . . . . * * * • . . . We are raising our 1997 earnings forecast to $1.42 from $1.36 and our 1998 estimate to $1.81 from $1.72. . . . While the stock has appreciated considerably since going public last July, we continue to believe there is upside to its price over the next 12- months. In addition to earnings, accretive acquisitions (likely before year-end, we believe) and the SPLS-ODP merger should act as catalysts to the stock throughout 1997. * * * In our opinion, Shade-Allied provides yet another significant growth opportunity for AGP, fits perfectly - 73 - ------------------------------------------------------------------------ within the AGP business strategy, [and] should be accretive from day 1 . . . . 73. On 1/8/97, Alex. Brown issued a report on American Pad, written by Vroom. The information in the report was obtained by Vroom from Hanson and McAleer. The report stated: VERY POSITIVE ON NEW ACQUISITION OF SHADE-ALLIED. American Pad & Paper was formed to exploit the changing demand patterns precipitated by increasing retail consolidation. As leading operators such as Corporate Express, Staples and Officemax gain market share, they displace smaller participants in the market and demand, from their vendors, greater sophistication--from a management, distribution and financial standpoint. Additionally, as smaller players go out of business, so too, do the small, regional vendors that sold into that channel. Thus, the business implications of superstore and contract stationer growth are two-fold: (1) it increases the demand for larger vendors capable of servicing national chains and (2) it pressures the smaller manufacturers. AP&P is singularly well-positioned to benefit from both of these trends. . . . These twin engines of growth should propel AP&P earnings at better than the 20% annual clip that we estimate from internal growth alone for the next three to five years. * * * CORE BUSINESS STRONG. In addition to successfully executing an intelligent acquisition strategy, AP&P management has refined merchandising and marketing initiatives in a manner that has helped drive solid business momentum. Specifically, we look for 15% 4Q revenue growth--the best gain all year--and a 55% EPS gain to $0.42. Our full-year estimate remains $1.03 while for CY 1997 we project a 30% gain to a range of $1.33-1.35. 74. On 1/8/97, Bankers Trust/BT Securities issued another report on American Pad, written by Kanev, which raised the 97 and 98 EPS forecast for American Pad to $1.45 and $1.70, respectively, while continuing to forecast a 15% secular growth rate for American Pad. The information in the report was obtained by Kanev from Hanson and McAleer. The report stated: - 74 - ------------------------------------------------------------------------ American Pad & Paper Company signed a definitive purchase agreement to acquire Shade-Allied, Inc. . . . * * * Management expects the acquisition to be immediately accretive to earnings. Our 1997 and 1998 projections have been revised to reflect contribution from Shade- Allied's base business as well as additional revenues to be gained from cross-selling the machine papers products to AGP's current customer base. Our revised sales estimates are $850 million ($95 million from Shade- Allied) and $940 million ($110 million from Shade-Allied) in 1997 and 1998, respectively, and EPS of $1.45 (formerly $1.30) in 1997 and $1.70 (formerly $1.55) in 1998. 75. On 1/9/97, First Boston issued a report on American Pad, written by Romm, which raised the 97 EPS forecast for American Pad to $1.50 due to the Shade-Allied acquisition. The information in the report was obtained by Romm from Hanson and McAleer. This report stated: American Pad & paper announced a definitive agreement to purchase Shade-Allied, Inc., a leading manufacturer of machine papers . . . . The acquisition . . . will be accretive immediately in 1997. We are raising our 1997 estimate on AMPAD by $0.10 to $1.50 from $1.40, previously. 76. The positive representations and statements made about American Pad by the defendants between 12/16/96 and 1/9/97, as pleaded in ¶¶70-75, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That during 96, American Pad's core operations and profitability were being adversely affected by price cuts which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being - 75 - ------------------------------------------------------------------------ disguised by American Pad's manipulation and falsification of its cost of sales calculations, especially in its Williamhouse Division as detailed in ¶¶116-138; (b) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (c) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the deliberate manipulation of Williamhouse's cost of sales as detailed in ¶¶1l6-138; (d) That American Pad's core Ampad paper products business was suffering from persistently weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (e) That American Pad's acquisition pipeline was not full nor was American Pad actively pursuing a number of acquisitions which had a reasonable probability of completion in the foreseeable future as, in fact, due to American Pad's increasingly serious internal business problems, its executives had neither the time nor the ability to pursue significant acquisitions - 76 - ------------------------------------------------------------------------ in the near term and no acquisition other than Shade-Allied would occur; (f) That the Shade-Allied acquisition would not immediately benefit American Pad's EPS as the acquisition would not be completed for months after it was announced and even then, due to consolidation issues and steps and weak sales of Shade-Allied products, would not significantly advance American Pad's EPS for several months; (g) That as a result of these negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the 97 and 98 EPS forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (h) That as a result of these negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew their forecasts of 20+% EPS growth for American Pad over the next three-five years were false and misleading when made, as such EPS growth could not be achieved by American Pad. 77. On 1/29/97, American Pad's stock fell sharply to $22-3/4 from $26-1/2 on 1/28/97, when rumors about weakening sales for American Pad entered the market. The American Pad Defendants wanted to support the stock price and contacted Alex. Brown to have it issue positive information to the market to help support the stock price. On 1/29/97, Alex. Brown issued a report, written by Vroom. Prior to issuing this report, Vroom had discussions with Hanson and McAleer about American Pad's business and its future prospects, and was told about a "slight" revenue short fall in 4thQ - 77 - ------------------------------------------------------------------------ 96 revenues that had no impact on American Pad's core business or growth prospects. The information in the report was obtained by Vroom from Hanson and McAleer. The report stated: We continue to recommend aggressive current purchase of American Pad & Paper Company (AP&P) common shares especially in view of the recent share price weakness. We remain convinced that AP&P is singularly well positioned to benefit from the ongoing consolidation of the retail channel within the office products industry. The Company's core business remains solid with persistent market share gains continuing as management's merchan- dising prowess and low cost production help drive sales. For 4Q 1996, however, we have modestly revised our revenue and EPS forecast to reflect the loss of several commodity-grade paper orders from customers tightening inventory levels. We continue to forecast above-trend line EPS growth in both 1997 and 1998 . . . . HIGHLIGHTS * Light sales in the retail channel prompted retailers to tighten inventory levels, in our opinion, and cancel some orders for commodity-grade items during 4Q 1996. * We've lowered our revenue estimate by $15 million to $180 million reflecting the shortfall; our 4Q 1996 EPS estimate correspondingly has been lowered to $0.38 from $0.40 and the FY 1996 EPS estimate is now $1.01, previously $1.03. * We perceive neither a fundamental change in the business nor an adverse shift in AP&P's relationships with its customers. * Core business remains quite strong. * Our unchanged EPS estimate range of $1.30-1.35 for 1997 does not reflect potential accretion from the announced acquisition of Shade-Allied. * * * ANALYSIS Slight Revenue Miss Causes Us To Trim EPS Estimates. A modest sales shortfall at retail in 4Q 1996 led to tightening of inventories, in our opinion, causing retailers to cancel some orders of commodity-grade items . . . Our 4Q 1996 EPS estimate has been reduced to $0.38 from $0.40, bringing the full year to $1.01 from the prior $1.03 estimate. . . . We continue to look very - 78 - ------------------------------------------------------------------------ favorably upon the Company's prospects for growth with--and increasing penetration of--the fast-growing dominant retailers in the segment. We stress that we perceive no deterioration of the fundamentals or adverse shift in AP&P's relationships with its key accounts -- relationships that the Company has attentively cultivated over the past three years. Core Business Remains Solid. Revenue gains in AP&P's core business have been driven by a three-pronged approach: growth with the dominant retailers in consoli- dating segments of the market, increasing penetration of existing product lines into those key accounts, and expansion into complementary product lines to expand the opportunity further. The Company has done, and we believe continues to do, an excellent job driving sales in this manner. Indications are that key accounts are pleased with the growing relationships. Year-over-year pro forma revenue growth in 4Q 1996 is projected at 7%, despite unfavorable paper price comparisons and today's downward revision to the top line. * * * Believe Staples/Office Depot Merger Will Prove Positive For AP&P. AP&P is an important supplier to both Staples and Office Depot . . . the pending merger of Staples and Office Depot will benefit AP&P by enabling the Company to expand . . . . 78. On 2/18/97, American Pad reported its 4thQ 96 results -- revenues of $176 million, net income of $10.5 million and EPS of $.36 (before an extraordinary item) and pro forma net income of $11.3 million and EPS of $.38 -- and its full year 96 results -- revenues of $583 million, net income of $18 million and EPS of $.62 before an extraordinary charge due to the early extinguishment of debt. The report stated: "[T]he company performed exceptionally well during this critical phase," said Charles G. Hanson, III, the Company's Chairman and Chief Executive Officer. "We achieved our goals in revenue growth and profitability while increasing market penetration with our target customers." 79. On 2/18/97, American Pad held a conference call for large American Pad shareholders, money and portfolio managers, securities - 79 - ------------------------------------------------------------------------ analysts, brokers and stock traders. During that call, Hanson and McAleer made presentations and answered questions and told participants they would be available to the individuals for follow- up discussions. During the call and in follow-up one-on-one conversations with participants, Hanson, Gard and McAleer stated: • American Pad's 4thQ 96 revenue softness was due to short- term/one-time issues and revenue growth was already showing up in new orders. • American Pad's fundamentals were on track and its growth strategy was intact and on track. • American Pad had been able to maintain strong gross dollar profit margins, despite lower retail prices. • Due to a slight delay in closing the Shade-Allied acquisition, that acquisition would not add as much EPS in 97 as earlier forecast, but it would still be accretive. • American Pad's management was successfully controlling costs, especially in its Williamhouse Division, and thus continued to expect EPS growth to exceed revenue growth. • American Pad was still in the process of making accretive acquisitions which would boost its 97-98 EPS. • There was no change in the fundamental growth characteristics of American Pad's business. American Pad still expected 12%-14% internally generated revenue growth and 25% on average EPS growth over the next three-five years. • American Pad expected to show at least 20% EPS growth sequentially during 97. • Due to short-term factors -- and not any further problems with American Pad's business, American Pad was now forecasting slightly lower EPS growth in 97 and 98, with 97 EPS of $1.25- $1.35 and 98 EPS of $1.60-$1.70, and 20% annual EPS growth going forward from then. 80. On 2/20/97, Alex. Brown issued a report on American Pad, written by Vroom, which was based on and repeated information provided in the conference call and follow-up conversations with Hanson and McAleer. The report forecast 97 and 98 EPS of $1.30- $1.35 and $1.60-$1.65, respectively, for American Pad and stated: - 80 - ------------------------------------------------------------------------ -- Fundamentals are on track. * * * ANALYSIS: STRONG EARNINGS GROWTH DRIVEN BY TOP LINE GAINS, GROSS MARGIN CONTROL. . . . Though below our earlier expectations, the results are nonetheless impressive; paper price deflation obscures the significant inroads the Company has made selling to its largest customers . . . . Strong gross margin gains neutralized the revenue volatility . . . . AP&P's pricing policy enables it to manage gross profits regardless of high or low paper price levels. We consider this to be a significant mitigant to the top-line volatility expected of a producer of paper products . . . . EXPECT REVENUE ISSUES TO BE SHORT-LIVED. As to the 4Q 1996 inventory tightening issue, the Company's EDI links showed sales at retail to be ahead of reorders toward the quarter end, suggesting that retailers were working down inventory levels; so far in 1Q 1997, retail sales seem to be more in line with reorders. * * * 1997 EPS ESTIMATES UNCHANGED. We've now incorporated $0.05 accretion from Shade-Allied in our 1997 EPS estimate . . . . Our 1997 EPS estimate range of $1.30-1.35 would represent about 30% EPS growth as the production and distribution infrastructure is leveraged. 81. On 2/21/97, First Boston issued a report on American Pad, written by Romm, which was based on and repeated information provided in the conference call and follow-up conversations with Hanson and McAleer. The report forecast 97 EPS of $1.32 for American Pad. The report stated: During the fourth quarter, American Pad & Paper stated that several key customers were working off inventories, which had a modest impact on shipments. * * * Since we are reviewing our 1997 estimate, we want to be very clear that we remain optimistic about American Pad & Paper's ability to achieve strong growth in revenues and excellent improvements in cash flow and net income. - 81 - ------------------------------------------------------------------------ * * * We are now using a revenue base of $804 million for 1997. This is somewhat lower than where we had been, in part reflecting lower paper prices that will continue to affect American Pad & Paper's results during the first quarter. In addition, American Pad & Paper's shipments are likely to continue running behind sales at retail because key customers are tightening controls on inventory. This is particularly true for commodity items among some of the key mass-merchant customers, which American Pad & Paper is aggressively pursuing. At the margin level, we believe that American Pad & Paper will show stable gross margins but increased EBIT margins because of the continuing benefits of consolidating general and administrative expenses from its acquired companies. 82. On 2/26/97, Morgan Stanley issued a report on American Pad, written by Bruce Missett, which was based on and repeated information from the 2/18/97 conference call and follow-up conversations with Hanson and McAleer. The report forecast 97 and 98 EPS of $1.30 and $1.70, respectively, and a five-year EPS growth rate of 25% for American Pad. The report upgraded Morgan Stanley's rating on American Pad to "Strong Buy" and stated: We are raising our rating on American Pad & Paper to Strong Buy . . . . The stock price has dropped . . . in the face of no change in the fundamental growth characteristics of the company. * * * Acquisition Pipeline is Full - Management is still very much focused on accretive acquisition opportunities and announcements are likely over the next 12 months. * * * . . . The stock price has dropped . . . in the face of no change in the fundamental growth characteristics of the company. . . . Stock Price catalysts will likely be acquisition announcements, continued projected internal top-line growth of 12-14%, and expected bottom line growth in excess of 25%. . . . Last week we adjusted our EPS estimates to $1.30 for 1997 and $1.70 for 1998, down from $1.42 and $1.81, respectively. . . . Importantly, there is no - 82 - ------------------------------------------------------------------------ change in our fundamental growth forecast which calls for 12-14% internally generated revenue growth and 25% earnings growth over the next 3-5 years. * * * . . . We are conservatively forecasting 1Q97 EPS of $0.17, which . . . doesn't fully reflect stronger growth n AGP'S core businesses. We fully expect a resumption of 20%-plus EPS growth in each of the remaining quarters of 1997. 83. On 3/12/97, Bankers Trust/BT Securities issued a report on American Pad, written by Kanev. Prior to issuing this report, Kanev had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Kanev from Hanson and McAleer. Kanev provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured Kanev it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report forecast 96 and 97 EPS of $1.25 and $1.60, respectively, and a 15+% secular growth rate for American Pad and stated: * Fourth quarter 1996PF EPS were $0.38 vs. $0.27 in 1995PF. Softer paper prices (changes in paper costs are passed through to customers) resulted in lower-than- expected sales of $176 million for the quarter vs. sales of $168 during 4Q95. However, gross margin increased 230 basis points, to 23.2% vs. 20.9% in 1995, primarily a result of favorable product mix, as well as the company's ability to maintain margins during periods of fluctuating paper prices and meticulous attention to operating costs. 84. On 3/17/97, Morgan Stanley issued another report on American Pad, written by Missett, which again forecast 97 and 98 EPS of $1.30 and $1.70 and a five-year EPS growth rate of 20% for American Pad. Prior to issuing this report, Missett had - 83 - ------------------------------------------------------------------------ discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Missett from Hanson and McAleer. Missett provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured Missett it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report stated: Key Points * We recently raised our rating to Strong Buy from Outperform . . . . * Growth remains strong . . . . * Management remains focused on accretive acquisition opportunities, and we believe announcements are likely over the next 12 months. * * * Key investment positives have not changed since we initialed coverage in July 1996 . . . . * * * Growth Remains Strong with Core Customers . . . . AGP also continues to see stronger growth . . . from newly developed products. . . . Acquisition Pipeline Is Full Management is still very much focused on accretive acquisition opportunities, and we believe additional announcements are likely over the next 12 months. These should push up our earnings forecasts, since current estimates assume only internally generated growth. * * * . . . There is no change in our fundamental growth forecast of 12-14% internally generated revenue growth and 25% earnings growth over the next 3-5 years. - 84 - ------------------------------------------------------------------------ * * * . . . We are forecasting EPS of $0.17, which we view as conservative; this would represent a modest-looking 7.1% increase from pro forma 1Q96 EPS of $0.16 and doesn't fully reflect expected strong growth in AGP's core businesses. We are confident that 20% plus EPS growth will again be posted in each of the remaining quarters of 1997. 85. In late 3/97, American Pad issued its 96 Annual Report to Shareholders, which reported 96 revenues of $583 million, net income of $18 million and EPS of $.62 before an extraordinary item relating to early extinguishment of debt. The report contained a letter signed by Hanson which stated: Tough to beat. That's American Pad & Paper. We were tough to beat as a private company and with our new access to capital as a public company we will be even tougher. Our business is to supply paper-based office products to those tough customers who dominate the industry: • Office Products Superstores (Office Depot, Office Max, Staples) • Mega-retailers (Wal-Mart) • National Contract Stationers (BoiseCascade Office Products, BT Office Products, Corporate Express, US Office Products) • Paper Merchants (Nationwide, ResourceNet, Unisource, Zellerbach) • Office Products Wholesalers (United Stationers and S.P. Richards) These giant resellers are successful because they offer the end user the best value. This includes the most competitive prices, but equally important is the quality and depth of the products lines, outstanding service and innovative products that aid the end user in their business needs. AP&P's strategy is successful because we offer these giants the best value. This includes the most competitive prices, quality and completeness of our - 85 - ------------------------------------------------------------------------ product offerings as well as outstanding service and a steady flow of innovative products. Our strategy is working. We have achieved notable successes during the year reaching our short-term goals and building the infrastructure to move aggressively toward our long-term goals. * * * Our strategy is to provide rapid, profitable and sustainable growth by becoming the preferred supplier to the dominant, fast-growing players in the office products industry. We have in place the requirements to dominate this market, including: • National distribution • Multiple and complete product lines • Innovative products • Competitive cost structure. One key to our strategy is to buy companies that expand or complement our national distribution channels, make products that we can cross-sell to existing distribution channels, increase our production capacities and provide products that are innovative and valuable to our customers. * * * New products are another ingredient in our growth, providing strong margins for our company and our customers. . . . . . .The office products industry (supply portion only) has been estimated at $60-$70 billion annually, with the highest growth in the markets of our five customer groups. . : . . . . When we acquire a company, redundancies are eliminated and excess costs are brought in line. Our ability to recognize and capitalize on opportunities to improve efficiencies makes AP&P one of the leanest companies in the industry, which allows us to offer customers very competitive prices. 86. Elsewhere, the 96 Annual Report stated: The reason AP&P's acquisition strategy has been success- ful is that the company makes the tough decisions when evaluating a target. - 86 - ------------------------------------------------------------------------ They made the right decision when they acquired Williamhouse. The Williamhouse acquisition added a new product line -- commercial envelopes -- and distribution channel -- paper merchants -- to AP&P's strategy. Paper merchants sell envelopes to printers who print the envelopes, typically with corporate letterhead, for the end user. AP&P is now the leader in this market. * * * . . . As a successful consolidator, AP&P has merged seven management teams, sales forces, delivery fleets and back offices, into one company, creating a lean and efficient organization. 87. In late 3/97, American Pad filed its Report on Form 10-K with the SEC which included its 96 financial results and stated: Paper Prices. Paper represents a majority of the Company's cost of goods sold. . . . Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. The Company believes that it is now able to price its products so as to minimize the impact of price volatility on dollar margins. The 10-K was signed by Gard, Hanson, Gay, Lavine, Wolpow, Benson, Watterson and McAleer. 88. The positive representations and statements made about American Pad by the defendants between 1/29/97 and late 3/97, as pleaded in ¶¶77-87, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations and thus its business remained as exposed as ever to the adverse profit margin impact of such price fluctuations, but American Pad was concealing this by - 87 - ------------------------------------------------------------------------ manipulating and falsifying its financial statements, including its cost of goods sold and LIFO reserves as detailed in ¶¶116-138; (b) That during 96, American Pad's core operations and profitability had been adversely affected by price cuts which it was being forced to pass along to its customers, especially purchasers of envelope products, which adverse impact was being disguised by American Pad's manipulation and falsification of its cost of sales calculations, especially in its Williamhouse Division as detailed in ¶¶116-138; (c) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products as its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had failed; (d) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive advantages, including purchasing advantages over major competitors in that marketplace; (e) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers and thus was continuing to be exposed to all the negative force present in a highly competitive commodity product business, including the adverse - 88 - ------------------------------------------------------------------------ impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; (f) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, was meeting those goals by manipulating and falsifying its financial statements as detailed in ¶¶116-138; (g) That American Pad's 96 financial statements had been materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (h) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (i) That the ongoing consolidation of the office products retail channel into larger superstores was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was increasingly negatively impacted due to the sophisticated inventory management practices which the larger retail stores were able to bring to their businesses and which reduced their inventory carry; (j) That paper price hikes from its major suppliers during early 97 were already having a material adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the manipulation of American Pad's LIFO - 89 - ------------------------------------------------------------------------ reserve and thus falsification of its publicly reported financial results as detailed in ¶¶116-138; (k) That American Pad's core Ampad paper products business was suffering from persistently weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (l) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by defendants' deliberate manipulation of Williamhouse cost of sales to conceal this negative impact; (m) That the Shade-Allied acquisition would not benefit American Pad's EPS for several months and even then, due to consolidation issues and steps and weak sales of Shade-Allied products, would not significantly advance American Pad's EPS; (n) That as a result of these negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the 97 and 98 EPS forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (o) That as a result of these negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew their forecasts of 20% EPS growth for American Pad over the next three-five years were false and - 90 - ------------------------------------------------------------------------ misleading when made, as such EPS growth could not be achieved by American Pad. 89. On 4/l/97, American Pad disclosed its 1stQ 97 revenues and EPS would be about $149 million and $.15-$.16 -- slightly below earlier forecasts, blaming this on the "current consolidation activities in the office superstore market" and a "slight softening of prices." This disappointing announcement caused American Pad's stock to plunge from $16 on 3/31/97 to as low as $11-1/8 on 4/l/97. This decline in American Pad's stock price was a matter of great concern to the defendants, as it came just nine months after the IPO and with the stock price so low would make it impossible for American Pad to use the stock to make acquisitions or to have another stock or convertible debt offering to raise the millions of dollars in additional capital the Company still needed. Thus, defendants mounted a strong effort to support and reinflate the stock price by minimizing the nature of the 1stQ 97 shortfall and representing that American Pad's core business was strong and its growth prospects largely intact and that American Pad would show strong EPS growth in the second half of 97. For instance, the 4/l/97 release stated that American Pad considered its 1stQ 97 results a "respectable operating performance," was "pleased with our ability to maintain operating margins in this environment," and reassured investors that "the fundamental core business is sound." 90. On 4/l/97 and 4/2/97, American Pad had conversations with securities analysts to reassure them that the 1stQ 97 shortfall was minimal and that American Pad's core business strategy was working and it was positioned to achieve strong EPS growth in 97 and 98. During those conversations, Hanson, Gard and McAleer stated: - 91 - ------------------------------------------------------------------------ • The 1stQ 97 softness was due to short-term/one-time "mechanical" issues which would be overcome in the second half of 97. Sell through of American Pad products at retail remained strong. • American Pad's fundamentals were intact and its business growth strategy was on track. • American Pad was able to maintain strong gross profit margins, despite lower retail prices and even in the face of paper price hikes to it. • The Shade-Allied acquisition would be accretive to 97 EPS. • American Pad's management was successfully controlling costs, especially in its Williamhouse Division, and thus expected EPS growth to exceed revenue growth. • The increase in American Pad's inventory levels was not due to softening demand, but the result of a decision to build up inventory levels in anticipation of 2ndQ and 3rdQ sales. • American Pad would make acquisitions in the near term, which would boost its EPS. • There was no change in the fundamental growth characteristics of American Pad's business. American Pad still expected 12%-14% internally generated revenue growth and 25% on average EPS growth over the next three to five years. • American Pad expected to show at least 20% EPS growth sequentially during 97. • Due to short-term factors -- and not any significant problems with American Pad's business, American Pad was still forecasting EPS growth in 97 and 98, with 97 EPS of $1.15- $1.35 (and very strong 3rdQ and 4thQ 97 EPS) and 98 EPS of $1.40-$1.70, with 15%-25% annual EPS growth going forward. 91. On 4/2/97, Morgan Stanley issued a report on American Pad written by Bruce Missett. Prior to issuing this report, analyst Missett had discussions with Hanson and/or McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Missett from Hanson and McAleer and this report was based on and repeated information provided him by them. Missett provided a draft of this report to Hanson and McAleer before it was issued so they could review it for - 92 - ------------------------------------------------------------------------ accuracy. Hanson and McAleer reviewed the report before it was issued and assured Missett it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. This report forecast 97 and 98 EPS of $1.30 and $1.70 and a 20%-25% five-year EPS growth rate, with 97 quarterly EPS as follows, actually increasing the 4thQ 97 EPS forecast for American Pad from $.46 to $.47: Q1 $ .16 Q2 $ .22 Q3 $ .45 Q4 $ .47 Year $1.30 The report stated: We are maintaining our Strong Buy rating on American Pad & Paper and view the recent weakness as a compelling buying opportunity. Slight shortfalls in Q1 -- with the emphasis on slight -- appear to have been caused by mechanical timing issues of customer re-orders and NOT by a fundamental change in demand for AGP's products or services. Importantly, there is no change in the fundamental growth story behind AGP's business . . . . * * * Management attributed the revenue shortfall to expected March reorders -- primarily from the superstores and the paper merchants -- that did not materialize. The largest portion of the shortfall was in the superstore channel -- where the pending merger of Staples and Office Depot continues to cast uncertainty . . . . Sell-throughs at Retail Remain Strong Retail sell- throughs of AGP's products remain strong. We believe that the slippage of retail reorders in March is not a reflection of product demand, but rather mechanical timing differences in the inventory process. We believe that sales will reaccelerate once paper price[s] stabilize and once the fate of Office Depot is resolved. Acquisition Pipeline is Full -- Management is still very much focused on accretive acquisition opportunities and announcements are likely over the next 12 months. We believe that the pipeline remains full. - 93 - ------------------------------------------------------------------------ No Change to Full Year Estimates -- We are maintaining our EPS estimates of $1.30 and $1.70 for 1997 and 1998 . . . . 92. On 4/2/97, Alex. Brown issued a report on American Pad written by Vroom. Prior to issuing this report, Vroom had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Vroom from Hanson and McAleer. Vroom provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured Vroom it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report stated American Pad "continues to be well-positioned long-term," called the stock a "strong buy," continued to forecast 97 and 98 EPS of $1.30-$1.35 and $1.60-$1.65, and stated: American Pad & Paper today announced that revenues and EPS for 1Q 1997 would be below analysts' estimates, with the shortfall primarily attributed to lower-than- expected sales to office product superstore operators, and, secondarily, to the recent decline in the cost of uncoated free sheet. In our opinion, these issues are short-term and the Company remains well positioned to benefit from the ongoing consolidation of the retail channel within the office products industry. * * * ISSUES THOUGHT TO BE NEAR-TERM. With regard to the superstores, we believe AP&P's sales disappointment relative to expectations relates to some near-term issues and that AP&P remains well positioned to grow these relationships longer term. Systems enhancements and a new distribution system at Staples are allowing that company to replenish store inventories more frequently and to carry lower levels of inventory. The transition to a permanently lower inventory level, now under way, should be a one-time reduction and normal reorder patterns should resume thereafter. As to Office Depot, - 94 - ------------------------------------------------------------------------ we believe that company has adopted a more conservative purchasing posture in view of the proposed merger with Staples; thus, orders can be expected to rebound once the merger is approved . . . . Another factor contributing to the lower-than- planned revenues is the March 1997 decline in uncoated free sheet prices initiated by the mills. We believe sales to paper merchants could be temporarily constrained by those customers delaying purchases in anticipation of further price declines. We note that price declines would impact top-line growth but would not necessarily be negative to profitability since AP&P's arrangements with customers allows it to manage gross profit dollars. GOOD MARGIN CONTROL LIMITS EPS SHORTFALL TO $0.01- 0.02. . . . We . . . continue to estimate full-year EPS in a range of $1.30-$1.35. For 1998, we maintain our EPS estimate range of $1.60-$1.65 . . . . WE BELIEVE AP&P IS POSITIONED TO BENEFIT FROM INDUSTRY CONSOLIDATION. * * * . . . We project compound annual EPS growth of 20% over the next 3-5 years, with 1997 and 1998 growth expected to exceed that level. 93. On 4/2/97, Bankers Trust/BT Securities issued a report on American Pad, written by Kanev, which upgraded American Pad to a "strong buy" and forecast 97 and 98 EPS of $1.15 and $1.40, as well as a 15% secular growth rate. Prior to issuing this report, analyst Kanev had discussions with Hanson and McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by Kanev from Hanson and McAleer. Kanev provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured Kanev it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, - 95 - ------------------------------------------------------------------------ thus adopting its statements and forecasts as its own. The report stated: * Since March 26th, AGP's shares have declined almost 40%, from $18 1/4 to an intraday low of $11 1/8, before recovering to close at $13 7/8 per share. . . . (W]e believe most of the decline stemmed from investors, anxiety over the lack of information coming from management over the past several days. * A press release late in the day yesterday allayed some concern when management pre-announced first quarter earnings of $0.15-$0.16 per share, below our (and consensus') estimate of $0.17 per share. Slightly lower- than-expected sales during the quarter resulted primarily from reduced orders from major superstores customers in anticipation of the proposed Staples/Office Depot merger; a $0.01 paper price increase in March also contributed to slightly lower margins. * We are revising our estimates accordingly, and forecast earnings of $1.15 in 1997 (vs. our previous $1.25 estimate) and $1.40 in 1998 (from $1.60). The old consensus estimates (as of yesterday) were $1.30 in 1997 and $1.63 in 1998. 94. As a result of these positive reassurances and forecasts of continued growth, American Pad's stock rallied to close at $13- 7/8 on 4/l/97 and started to move higher, reaching $19-7/8 on 5/7/97 and as high as $24-5/16 on 8/22/97, recovering virtually all the ground it had lost over the prior several months. 95. On 4/21/97, American Pad reported its actual 1stQ 97 results, revenues of $149.8 million, net income of $4.7 million and EPS of $.16 (excluding a consulting fee associated with the Niagara acquisition). The release stated: "We are satisfied with our performance in the first quarter, particularly considering the external business factors we experienced," commented Mr. Charles G. Hanson III, Chairman of the Board and Chief Executive Officer. "These included a substantial reduction of the planned flow of product to superstores due to the impact of consolidation activities and a more conservative inven- tory strategy by our customers due to the perceived softening of uncoated free sheet. Despite these - 96 - ------------------------------------------------------------------------ challenging market conditions we were able to maintain our gross profit margins." "Our ability to offer broad product lines, higher value added products national distribution capabilities, low costs and reliable service gives us a competitive advantage and strengthens our position as supplier of choice to giant customers," continued Mr. Hanson. * * * "Our acquisition pipeline is full," stated Mr. Hanson. . . . Mr. Hanson added, "We believe the factors impacting sales this quarter are short-term . . . . and believe we are strategically positioned to achieve our long-term goals." Later, American Pad filed its 1stQ 97 Report on Form 10-Q with the SEC signed by McAleer. The 10-Q reported the earlier released financial results and stated: Paper Prices. Paper represents a majority of the Company's cost of goods sold. . . . Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. The Company believes that it is able to price its products so as to minimize the impact of price volatility on dollar margins. Paper price volatility has and is expected to continue to have an effect on net sales and cost of sales. The 10-Q also stated that the increase "in inventories of $21.6 million [was] due to a buildup of inventory levels in anticipation of seasonal, promotional and new product sales in the second and third quarters." 96. On 4/21/97, American Pad held a conference call for large American Pad shareholders, money and portfolio managers, securities analysts, brokers and stock traders. During that call, Hanson, Gard and McAleer made presentations and answered questions and told participants they would be available to the individuals for follow- - 97 - ------------------------------------------------------------------------ up discussions. During the call and in follow-up one-on-one conversations with participants, Hanson, Gard and McAleer stated: • The 1stQ 97 softness was due to short-term/one-time "mechanical" issues which would be overcome in the second half of 97. Sell through of American Pad products and retail remained strong. • American Pad's fundamentals were intact and its business growth strategy was on track. • American Pad was able to maintain strong gross profit margins, despite lower retail prices and even in the face of paper price hikes to it. • The Shade-Allied acquisition would be accretive to 97 EPS. • American Pad's management was successfully controlling costs, especially in its Williamhouse Division, and thus expected EPS growth to exceed revenue growth. • The increase in American Pad's inventory levels was not due to softening demand, but the result of a decision to build up inventory levels in anticipation of strong 2ndQ and 3rdQ sales. • American Pad was still focused on making accretive acquisitions and would make acquisitions in the near term, which would boost its EPS. • There was no change in the fundamental growth characteristics of American Pad's business. American Pad still expected 12%-14% internally generated revenue growth and 25% on average EPS growth over the next three-five years. • American Pad expected to show at least 20% EPS growth sequentially during 97. • Due to short-term factors -- and not any significant problems with American Pad's business -- American Pad was still forecasting EPS growth in 97 and 98, with 97 EPS of $1.15-$1.25 (and very strong 3rdQ and 4thQ 97 EPS) and 98 EPS of $1.40-$1.70, with 15%-25% annual EPS growth going forward. 97. On 4/22/97, Morgan Stanley issued a report on American Pad, written by Missett, which was based on and repeated information from the 4/21/97 conference call and follow-up conversations with Hanson and McAleer. The report forecast five- - 98 - ------------------------------------------------------------------------ year EPS growth of 20%, 97 and 98 EPS of $1.25 and $1.70 and 97 quarterly results, as follows: Q1 $ .16A Q2 $ .18 Q3 $ .44 Q4 $ .47 Year $1.25 The report also stated: We are reiterating our Strong Buy rating on American Pad & Paper because we see no change in the underlying growth dynamics of AGP's core business. . . . the current valuation does not reflect the 20%-plus earnings growth that is likely to kick back in the second half of 1997. We believe that investors who can look through the industry-driven difficulties in 1H97 -- the uncertainty surrounding consolidation in the superstore channel and continued pressure on paper prices -- will be rewarded with strong double-digit top- and bottom-line growth in 2H97 and 1998. These industry issues put pressure on 1Q earnings, and this pressure will likely carry into the second quarter. However, we thinks these issues will be resolved by 2H97. More importantly, AGP has made significant inroads in increasing its penetration in the fast-growing office product distribution channels . . . the effects of which are expected to hit reported results in 2H97. * * * Reported 1Q EPS of $0.16 were in line with recently revised expectations . . . . The shortfall from original expectations came on the revenue line (revenue were $150 million vs. our original expectation of $162 million) and was caused by mechanical timing issues of customer reorders -- primarily due to the uncertainty surrounding consolidation in the superstore channel and continued pressure on paper prices -- and not any change in the underlying demand for AGP's products. . . . We are adjusting our 2Q EPS forecasts to reflect continued industry uncertainty in the near-term, but are retaining our strong growth outlook for 2H97 & 1998. Our 3Q and 4Q estimates suggest 2H97 EPS growth 34% over LY's proforma EPS. Our full-year 1997 EPS forecast is now $1.25, down from our previous $1.30. we are retaining our previous 1998 EPS forecast of $1.70. Revenue growth expected to accelerate in 2H97 due to increased penetration with core customer base . . . . * * * - 99 - ------------------------------------------------------------------------ Acquisition Pipeline is Full. Management is still very much focused on accretive acquisition opportunities, and announcements are likely over the next 12 months. . . . [W]e believe management is in negotiations with a number of candidates. 98. On 4/23/97, First Boston issued a report on American Pad, written by Romm, which was based on and repeated information from the 4/21/97 conference call and follow-up conversations with Hanson and McAleer. The report forecast five-year EPS growth of 20%, 97 and 98 EPS of $1.25 and $1.50 and 97 quarterly results, as follows: Q1 $ .16 Q2 $ .18 Q3 $ .41 Q4 $ .50 Year $1.25 The report stated: First quarter gross margin improved to 20.7% versus 19.2% despite weak sales since the shortfall in revenues was largely in machine papers and commodity envelopes, traditionally among the company's lowest margin products. Gross margin dollars should continue to improve in subsequent quarters, especially if the 6%-9% cutsize price increases that the paper mills announced for April and May actually hold. * * * Outlook The outlook for the remainder of the year is expected to improve significantly for the following reasons: The Shade-Allied acquisition is completed and the full integration of the company will result in $3.0 million in cost savings during the second half of the year. Third and fourth quarter performance will improve . . . . 99. On 4/24/97, Bankers Trust/BT Securities issued a report on American Pad, written by Kanev, which was based on and repeated information provided him by Hanson and McAleer in the 4/21/97 conference call and in later follow-up one-on-one conversations - 100 - ------------------------------------------------------------------------ with them. The report forecast 97 EPS at $1.15 and 98 EPS at $1.40 and estimated secular growth at 15+%. The report also stated: A strong gross profit margin of 20.7%, or 150 basis points higher than the year-ago quarter, offset relatively flat sales (up 1%) resulting mainly from reduced orders from major superstores as well as soft paper prices. We are maintaining our earnings forecast of $1. 15 in 1997 and $1.40 in 1998 . . . . * * * Based on the stock's attractive valuation and our 15% projected growth rate, we maintain a STRONG BUY recommendation. . . . Outlook Sales growth for the balance of 1997 will be closely linked to AGP's success in maintaining and expanding its relationships with its largest customers, which include superstores; over half of its are sales [sic] derived from its top 13 customers. We believe AGP is well- positioned to deepen these relationships, given its broad product line and competitive prices. Management indicated that the company will increase the number of different products it will supply to Wal-Mart to 121 in the second quarter from 73 in the first quarter, and that about half of the Wal-Mart chain will be carrying its products. AGP has a solid record in controlling costs, especially in the integration of its acquisitions. The company expects about $3 million in cost savings in 1997 after full integration of Shade-Allied (acquired in January). Finally, we believe management could announce another acquisition during the year, consistent with its intention to make one to two acquisitions per year. 100. The positive representations and statements made about American Pad by the defendants between 4/1/97 and 4/24/97, as pleaded in ¶¶89-99, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or - 101 - ------------------------------------------------------------------------ recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations and thus its business remained as exposed as ever to the adverse profit margin impact of such price fluctuations, but American Pad was concealing this by manipulating and falsifying its financial statements, including its cost of goods sold and LIFO reserves as detailed in ¶¶116-138; (b) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products as its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had failed; (c) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers and thus was continuing to be exposed to all the negative forces present in a highly competitive commodity product business, including the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; (d) That American Pad was neither uniquely nor well positioned to benefit from the consolidation going on at the retail level in the office paper products business, as it offered neither distinctive products nor did it have significant competitive - 102 - ------------------------------------------------------------------------ advantages, including purchasing advantages over major competitors in that marketplace; (e) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls, but rather was apparently meeting those goals by manipulating and falsifying its financial statements as detailed in ¶¶116-138; (f) That American Pad's 96 and 1stQ 97 financial statements were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (g) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, especially with respect to American Pad's financial and cost accounting systems; (h) That the ongoing consolidation of the office products retail channel into larger superstores, such as Staples and Office Depot, was a negative trend for American Pad because as smaller retail vendors were increasingly displaced by larger and more sophisticated enterprises, American Pad's ability to achieve increased sales was increasingly negatively impacted due to their sophisticated inventory management practices which reduced their inventory carry; (i) That the merger of Staples and Office Depot would and was having a material adverse impact on American Pad's business because of store consolidations and tighter inventory management practices which would decrease American Pad's sales to the surviving entity; - 103 - ------------------------------------------------------------------------ (j) That paper price hikes from its major suppliers in early 97 were having a material adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the manipulation of American Pad's LIFO reserve and thus falsification of its publicly reported financial results as detailed in ¶¶116-138; (k) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the deliberate manipulation of Williamhouse cost of sales as detailed in ¶¶116-138; (l) That American Pad's core Ampad paper products business was suffering from weak demand and sell through at the retail level, and its actual results were below American Pad's internal budgets or forecasts; (m) That the Shade-Allied acquisition would not immediately benefit American Pad's EPS as, due to consolidation issues and steps and weak sales of Shade-Allied products, it would not significantly advance American Pad's EPS for several months; (n) That the increased amount of inventories of American Pad's products was not the result of a deliberate decision to build out more product in anticipation of strong growth and/or increased seasonal demand in the coming quarters, but rather, because American Pad had accumulated millions of dollars of excessive inventory due to weak retail sell through of its products, both in - 104 - ------------------------------------------------------------------------ the Ampad and Williamhouse Divisions, significant amounts of which inventories would have to be written off or sold at unprofitable prices in the near term; (o) That American Pad's acquisition pipeline was not full nor was American Pad actively pursuing a number of acquisitions which had a reasonable probability of completion in the foreseeable future as, in fact, due to the increasingly serious internal business problems of American Pad, its executives had neither the time nor the ability to pursue significant acquisitions in the near term and no acquisition other than Shade-Allied would occur; (p) That as a result of these negative factors which were negatively impacting American Pad's results from operations, the defendants actually knew that the 97 and 98 EPS forecasts being made by and for American Pad were false when made, as such results were unachieveable; and (q) That as a result of these negative factors which were adversely affecting American Pad's results from operations, the defendants actually knew their forecasts of 20% EPS growth for American Pad over the next three-five years were false and misleading when made, as such EPS growth could not be achieved by American Pad. 101. On 7/16/97, American Pad reported extremely good 2ndQ 97 results -- net income of $5.4 million and EPS of $.18 (excluding a consulting fee associated with the acquisition of Niagara) -- ahead of expectations. The release stated: The Company also reported that operating margins for the six months improved to 11.4% . . . . - 105 - ------------------------------------------------------------------------ "I am encouraged by our results in the second quarter as we grew sales 12% over the first quarter by continuing to expand our customer base as well as increase distribution of innovative products to our existing customers," stated Charles G. Hanson III, Chairman and Chief Executive officer. * * * "We believe that the challenging market conditions experienced during the first half of the year have stabilized . . ." continued Mr. Hanson. "The Company is strategically positioned to benefit from the consoli- dation within the industry . . . . Later, American Pad filed its 2ndQ 97 Report on Form 10-Q with the SEC signed by McAleer. The 10-Q repeated the earlier reported 2ndQ 97 financial results and stated: Paper Prices. Paper represents a majority of the Company's cost of goods sold. . . . Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. The Company believes that it is able to price its products so as to minimize the impact of price volatility on dollar margins. Paper price volatility has and is expected to continue to have an effect on net sales and cost of sales. The 10-Q also attributed American Pad's increased inventories to "a buildup in anticipation of seasonal, promotional and new product sales in the second half of the year." 102. On 7/16/97, American Pad held a conference call for large American Pad shareholders, money and portfolio managers, securities analysts, brokers and stock traders. During that call, Hanson, Gard and McAleer made presentations and answered questions and told participants they would be available to the individuals for follow- up discussions. During the call and in follow-up one-on-one conversations with participants, Hanson, Gard and McAleer stated: • The industry conditions which had contributed to American Pad's soft 4thQ 96 and 1stQ 97 were due to short-term/one-time "mechanical" issues which had been overcome. American Pad - 106 - ------------------------------------------------------------------------ expected very strong growth in the second half of 97. Sell through of American Pad products and retail remained strong. • American Pad's fundamentals were intact and its business growth strategy was on track. • American Pad was able to maintain strong gross profit margins even in the face of paper price hikes. American Pad had successfully passed on paper price increases in 97 to date. • American Pad's management was successfully controlling costs, especially in its Williamhouse Division, and thus expected EPS growth to exceed revenue growth. • The increase in American Pad's inventory levels was not due to softening demand, but the result of a deliberate decision to build up inventory levels in anticipation of much stronger 3rdQ and 4thQ sales. • American Pad was still focused on making accretive acquisitions and would make acquisitions in the near term, which would boost its EPS. • There was no change in the fundamental growth characteristics of American Pad's business. American Pad still expected 15%-25% EPS growth over the next three to five years. • American Pad expected to show at least 20% EPS growth sequentially during 97. • Due to short-term factors -- and not any significant problems with American Pad's business -- American Pad was still forecasting EPS growth in 97 and 98, with 97 EPS of $1.21-$1.30 (and very strong 3rdQ and 4thQ 97 EPS) and 98 EPS of $1.50-$1.70, with 15%-25% annual EPS growth going forward. 103. On 7/17/97, Alex. Brown issued a report on American Pad, written by Vroom, entitled "F2Q RESULTS CONFIRM EFFECTIVE STRATEGY" which was based and repeated statements from the 7/16/97 conference call and follow-up conversations with Hanson and McAleer. The report forecast 97 EPS of $1.21 and 98 EPS of $1.50, and 97 quarterly EPS as follows: 1Q $ .16 2Q $ .18 3Q $ .41 4Q $ .46 Year $1.21 - 107 - ------------------------------------------------------------------------ The report stated: Details of Wednesday's conference call . . . follow. HIGHLIGHTS: AP&P reported F2Q 1997 EPS of $0.18, one cent ahead of both our estimate and F2Q 1996's performance. -- Revenues, at $167 million, advanced 19% over F2Q 1996 pro forma revenues; on an actual basis, revenues climbed 47% year-over-year, evidencing excellent progress selling into the most important retail segments. * * * -- The Company has successfully passed on paper price increases to its customers since implementing its pricing policy in January 1995, thereby mitigating the gross profit risk normally associated with such commodity fluctuations. -- Integration of the Shade-Allied acquisition is complete and results are exceeding the Company's cost- cutting objectives. * * * -- The F2Q 1997 performance is indicative of the successful strategy and we remain optimistic about AP&P's long-term growth prospects; we maintain our "buy" investment rating. ANALYSIS: GOOD SALES AND OPERATING PERFORMANCE UNDERSCORE SUCCESSFUL STRATEGY. F2Q sales advanced $27 million, or 19%, on a pro forma basis and 47% on an actual basis, as the Company's 3-pronged growth strategy--aligning itself with the fastest growing retailers, increasing penetra- tion of those accounts, and consolidating the supply channel to broaden its own scale, distribution reach and product offering--continued to be effective. . . . . . . In addition to carefully controlling SG&A expenses, cost cutting objectives related to the Shade- Allied integration were ahead of expectations. That integration is now virtually complete and the higher level of savings should be sustainable, in our view. PAPER PRICE ENVIRONMENT AND PRICING POLICY POSITIVE FOR AP&P. Given AP&P's policy of passing price increases on to customers quickly, the current environment of stable to rising paper prices is positive to AP&P's top- line growth. . . . We project 28% top-line growth in 2H 1997 over 2H 1996, driving a similar rate of EPS growth. - 108 - ------------------------------------------------------------------------ 104. On 7/17/97, First Boston issued a report on American Pad, written by Romm, which was based and repeated statements from the 7/16/97 conference call and follow-up conversations with Hanson and McAleer. The report forecast 97 EPS of $1.25 and 98 EPS of $1.50, and 97 quarterly EPS as follows: 1Q $ .16A 2Q $ .18A 3Q $ .41 4Q $ .50 Year $1.25 The report stated: AGP is also benefitting from the continuing consolidation in the office products industry, as the company's strong distribution operation, multiple product line and low costs makes it the preferred supplier to the key growth channels of the business. AGP is tightly controlling its costs . . . . With this greater focus on controlling costs, AGP is positioning itself as a low cost supplier to the large players in the business. The company is also improving its production and distribution . . . . Outlook for the Balance of the Year We expect . . . net income levels to accelerate in the second half of 1997. The company indicated that Q3 revenues could be as much as 30% higher than Q2 revenues or in excess of $200 million. We expect this trend to continue into the fourth quarter leading to total net revenues in the $700-775 million range. Gross margins will continue to trend in the 21% range as higher prices instituted by the major paper companies during the second quarter and into the third quarter appear to be holding. Tighter supply of uncoated free sheet paper is expected to raise prices again in August, it has been American Pad & Paper strategy to pass along the higher cost of paper at the time of invoice. The net effect is that margins tend to lag in a rising paper market although the dollar profit margin remains the same. We believe that with AGP's focus on SG&A and tight controls of its variable costs, net income should increase to the $36.8 million level, a growth rate of 23% year over year. Our earnings per share estimate of $1.25 remains in effect . . . . Comment on 1998 Outlook - 109 - ------------------------------------------------------------------------ The company's revenue and net income momentum will accelerate in the second half of 1997 [and] should carry into 1998. We are maintaining an aggressive forecast of $1.50 for full year 1998 on revenues of $855 million. AGP continues to focus intensely on acquisitions, as it anticipates further consolidation in the office supplies industry. The company will continue to look for acquis- itions in machine papers, filing products and envelopes. . . . We believe that AGP has done an excellent job in integrating its acquisitions and making them accretive to earnings, as evidenced by the recent transactions of Niagara Envelope and Shade Allied. While the first half of 1997 has started slowly because of the aborted merger of Staples and Office Depot we believe that revenues and net income momentum is building as we enter the second half of 1997. The company's strategy continues to be very focused and should produce excellent earnings results over the next several quarters and into the new calendar year. 105. On 7/18/97, Morgan Stanley issued a report on American Pad, which was based on and repeated statements from the 7/16/97 conference call and follow-up conversations with Hanson and McAleer. The report was entitled "ON TRACK FOR STRONG SECOND HALF," and forecast 97 and 98 EPS $1.25 and $1.70, a 20% five-year EPS growth rate and 97 quarterly EPS as follows: Q1 $ .16A Q2 $ .18A Q3 $ .44 Q4 $ .47 Yr $1.25 The report stated: We reiterate our Strong Buy rating, based on our continued belief that AGP is well positioned to take advantage of supplier consolidation in the office products arena. The company continues to align itself with the strongest and fastest-growing distributors of office products, which we believe will set the stage for sustained sales and earnings growth and future acquisitions. * * * 2Q results reinforce our confidence in AGP's ability to produce accelerated sales and earnings growth in the second half of 1997. - 110 - ------------------------------------------------------------------------ The industry issues that affected EPS growth in the first half of 1997 -- falling paper prices, customer inventory reductions, and uncertainty relating to the merger between Office Depot and Staples -- should have little or no effect on 2H results, further increasing our confidence in AGP's prospects for accelerated growth in the second half. * * * . . . Management says it remains very focused on pursuing acquisitions that will augment or extend their product line offerings. Summary and Investment Conclusion We reiterate our Strong Buy rating because we continue to see strong underlying growth dynamics in AGP's core business -- it continues to increase its market share among its top 13 customers -- and we believe the current valuation does not reflect the 20%-plus earnings growth that is likely to kick back in during 2H97. The 2Q results reinforced our confidence in AGP's ability to produce accelerated sales and earnings growth in the second half of 1997. . . . . . . The office product superstore retailers are intensifying their focus on inventory efficiency -- primarily by consolidating purchases with fewer vendors --.which should benefit the strong, national players such as AGP. AGP is well positioned to take advantage of supplier consolidation in the office products arena. * * * . . . We expect 2H gross margins to rebound to the 21-22% range due to favorable mix shifts (sales of new, higher-margin machine paper SKUs begin to roll into results) and manufacturing efficiencies. . . . . . . AGP had above-plan inventory levels going into the second quarter, due to 1Q sales shortfalls. In addition, AGP had to build up inventories to support the roll-out of its new product programs with Wal-Mart. Inventories totaled $144 million at the end of 2Q, up 37% from year-end. We believe that these inventory levels are in line with the accelerated sales growth we expect to see in 3Q and 4Q. Earnings Outlook Our EPS forecasts are unchanged and reflect our expectation of a resumption of strong growth in 2H97 and 1998. Our 3Q and 4Q estimates suggest 2H97 EPS growth of 34% over last year's pro forma EPS. We are maintaining - 111 - ------------------------------------------------------------------------ our current full-year estimates of $1.25 and $1.70 for 1997 and 1998, respectively. Revenue growth expected to accelerate in 2H97, due to increased penetration with core customer base and resolution of nagging industry issues. 106. On 8/l/97, Morgan Stanley issued a report on American Pad, written by Sheelagh McCaughey, which continued to forecast 97 and 98 EPS of $1.25 and $1.70 and 3rdQ and 4thQ 97 EPS of $.44 and $.47, along with a 20% five-year EPS growth rate. Prior to issuing this report, McCaughey had discussions with Hanson and/or McAleer about the current state of American Pad's business and its future prospects. The information in the report was obtained by McCaughey from Hanson and McAleer. McCaughey provided a draft of this report to Hanson and McAleer before it was issued so they could review it for accuracy. Hanson and McAleer reviewed the report before it was issued and assured McCaughey it was accurate. After the report was issued, American Pad copied and publicly distributed copies of this report, thus adopting its statements and forecasts as its own. The report stated: Reiterating Strong Buy rating * * * Maintaining current earnings estimates. Importantly, we remain comfortable in our above-consensus EPS forecast of $1.70 for 1998. Fundamental trends remain strongly in place, . . . office product distributors are aggregating their purchases with fewer suppliers; AGP continues to strengthen its relationships with the fastest growing distributors; and industry issues that clouded performance in 1H97 appear to be clearing. Recently reported (July 16th) 2Q results reinforced our confidence in AGP's ability to produce accelerated sales and earnings growth in the second half of 1997. - 112 - ------------------------------------------------------------------------ Management remains very focused on acquisition opportunities. DETAILS: Summary and Investment Conclusion We reiterate our Strong Buy rating, based on our continued belief that AGP is well positioned to take advantage of supplier consolidation in the office products arena. The office product retailers are intensifying their focus on inventory efficiency -- primarily by consolidating purchases with fewer vendors - which should benefit the strong, national players such as AGP. . . . We believe the current valuation does not reflect the 20%-plus earnings growth that is likely to kick back in during 2H97. Recently reported 2Q results reinforced our confidence in AGP's ability to produce accelerated sales and earnings growth in the second half of 1997. Second-half results likely will be driven by improving industry fundamentals and important new products and customer mandates. . . . We believe that earnings growth will accelerate sharply in 30 (likely up 47%) and that this will significantly re-anchor investor confidence in AGP's ability to post 20%-plus earnings growth. Earnings Outlook Our EPS forecasts are unchanged and reflect our expectation of a resumption of strong growth in 2H97 and 1998. Our 3Q and 4Q estimates suggest 2H97 EPS growth of 34% over last year's pro forma EPS. Our full-year 1997 EPS forecast remains $1.25, a 23.5% increase over P1996 EPS of $1.01. More important, we remain comfortable with our above-consensus EPS forecast of $1.70 for 1998, which suggest 36% growth. 107. As a result of American Pad's apparently very strong and above expectation 2ndQ results and the defendants' very favorable statements, assurances and forecasts, American Pad's stock climbed to $24-15/16 on 8/22/97, back to close to its all-time high of $26-1/2. 108. The positive representations and statements made about American Pad by the Defendants between 7/16/97 and 8/l/97, as pleaded in ¶¶101-106, were each known to be, or were recklessly - 113 - ------------------------------------------------------------------------ disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully implemented a new pricing strategy which would protect its gross dollar profit margins from paper price fluctuations and thus its business remained as exposed as ever to the adverse profit margin impact of such price fluctuations, but American Pad was concealing this by manipulating and falsifying its financial statements, including its cost of goods sold and LIFO reserves as detailed in ¶¶116-138; (b) That American Pad was not significantly improving its business or profitability by the successful introduction of distinctive value-added products as its office paper products business remained one where virtually all its products were commodities and American Pad's attempt to develop distinguishing characteristics for new products to boost its profitability had failed; (c) That paper price hikes from its major suppliers in early 97 were having a material adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by the manipulation of American Pad's LIFO reserve and thus falsification of its financial results as detailed in ¶¶116- 138; (d) That American Pad's 96 and 1stQ and 2ndQ 97 financial statements were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; - 114 - ------------------------------------------------------------------------ (e) That American Pad had no significant competitive strengths different from, or advantages over, other large integrated paper office products suppliers and thus was continuing to be exposed to all the negative forces present in a highly competitive commodity product business, including the adverse impact of retail price declines on its profits and the adverse impact of price increases on its raw materials; and (f) That American Pad was not meeting its profitability goals due to strong product sales or tight cost controls as represented, but rather, was meeting those goals by manipulating and falsifying its financial statements as detailed in ¶¶116-138. 109. On 9/15/97, American Pad suddenly revealed that instead of the strong 3rdQ and 4thQ 97 revenue and EPS growth defendants had been forecasting it would achieve, American Pad would at best achieve flat revenues and would suffer a sharp decline in EPS during those quarters. American Pad's stock dropped sharply falling from $24-3/8 per share on 9/15/97 to $11-1/2 per share over the next five trading sessions as investors reacted to these startling revelations. However, because the American Pad Defendants did not make full and complete disclosure of the true nature and extent of the adverse facts which they knew were impacting American Pad's business, American Pad's stock continued to trade at artificially inflated prices throughout the balance of the Class Period. For instance, American Pad continued to forecast in private discussions with analysts 97 EPS of $.48-$.52, that even with the disappointing 3rdQ and 4thQ 97 results the Company would be profitable in both of those quarters and achieve 97 EPS of $.48- $.52 per share, while representing that the Company's long-term - 115 - ------------------------------------------------------------------------ growth prospects remained intact. However, all these statements were false. In fact, American Pad was losing money from its operations and would suffer losses in the 3rdQ 97 although it disguised and concealed this loss by manipulating and falsifying its financial statements as pleaded in ¶¶116-138. In addition, due the severity of the problems impacting American Pad's business, there was no basis whatsoever to forecast profitability in the 4thQ 97 or fiscal 9 either, as, in fact, American Pad would suffer losses in those periods. Thus, American Pad's stock continued to trade at inflated prices throughout the balance of the Class Period. 110. On 10/22/97, American Pad reported its actual 3rdQ 97 results -- revenues of $176.5 million, net income of $1.6 million and EPS of $.06. The release stated: Mr. Hanson added, "Despite the current challenging market conditions, we remain confident that our strategy of offering broad product lines, higher value-added products, national distribution capabilities and reliable services positions us for the long-term as the supplier of choice to the office supply retailers." 111. On 10/22/97, American Pad held a conference call for large American Pad shareholders, money and portfolio managers, securities analysts, brokers and stock traders. During that call, Hanson and McAleer made presentations and answered questions and told participants they would be available to the individuals for follow-up discussions. During the call and in follow-up one-on-one conversations with participants, Hanson and McAleer stated: • American Pad was still focused on making accretive acquisitions and would make acquisitions in the near term, which would boost its EPS. • American Pad still expected 12%-14% internally generated revenue growth and EPS growth over the next three-five years. - 116 - ------------------------------------------------------------------------ • American Pad expected to report 4thQ 97 EPS of $.10-$.12 and a profit for all of 97 of $.48-$.52. • American Pad was still forecasting EPS growth in 98 to $.70-$.80 with 15%-25% annual EPS growth going forward. 112. On or about 11/14/97, American Pad filed its Report on Form 10-Q for the quarter ended 9/30/97, which reported the same 3rdQ 97 financial results announced earlier. The 10-Q also stated: Paper Prices. . . . Beginning in January 1995, the Company adopted new pricing policies enabling it to set product prices consistent with the Company's cost of paper at the time of shipment. The Company believes that it is able to price its products so as to minimize the impact of price volatility on dollar margins. Paper price volatility has and is expected to continue to have an affect on net sales and cost of sales. * * * As part of the Company's expected growth in the near term and in connection with certain potential acquisitions which may be completed in the next year, the Company has commenced discussions with its lenders to increase the amount of borrowing capacity available under the revolving credit agreement and to modify certain debt covenants. The Company has been given preliminary oral indications the results of such discussions will be favorable. 113. The positive representations and statements made about American Pad by the defendants between 9/15/97 and 1/14/97, as pleaded in ¶¶109-112, were each known to be, or were recklessly disregarded by defendants as being, false and misleading when made. The true facts, which the defendants knew but intentionally or recklessly concealed -- and disclosure of which was necessary to make the statements made not misleading -- were: (a) That American Pad had not successfully integrated the Williamhouse/Niagara acquisitions as represented and, in fact, American Pad was incurring significant and persistent difficulties in integrating their operations into American Pad's business, - 117 - ------------------------------------------------------------------------ especially with respect to American Pad's financial and cost accounting systems; (b) That American Pad's 3rdQ 97 financial statements were materially misleading as they were manipulated and falsified as detailed in ¶¶116-138; (c) That sales of Williamhouse envelope products were below levels internally forecasted or budgeted due to intensive competition and American Pad was being forced to sell those products at reduced prices in order to move inventory, which was having an adverse impact on American Pad's actual results of operations, which adverse impact was being concealed by defendants' deliberate manipulation of Williamhouse cost of sales to conceal this negative impact; (d) That American Pad was not in discussions with its lending banks regarding revisions to bank lending agreements to facilitate its growth in the near term as, in fact, American Pad's business was not growing, but stagnating or contracting, and that the discussions with the lending banks resulted from the serious decline in American Pad's financial condition which placed it on the verge of violation of its bank lending covenants and which American Pad's insiders and the banks knew, given American Pad's actual results from operations, i.e., losses rather than profits, meant that American Pad was already in violation of its bank lending covenants or soon would be and would require waivers from its lenders to continue operations; and (e) That as a result of these negative factors which were impacting American Pad's results from operations, the defendants actually knew that the 4thQ 97, full-year 97 and 98 - 118 - ------------------------------------------------------------------------ forecasts being made by and for American Pad were false when made, as such results were unachieveable. 114. On 11/3/97, American Pad announced its CFO McAleer had resigned "in order to pursue other interests." On 11/10/97, knowing that American Pad had been falsifying its reported financial results for several quarters and that this would shortly be exposed, Hanson and Gard each sold off 50,000 shares of their American Pad stock -- 20% of the stock they actually owned at $13 per share -- allowing them each to pocket $650,000 in illegal insider-trading proceeds. These sales took place when Hanson and Gard were forecasting that American Pad would achieve 4thQ 97 profits and 97 EPS of $.48-$.52, when they in fact knew the company's financial results to date in 97 had been phony and American Pad would in fact suffer a huge loss in the 4thQ 97 and a loss for 97 as a whole. 115. On 12/17/97, American Pad revealed it would suffer a huge 4thQ 97 loss of $.46-$.50 per share -- a loss so large that it would suffer a loss for the full year 97 as well. The loss was due, in part, to millions in accounting charges to increase American Pad's LIFO reserve to reflect the impact of paper price increases during 97 and adjustments to American Pad's cost of goods sold. American Pad revealed it had not been able to increase prices and, in fact, had been discounting product to sell it. American Pad's stock price declined sharply on these revelations from $12 per share on 12/16/97 to $7-3/4 on 12/18/97, from which level it has not recovered. As one analyst commented on 12/19/97: We are disappointed in AMPAD's inability to at least meet their own targeted expectations, let alone those of the investment community. We believe that it will take some - 119 - ------------------------------------------------------------------------ time for the company's credibility to be restored, in view of their recent history. AMPAD will have to demonstrate that its business is once again on a growth curve before the stock can outperform the market. We believe this will take several months, if not longer . . . . AMERICAN PAD'S FALSE FINANCIAL REPORTING DURING THE CLASS PERIOD 116. In order to overstate the Company's gross margin, net income and EPS, the defendants caused the Company to misreport its inventory (particularly at the Williamhouse Division) and understate American Pad's costs of sales, thereby overstating the company's earnings during 96 and the first three quarters of 97. As a result of American Pad's improper recording of costs of sales at the Williamhouse Division and American Pad's unreasonable estimates of its LIFO reserve in the face of price increases during 97, American Pad presented materially false financial results during the Class Period in violation of GAAP. 117. American Pad reported the following financial results during the Class Period: Q2 96 Q3 96 Q4 96 Revenues $114.1 M $173.6 M $176.0 M Net Income (Loss) $ 0.7 M* $ 6.9 M* $ 10.5 M EPS $ 0.02 * $ 0.24 * $ 0.36 Q1 97 Q2 97 Q3 97 Revenues $149.8 M $167.2 M $176.5 M Net Income $ 4.0 M $ 4.7 M $ 1.6 M EPS $ 0.14 $ 0.16 $ 0.06 * Earnings before extraordinary charges for losses on extinguishment of debt. 118. American Pad later included its annual 96 results in a Form 10-K and its quarterly results in Forms 10-Q for 96 and 97 which were filed with the SEC. The Form 10-K included a report - 120 - ------------------------------------------------------------------------ entitled "Responsibility for the Consolidated Financial Reports" which was signed by Hanson and McAleer, and represented that the Company management is responsible for the preparation, accuracy and integrity of the consolidated financial statements and other financial information included in this Annual Report. This responsibility includes preparing the statements in accordance with generally accepted accounting principles and necessarily includes estimates that are based on management's best judgments. 119. The Forms 10-Q represented that with respect to the financial statements included therein, such financial statements included all adjustments necessary "for a fair presentation" of American Pad's financial results and financial position. 120. These statements were false and misleading as to the financial results released during the Class Period as such financial information was not prepared in accordance with GAAP, nor did the financial information "present fairly" the Company's operations due to the Company's improper accounting for its inventory and costs of sales, which improper accounting caused the Company's earnings to be materially overstated in violation of GAAP and SEC rules. 121. GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. Regulation S-X (17 C. F.R. §210.4-01(a)(1)) states that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate. Regulation S-X requires that interim financial statements must also comply with GAAP, with the exception that interim financial statements need not include disclosure which would be duplicative of - 121 - ------------------------------------------------------------------------ disclosures accompanying annual financial statements. 17 C.F.R. §210.10-01(a). 122. GAAP, as set forth in Accounting Research Bulletin No. 43, Chapter 4, Statement 2, states: A major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues. 123. American Pad utilized the LIFO method to account for the cost of its inventory, which meant that during times of rising prices, American Pad should have experienced higher costs of sales. SEC Accounting Series Release No. 293 states: LIFO is an inventory pricing method based on a flow- of-cost assumption that the last item purchased is the first item sold. In times of rising prices, LIFO generally results in higher current costs being charged against income, while older, lower costs are retained in inventory. Of the two fundamental reasons for using LIFO, one is oriented toward financial accounting and the other is income tax oriented. From the standpoint of financial accounting, proponents of LIFO argue that, by charging to expense those costs which more closely reflect the replacement cost of inventory, LIFO tends to reduce the illusionary profits obtained from merely holding inventories and thereby reflects more accurately the "true" income of a company. 1981 SEC LEXIS 1151, at *2 (7/2/81). 124. A LIFO reserve is defined as: "the difference between (a) inventory at the lower of LIFO cost or market and (b) inventory at replacement cost or at the lower of cost determined by some acceptable inventory accounting method (such as FIFO or average cost) or market." AICPA Issues Paper, Identification and Discussion of Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories, 12-24 (11/30/94).2 ___________________ 2 The SEC has endorsed this Issues Paper. Staff Accounting Bulletin, No. 58 (3/19/85). - 122 - ------------------------------------------------------------------------ 125. GAAP also requires that the information presented be reliable. See FASB Statement of Concepts No. 2, ¶¶58-59. FASB Statement of Concepts No. 2 defines reliability as: The quality of information that assures that information is reasonably free from error and bias and faithfully represents what it purports to represent. 126. In violation of GAAP, American Pad improperly reported its inventory in 96 and 97, and failed to adequately record its costs of sales, thereby artificially inflating its earnings, due to the following: (a) Soon after acquiring Williamhouse in 95, the Individual Defendants learned that Williamhouse's reporting system for cost of goods sold was inadequate and produced unreliable and faulty results. Thus, the Company determined to implement a new reporting method for the Williamhouse Division. However, during 96 and 97, the Company was unsuccessful in implementing the new system, and Williamhouse continued to under report its costs of sales. Nevertheless, the Company failed to properly adjust for this problem and consolidated Williamhouse's under-reported costs of sales into the Company's costs of sales. In this way, American Pad overstated its gross profit and net earnings; and (b) American Pad's inventory method (LIFO) required the Company adjust its inventory and costs of sales to account for price increases, through the Company's estimates of its "LIFO reserve." During the Class Period, American Pad experienced at least three price increases which should have resulted in American Pad's LIFO reserve increasing, with a corresponding charge against earnings. Nonetheless, American Pad actually reduced its LIFO - 123 - ------------------------------------------------------------------------ reserve and created a negative reserve in order to overstate its earnings. Note the trend in American Pad's LIFO reserve balance: [Chart 3 of 3] - 124 - ------------------------------------------------------------------------ 127. In fact, by eliminating the LIFO reserve at 12/31/96 and creating a negative reserve, the Individual Defendants added $8.05 million in gross profit and pretax earnings to American Pad's quarter and fiscal year ended 12/31/96. The increase of American Pad's earnings before taxes of $8.05 million for the quarter caused American Pad's reported gross margin to be 23.2% for the quarter versus a disastrous 18.7%, an increase of 24%. The Individual Defendants then misled analysts as to the reasons for American Pad's excellent gross profit margin. A First Boston report dated 2/19/97 stated: The gross margin for the fourth quarter was 23.2% versus 20.9% last year. This increase of 230 basis points was largely due to a change in product mix to higher margin upgraded products versus lower margin commodity products. 128. The Individual Defendants falsely attributed the increase in American Pad's gross profit in the 4thQ 96 to favorable product mix, when it was solely the result of accounting manipulations involving the pricing of American Pad's ending inventory. The effect of this LIFO reserve manipulation was material at 12/31/96 and as such, disclosure was required in American Pad's MDA for 12/31/96. 129. The Individual Defendants manipulated American Pad's LIFO reserve during the Class Period by reducing it to zero and creating a negative reserve. The LIFO reserve is normally utilized to reduce a company's ending inventory value, determined on a FIFO basis to LIFO costing. The LIFO method of valuation utilizes a cost flow assumption whereby a product's most recent cost is the amount charged to cost of sales, and the unit's older pricing is used to cost out the ending inventory. Therefore in an environment - 125 - ------------------------------------------------------------------------ of rising prices, such as that experienced by the paper industry for years, a Company's ending inventory under LIFO is valued at a much lower cost, since the most recent higher priced products have been relieved from inventory leaving the older lower priced units. In an environment of rising prices, American Pad's LIFO reserve should have increased, not have been eliminated. Furthermore, the creation by American Pad of an inventory valuation higher than under FIFO should have caused the Individual Defendants to evaluate the inventory for write-downs to net realizable value since its cost would exceed market value. 130. Ultimately, however, in 4thQ 97, the Individual Defendants knew they would no longer be able to conceal their improper accounting, and announced that the Company would incur a special charge of $11.9 million, $5.9 million of which was to adjust its LIFO reserve for the price increases which had occurred during 97. The $11.9 million charge was also partially attributed to the Company's inability to successfully implement a new method of reporting costs of sales in the Williamhouse Division. 131. Due to the aforementioned accounting improprieties, the Company presented its financial results and statements in a manner which violated GAAP, including the following fundamental accounting principles: (a) The principle that interim financial reporting should be based upon the same accounting principles and practices used to prepare annual financial statements (APB No. 28, ¶10); (b) The principle that financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational - 126 - ------------------------------------------------------------------------ investment, credit and similar decisions was violated (FASB Statement Of Concepts No. 1, ¶34); (c) The principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and effects of transactions, events and circumstances that change resources and claims to those resources was violated (FASB Statement of Concepts No. 1, ¶40); (d) The principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it was violated. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general (FASB Statement of Concepts No. 1, ¶50); (e) The principle that financial reporting should provide information about an enterprise's financial performance during a period was violated. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance (FASB Statement of Concepts No. 1, ¶42); (f) The principle of completeness, which means that nothing is left out of the information that may be necessary to insure that it validly represents underlying events and conditions was violated (FASB Statement of Concepts No. 2, ¶79); - 127 - ------------------------------------------------------------------------ (g) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered was violated. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (FASB Statement of Concepts No. 2, ¶¶95, 97); and (h) The principle that inventory should be reported at the lower of cost or market was violated (ARB No. 43, Chapter 4). 132. Further, the undisclosed adverse information concealed by defendants during the Class Period is the type of information which, because of SEC regulations, regulations of the national stock exchanges and customary business practice, is expected by investors and securities analysts to be disclosed and is known by corporate officials and their legal and financial advisors to be the type of information which is expected to be and must be disclosed. AMERICAN PAD MANAGEMENT'S RESPONSIBILITY FOR, AND FAILURE TO, IMPLEMENT AND MAINTAIN ADEOUATE INTERNAL ACCOUNTING CONTROLS 133. American Pad had a responsibility to maintain sufficient accounting controls to accurately report its financial results. It is well settled that the representations made by a company in its financial statements and in other financial disclosures to the public are the representations of that company's management. Indeed, even when a company issues audited financial statements together with the report of that company's independent auditors, that report always expressly provides that "the financial statements are the responsibility of [the company's] management." - 128 - ------------------------------------------------------------------------ 134. According to SEC rules, to accomplish the objectives of accurately recording, processing, summarizing and reporting financial data, a company must establish an internal control structure. Pursuant to §13(b)(2) of the 1934 Act, American Pad was required to: (A) Make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; and (B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that -- (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary (I) to permit the preparation of financial statements in conformity with generally accepted accounting principles 135. Moreover, according to Appendix D to Statement on Auditing Standards No. 55, Consideration of the Internal Control Structure in a Financial Statement Audit ("SAS 55"), management should consider, among other things, such objectives as (i) making certain that "[t]ransactions are recorded as necessary . . . to permit preparation of financial statements in conformity with generally accepted accounting principles . . . [and] to maintain accountability for assets," and (ii) making certain that "[t]he recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences." 136. As described in SAS 55, the applicability and importance of specific control environment factors, accounting system methods and records, and control procedures that an entity should establish - 129 - ------------------------------------------------------------------------ should be considered within the context of such criteria as an entity's size, its organization and ownership characteristics, the nature of its business, the diversity and complexity of its operations, the entity's method of processing data, and its applicable legal and regulatory requirements. In short, the larger the entity, the more the nature of the entity's business is complex, diverse and sophisticated, and the public ownership of the entity customarily requires a sophisticated internal control structure to ensure that transactions are accurately recorded and that, prior to the public disclosure of any financial information, such transactions are compared to the existing assets (e.g., comparing inventory as recorded on a company's books to those amounts actually "on hand") to eliminate any discrepancies between the recorded and actual amounts. Since the price of paper was a key element of American Pad's business, it was incumbent on management to ensure that adequate controls were in place to account for its inventory and costs accurately. 137. According to SAS 55.13: Establishing and maintaining an internal control structure is an important management responsibility. To provide reasonable assurance that an entity's objectives will be achieved, the internal control structure should be under ongoing supervision by management to determine that it is operating as intended and that it is modified as appropriate for changes in conditions. 138. Contrary to the requirements of GAAP and SEC rules, American Pad failed to implement and maintain an adequate internal accounting control system. Since the beginning of 96, at the latest, American Pad management failed to implement adequate cost of goods sold controls to ensure that costs were properly recorded at the Williamhouse Division in compliance with GAAP. - 130 - ------------------------------------------------------------------------ THE AMERICAN PAD DEFENDANTS' STOCK SALES 139. American Pad's insiders and controlling shareholders issued false and misleading statements about American Pad's business for the purpose of selling their American Pad stock at inflated prices, selling over 16 million shares for proceeds of over $223 million, profiting from the artificial inflation of American Pad's stock price their fraud and illegal conduct had created. Notwithstanding their access to non-public information as a result of their positions with American Pad, the American Pad Defendants listed below sold the following amounts of American Pad shares at artificially inflated prices while in possession of material non-public information: Shares Aggregate Defendant Sold Proceeds --------- ------ --------- American Pad 12,500,000 $ 172,800,000 Bain Capital 3,467,148* $ 49,025,473 Gard 50,000 $ 650,000 Hanson 50,000 $ 650,000 ---------- ------------- GRAND TOTALS: 16,067,148 $ 223,125,473 ============= * Including over-allotment shares 140. Gard's and Hanson's sales of American Pad stock during the Class Period were unusual in timing and amount and inconsistent with their prior transactions in American Pad stock. Gard and Hanson each sold 50,000 shares during the Class Period. Neither of these defendants had ever sold any of their American Pad stock before. These stock sales occurred at suspicious times. By 11/97, knowing that American Pad had been falsifying its reported financial results for several quarters and that this would shortly be exposed, Hanson and Gard each sold off 50,000 shares of their American Pad stock -- 20% of the stock they actually owned at $13 - 131 - ------------------------------------------------------------------------ per share -- allowing them each to pocket $650,000 in illegal insider-trading proceeds. These sales took place when Hanson and Gard were forecasting that American Pad would achieve 4thQ 97 and 97 profits when in fact they knew the Company's financial status to date in 97 had been phony and American Pad would in fact suffer a huge loss in the 4thQ 97 and a loss for 97 as a whole. 141. The 7/2/96 IPO generated $172.8 million in needed cash for American Pad, salvaged the controlling shareholders' LBO of American Pad by generating $49 million in cash for Bain Capital and boosted the book value of the 12 million American Pad shares owned by Bain Capital, Hanson and Gard from a negative ($17.06) per share to ($3.61) per share -- a $13.45 per share increase in American Pad's book value -- a $160 million windfall for them. CLAIM FOR RELIEF I For Violation Of Section 10(b) Of The 1934 Act And Rule 10b-5 Against All Defendants 142. Plaintiffs incorporate by reference ¶¶1-141. 143. Each of the defendants: (a) knew or had access to the material adverse non-public information about American Pad's financial results and then existing business conditions, which was not disclosed; and (b) participated in drafting, reviewing and/or approving the misleading statements, releases, reports and other public representations of and about American Pad. 144. During the Class Period, defendants, with knowledge of or reckless disregard for the truth, disseminated or approved the false statements specified above, which were misleading in that they contained misrepresentations and failed to disclose material - 132 - ------------------------------------------------------------------------ facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. 145. Defendants violated §10(b) of the 1934 Act and Rule 10b-5 in that they: (a) Employed devices, schemes and artifices to defraud; (b) Made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (c) Engaged in acts, practices and a course of business that operated as a fraud or deceit upon plaintiffs and others similarly situated in connection with their purchases of American Pad common stock during the Class Period. 146. Plaintiffs and the Class have suffered damages in that, in reliance on the integrity of the market, they paid artificially inflated prices for American Pad stock. Plaintiffs and the Class would not have purchased American Pad stock at the prices they paid, or at all, if they had been aware that the market prices had been artificially and falsely inflated by defendants' misleading statements. CLASS ACTION ALLEGATIONS 147. Plaintiffs bring this action as a class action pursuant to Federal Rule 23(a) and (b)(3) on behalf of all persons who purchased American Pad stock during the Class Period. Excluded from the Class are defendants, members of their immediate families and any entity in which a defendant has a controlling interest. 148. The members of the Class are so numerous that joinder of all members is impracticable. The disposition of their claims in - 133 - ------------------------------------------------------------------------ a class action will provide substantial benefits to the parties and the court. During the Class Period, American Pad had more than 27 million shares of stock outstanding, owned by hundreds of shareholders. 149. There is a well-defined commonality of interest in the questions of law and fact involved in this case. The questions of law and fact common to the members of the Class which predominate over questions which may affect individual Class members include the following: (a) Whether the federal securities laws were violated by defendants; (b) Whether defendants omitted and/or misrepresented material facts; (c) Whether defendants' statements omitted material facts necessary to make the statements made, in light of the circumstances under which they were made, not misleading; (d) Whether defendants acted with scienter; (e) Whether the price of American Pad stock was artificially inflated during the Class Period; and (f) The extent of damage sustained by Class members and the appropriate measure of damages. 150. Plaintiffs' claims are typical of those of the Class because plaintiffs and the Class sustained damages from defendants' wrongful conduct. 151. Plaintiffs will adequately protect the interests of the Class and have retained counsel who are experienced in class action securities litigation. Plaintiffs have no interests which conflict with those of the Class. - 134 - ------------------------------------------------------------------------ 152. A class action is superior to other available methods for the fair and efficient adjudication of this controversy. 153. The prosecution of separate actions by individual Class members would create a risk of inconsistent and varying adjudications. STATUTORY SAFE HARBOR 154. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to any of the allegedly false forward-looking statements pleaded in this Complaint. Many of those statements were made in, or in connection with, American Pad's IPO. The Safe Harbor also does not apply to false financial statements. Also, none of the forward-looking statements pleaded herein were identified as "forward-looking statements" when made. Nor was it stated that actual results "could differ materially from those projected." Nor did meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statements accompany those forward-looking statements. Each of the forward-looking statements alleged herein was made by or authorized by an executive officer of American Pad, and was actually known by each of the Individual Defendants to be false when made. BASIS OF ALLEGATIONS 155. Because the PSLRA, §21D(c) of the 1934 Act [15 U.S.C. §78u-4(c)], requires complaints to be pleaded in conformance with Federal Rule of Civil Procedure 11, plaintiffs have alleged the foregoing based upon the investigation of their counsel, which included a review of American Pad's SEC filings, securities - 135 - ------------------------------------------------------------------------ analysts, reports and advisories about the Company, press releases issued by the Company, media reports about the Company, private investigations, and discussions with consultants, and, pursuant to Rule 11(b)(3), believe that after reasonable opportunity for discovery, substantial additional evidentiary support will likely exist for the allegations set forth herein. PRAYER FOR RELIEF WHEREFORE, plaintiffs pray for judgment as follows: 1. Declaring this action to be a proper class action pursuant to Rule 23(a); 2. Awarding plaintiffs and the members of the Class damages and post-judgment interest; 3. Awarding extraordinary, equitable, and/or injunctive relief as permitted by law, equity, and federal statutory provi- sions sued hereunder, pursuant to Rules 64, 65, and any appropriate state law remedies; and 4. Awarding such other relief as this Court may deem just and proper. JURY DEMAND Plaintiffs demand a trial by jury. DATED: March 10, 1998 STANLEY, MANDEL & IOLA, L.L.P. MARC R. STANLEY Texas State Bar No. 19046500 ROGER L. MANDEL Texas State Bar No. 12891750 /s/ ______________________________ ROGER L. MANDEL 3100 Monticello Avenue Suite 750 Dallas, TX 75205 Telephone: 214/443-4301 - 136 - ------------------------------------------------------------------------ Of Counsel: MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH California Bar No. 68581 ALAN SCHULMAN California Bar No. 128661 DARREN J. ROBBINS California Bar No. 168593 /s/ _____________________________ WILLIAM S. LERACH 600 West Broadway, Suite 1800 San Diego, CA 92101 Telephone: 619/231-1058 FINKELSTEIN & KRINSK, LLP HOWARD D. FINKELSTEIN California Bar No. 102964 JEFFREY R. KRINSK California Bar No. 109234 501 West Broadway, Suite 1250 San Diego, CA 92101 Telephone: 619/238-1333 BARRACK, RODOS & BACINE STEPHEN R. BASSER California Bar No. 121590 600 West Broadway, Suite 1700 San Diego, CA 92101 Telephone: 619/230-0800 Attorneys for Plaintiffs CASES\COMPLNTS\AMERP&P.CPT - 137 - ------------------------------------------------------------------------ CERTIFICATION OF NAMED PLAINTIFF PURSUANT TO FEDERAL SECURITIES LAWS Allan D. Zishka ("Plaintiff") declares, as to the claims asserted under the federal securities laws, that: 1. Plaintiff has reviewed the complaint and authorized its filing. 2. Plaintiff did not purchase the security that is the subject of this action at the direction of plaintiff's counsel or in order to participate in this private action. 3. Plaintiff is willing to serve as a representative party on behalf of the class, including providing testimony at deposition and trial, if necessary. 4. Plaintiff's transaction(s) in the security that is the subject of this action during the Class Period is/are as follows: # of American Pad Shares Transaction Date(s) Purchase/Sale Price ------------------------ ------------------- ------------------- 100 10/01/97 $ 12 3/4 5. During the three years prior to the date of this Certificate, Plaintiff has sought to serve or served as a representative party for a class in the following actions filed under the federal securities laws: None 6. Plaintiff has sought to serve or served as a representative party for a class in the following actions filed subsequent to December 22, 1995: None 7. Plaintiff will not accept any payment for serving as a representative party on behalf of the class beyond the Plaintiff's pro rata share of any recovery, except such reasonable costs and expenses (including lost wages) directly relating to the representation of the class as ordered or approved by the court. I declare under penalty of perjury that the foregoing is true and correct. Executed this 13 day of Feb. 1998, at _______________. /s/ ________________________ Allen D. Zishka ------------------------------------------------------------------------ CERTIFICATION OF NAMED PLAINTIFF PURSUANT TO FEDERAL SECURITIES LAWS Gerald R. Dailey ("Plaintiff") declares, as to the claims asserted under the federal securities laws, that: 1. Plaintiff has reviewed the complaint and authorized its filing. 2. Plaintiff did not purchase the security that is the subject of this action at the direction of plaintiff's counsel or in order to participate in this private action. 3. Plaintiff is willing to serve as a representative party on behalf of the class, including providing testimony at deposition and trial, if necessary. 4. Plaintiff's transaction(s) in the security that is the subject of this action during the Class Period is/are as follows: # of American Pad Shares Transaction Date(s) Purchase/Sale Price ------------------------ ------------------- ------------------- 200 Shares 7-1-96 15.00 5. During the three years prior to the date of this Certificate, Plaintiff has sought to serve or served as a representative party for a class in the following actions filed under the federal securities laws: None 6. Plaintiff has sought to serve or served as a representative party for a class in the following actions filed subsequent to December 22, 1995: None 7. Plaintiff will not accept any payment for serving as a representative party on behalf of the class beyond the Plaintiff's pro rata share of any recovery, except such reasonable costs and expenses (including lost wages) directly relating to the representation of the class as ordered or approved by the court. I declare under penalty of perjury that the foregoing is true and correct. Executed this 23 day of Feb. 1998, at _______. /s/ ________________________ Gerald R. Dailey Securities Class Action U.S.D.C. Robert Crown Stanford University Clearinghouse N.D. Cal. Law Library School of Law inquiries@securities.stanford.edu Source: Scanned paper copy of court-stamped document