R
/ L ~'~ UNITED STATES DISTRICT COURT Ir FOR THE NORTHERN DISTRICT OF ILLINOIS b EASTERN DIVISION MAR if 2004 Pc IN RE MIDWAY GAMES, INC. ) LITIGATION )) No. 03 C 6821 rc i T
THIS DOCUMENT RELATES TO : ) Judge Joan H. Lefkow ALL ACTIONS ) DOCKETED
NOTICE OF FILING MAR 0 9 2004
To: Counsel on the Attached Certificate of Service
PLEASE TAKE NOTICE that on March 8, 2004, we filed withthe Clerk of the United States
District Court for the Northern District of Illinois, Eastern Division, 219 South Dearborn Street ,
Chicago, Illinois the First Amended Consolidated Class Action Complaint, a copy of which is hereby served upon you.
DATED : March 8, 2004 By : Marvin A. Mil err Jennifer W. Sprengel Matthew E. Van Tine MILLER FAUCHER AND CAFFERTY LLP 30 North LaSalle Street, Suite 320 0 Chicago, Illinois 60602 (312) 782-4880
Liaison Counsel and Designated Local Counsel
Stuart L. Berman Andrew L. Zivitz Sean M. Handler SCHIFFRIN & BARROWAY, LLP Three Bala Plaza East, Suite 400 Bala Cynwyd, Pennsylvania 19004 (610) 667-7706
0 . ,
Samuel H. Rudman Russell J. Gunyan CAULEY GELLER BOWMAN & RUDMAN LLP 200 Broadhollow Road, Suite 200 Melville, New York 11747 (631) 367-7100
Attorneysfor Plaintiff
I C ERTIFICATE OF SERVIC E
I, Marvin A . Miller, one of plaintiffs attorneys, hereby certify that I caused the First Amended Consolidated Class Action Complaint to be served on all counsel on the attached service list by placing a copy of the same in the United States Mail at 30 North LaSalle Street, Chicago, Illinois this 8' day of March, 2004.
M 'n A. Miller yV
SERVICE LIST
Robert J. Kopecky Clinton A. Krislov Mark Nomellini Michael R. Karnuth Jeffrey J. Zeiger KRISLOV & ASSOCIATES, LTD. KIRKLAND & ELLIS LLP 20 North Wacker Drive 200 East Randolph Drive Suite 1350 Chicago, Illinois 6060 1 Chicago, Illinois 60606 (312) 861-2000 (312) 606-0500
Stuart L. Berman Andrew L. Zivitz Sean M. Handler SCHIFFRIN & BARROWAY, :LLP Three Bala Plaza East Suite 400 Bala Cynwyd, Pennsylvania 190(14 (610) 667-770 6
Samuel H. Rudman Russell J. Gunyan CAULEY GELLER BOWMAN & RUDMAN LLP 200 Broadhollow Road, Suite 20[ Melville, New York 11747 (631) 367-7100
William B. Federman FEDERMAN & SHERWOOD 120 N Robinson Avenue, Suite 2720 Oklahoma City, Oklahoma 7310:'. (405) 235-156 0
Carol V. Gilden Michael E . Moskovitz MUCH SHELIST FREED DErENBERG AMENT & RUBENSTIEN, P.C . 191 North Wacker Drive Suite 1800 Chicago, Illinois 60606 (312) 521-2403 UNITED STATES DISTRICT COURT P I FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION
IN RE MIDWAY GAMES, INC. ) cog llclf-q $ "700~ LITIGATION ) No. 03 C 6821 •S. Al~'t!
) ~'rn s
THIS DOCUMENT RELATES TO: ) Judge Joan H. Lefkow c~ ~T
ALL ACTIONS ) ) DOCKETED
FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT MAR 0 9 2004
Lead Plaintiffs (as define( .herein) have alleged the following against Midway Games, Inc.
("Midway" or the "Company") ani its senior management, Neil D. Nicastro, Thomas E. Powell and
Kenneth J. Fedesna (Nicastro, Powell and Fedesna are referred to herein collectively as "Individual
Defendants" and, with the Compau ty, "Defendants") based upon the investigation of Lead Plaintiffs' counsel, which included a review of United States Securities and Exchange Commission ("SEC")
filings by Midway, as well as regulatory filings and reports, press releases and other public statements issued by the Company, interviews with former employees of Midway and media reports about the Company. Lead Plaintif Cs believe that substantial additional evidentiary support will exist for the allegations set forth herein after a reasonable opportunity for discovery.
NATURE OF THE ACTION
1 . This is a federal securities class action brought on behalf of all purchasers of th e publicly traded securities of Midw ay, between December 11, 2001 and July 30, 2003 , inclusive (the
"Class Period"), seeking to recove r damages caused by Defendants' violations of federal securities laws and to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange Act").
-1- i
2 . Defendant Midway p .irportedly develops and publishes interactive entertainmen t
software. Historically, Midway's cor.; business was the coin-operated video game market . By 2001,.
the Company wound its coin-operated gaming operations down and began the transition to the home
video game market. The home video game industry is highly competitive and requires game
manufacturers to continuously introduce new titles . Accordingly, as a result of the Company's
decision to focus on the home video game market, Midway had to produce innovative, high-
technology games on a continuous basis and in a timely fashion .
3 . By the start of the Cla ss Period (which commences with Midway's sale of $60 million
of stock in apublic offering), however, as detailed herein, Defendants knew or recklessly disregarded
that the Company's entry into the home video gaming market was a complete disaster . During the
Class Period, Defendants conceale i the fact that Midway could not meet its publicly-announced
product release schedules. Indeed, according to numerous former employees of the Company,
Midway's production schedule w<
"warn" investors that Midway might not be able to complete production of its games in a timely
fashion, the true facts were much more severe and pronounced than Defendants' boilerplate warning s
- Midway was experiencing produ tion delays across virtually all of its product lines and the games
that it was producing were of pool quality.
4. Furthermore, the Company's inability to timely produce its titles placed it in a
precarious position, given the fast : -changing nature of the home video game market . As product
release deadlines came and wens, the market for video games and what was considered "hot"
changed radically . This dynamic placed the Company in a never-ending struggle to complete it s
games in a timely fashion. Often when the Company would belatedly complete a game and bring
-2- .k
it to market, the title was no longer in the "hot" segment of the market . Midway, however, was stil l
stuck with an inventory of the gam,: and its production costs for the game (which in many instances
it had already capitalized as an asset on its balance sheet, as detailed below).
5. Finally, Midway's inability to produce its games in a timely manner negatively
impacted the Company's revenues and earnings, thereby causing the Company to experience
declining demand for its products. By the start of the Class Period, as detailed herein , Defendants
knew, but concealed, that the Company was in financial trouble.
6. In order to conceal the financial impact of the foregoing problems for as long as
possible, Defendants engaged in ce fain improper and fraudulent accounting practices which violated
Generally Accepted Accounting Principles ("GAAP") as well as the Company's own stated
accounting policies .
Materially Understated Reserves For Returns And Price Protectio n
7. During the Class Period, Midway manipulated its reserves for product returns and
price protection in order to artificially inflate its reserves and earnings . Former Midway employees
confirmed that the Company materially understated necessary reserves for video game returns an d
price protection . Indeed, accorcing to one former Midway employee who was in charge o f
establishing reserves for product returns and client price protection, Midway senior managemen t
intentionally understated reserves in an effort to inflate its quarterly revenues and earnings ,
notwithstanding the employee's warnings to upper management that the reserves were too low .
Failure To Timely Writedown Capitalized Product Development Costs
8. In addition, Defendants failed to timely writedown Midway's ballooning capitalized
product development costs ("Cl'DC's"). CPDC's are costs associated with the research and-
-3- development of a video game once it has attained "technological feasibility," i.e., when the game
becomes a viable concept suit ib1e for mass production . The advantage of characterizing costs as
CPDC's rather than ordinary research and development expenses is that a company need no t recognize the CPDC's as expenses on its income statement until the game is released to the market ,
at which point the company may incrementally amortize the CPDC's.
9. In the event that Midway determines that a game previously deemed technologically
feasible is no longer commercially viable, they are required to record an immediate writedown o f the CPDC's attributable to that game.
10. As the Class Period progressed, the Company routinely missed production dates but the Company's CPDC's continl ed to climb . In truth and in fact, Midway should have been writing off the value of its CPDC's as it became clear that many of its titles were not commercially viable.
Although the Company purport .d to writedown the value of its CPDC's during the Class Period, those adjustments were inadequate given the Company's inability to produce its game titles in a timely fashion and the fact that the game titles that the Company did produce were of poor quality .
11 . Then, on April 29, 2003, DefendantNicastro assured investors that management had reviewed the Company's game pipeline for "commercial viability" and the Company would not b e taking any further writedowns of the CPDC' s with respect to games "released not just in 2003, but
2004." At the same time, Midway advised the market that it was commencing a private placemen t of 3,500 shares of Midway preferred convertible stock, thereby raising over $35 million in muc h needed working capital .
-4- 12. Less than two montl is later, on July 11, 2003, investors first learned that the Securities . and Exchange Commission ("SEC") was investigating the video gaming industry, including Midwa y concerning the manipulation of revenue reserves and CPDC's.
13. Forced to come clean, Midway revealed on July 29, 2003, that much ofits prospective game pipeline was not commercially viable and that the Company was writing down $23 million in-
CPDC's despite having explicitly told investors just 3 months earlier that the games were
"commercially viable" and no wri .-edown was forthcoming .
14. On July 30, 2003, in response to this announcement, the price of Midway stock plummeted almost 30%, or $0 .97 a share, to close at $2.42 per share, making Midway the bigges t percentage loser in the stock market that day. Additionally, the $2.42 closing price was a far cry from its Class Period high of $ 15 .80 reached on December 24, 2001 .
JURISDICTION AND VENUE
15. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) o f the Exchange Act, (15 U.S.C. §§ 78j(b) and 78t(a)), and Rule 1Ob-5 promulgated the reunder (1 7
C .F.R. § 240. 1Ob-5).
16. This Court has jurisdiction over the subject matter of this action pursuant to § 27 of the Exchange Act (15 U.S.C. § 7f aa) and 28 U.S.C. § 1331 .
17. Venue is proper in this Judicial District pursuant to § 27 of the Exchange Act, 1 5
U.S.C. § 78aa and 28 U .S .C. § 1391(b). Many of the acts and transactions alleged herein, including the preparation and disseminaticn of materially false and misleading information, occurred in substantial part in this District. Additionally, the Company maintains its principal executive offices in this Judicial District .
-5- 18. In connection with the acts, conduct and other wrongs alleged in this complaint, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, , including but not limited to, the United States mails, interstate telephone communications and th e facilities of the national securities -xchange .
THE PARTIE S
19. Lead Plaintiffs, William Lindesmith, Lance Coren, Paul Stanley Cobb, Jr ., Maurice-
W. Mihelich, and Leonard & Carol E. Willig, as trustees for the Willig Living Trust and as Joint
Tenants with Rights of Survivorship, ("Lead Plaintiffs or plaintiffs") purchased the common stock of Midway at artificially inflated prices during the Class Period and have been damaged thereby.
Copies of Lead Plaintiffs certifications previously filed with this court are incorporated herein by reference.
20. Defendant Midway, is a corporation organized and existing under the laws of
Delaware with its principal place of business located within this judicial district at 2704 Wes t
Roscoe Street, Chicago, IL 6061 8
21. Defendant Neil D . Nicastro ("Nicastro") was, until May 7, 2003, the Company's
President, Chairman, Chief Executive Officer, and Chief Operating Officer and from May 7, 200 3 through the end of the Class Period, Chairman.
22. Defendant Thoma: E. Powell ("Powell") was, at all relevant times during the Clas s
Period, the Company's Executive Vice President, Chief Financial Officer and Treasurer.
23 . Defendant Kennett J. Fedesna ("Fedesna") was, at all relevant times during the Class
Period, the Company's Executive Vice President--Product Development and Director .
-6- 1 -
24. It is appropriate to teat the Individual Defendants as a group for pleading purpose s and to presume that the false, misle,iding and incomplete information conveyed in Midway's publi c filings, press releases, and other cor amunications as alleged herein represented the collective actions of this group of defendants .
25 . The Individual Deft ndants, by virtue of their executive positions at Midway, directly participated in the management of the Company ; were directly involved in the day-to-day operations of the Company at the highest level ; and, had full access to non-public information concerning the
Company, its businesses, operation :,, growth, financial statements, and financial condition, as alleged herein. As senior management they were directly in control of and responsible for Midway's accounting practices and procedures; the review, accuracy and approval of Midway's financial statements; annual and periodic red ports filed with the SEC ; and, public statements about Midway's- earnings, financial results, and financial condition. The Individual Defendants, therefore, were required to be familiar with the di,, closure requirements of the federal securities laws and rules and with the financial condition, internal reports, and financial statements ofMidway . They participated in drafting, preparing, reviewing, approving, and disseminating the reports and statements alleged to be false and misleading herein, and approved and ratified those statements .
26. The Individual Def endants, had a duty to promptly disseminate accurate and truthful information with respect to the Ccmpany's operations, financial results, and financial condition, to correct any previously issued stai .ement that had become untrue, so that the market price of th e
Company's publicly traded securi :ies would be based upon truthful and accurate information . The
Individual Defendants' material misrepresentations and omissions during the Class Period violate d these requirements and obligatior .s.
-7- 4
27 . During the Class Period, each of the Individual Defendants, as senior executive
officers and/or directors of Midway, vas privy to non-public information concerning its business,
finances, products, markets and prese it and future business prospects via access to internal corporat e
documents, conversations and connections with other corporate officers and employees, attendance .
at management and Board of Directc•rs meetings and committees thereof and via reports and other
information provided to them in connection therewith . Because of their possession of such
information, the Individual Defendants knew or recklessly disregarded the fact that adverse fact s
specified herein had not been disclosed to, and were being concealed from, the investing public .
28 . Each of the Individual Defendants is liable as a direct participant with respect to a
fraudulent scheme and course of bus iness that operated as a fraud or deceit on purchasers of Midway
publicly traded securities by disscminating mate rially false and misleading statements and/or
concealing material adverse facts . The scheme deceived the investing public regarding Midway's-
business, operations, management, and the intrinsic value of Midway publicly traded securities and
caused Plaintiff and other members of the Class to purchase Midway securities at artificially inflated
prices.
29 . In addition, the Ind vidual Defendants, by reason of their status as senior executiv e
officers and directors were each z . "controlling person" within the meaning of Section 20 of th e
Exchange Act and had the power and influence to cause the Company to engage in the unlawful
conduct complained of herein . Bemuse of their position of control, the Individual Defendants were
able to and did, directly or indirectly, control the content of various SEC filings, press releases, and
other public statements pertaining to the Company during the Class Period.
_8_ ti.
30. The Individual Defendants, because oftheir positions with Midway were provided-
with copies of Midway's reports and press releases alleged herein to be misleading, prior to o r
shortly after their issuance and had be th the ability and opportunity to prevent their issuance or cause
them to be corrected . The Individual Defendants had the opportunity to commit the fraudulent act s
alleged herein. Accordingly, each of the Individual Defendants is responsible for the accuracy of the
public reports and releases detailed aerein and is therefore primarily liable for the representation s
contained therein.
31 . The Individual Defendants are liable, jointly and severally, as direct participants in
and co-conspirators of, the wrongs ,omplained of herein .
SUBSTANTIVE ALLEGATIONS
Backeround
32 . Defendant Midway claims to be a leading developer and publisher of interactiv e
entertainment software. Prior to July 2001, Midway developed coin-operated ("coin-op") arcade
games as well as home video game ;, most recently for 32- and 64-bit home game consoles . In June
2001, hoping to take advantage of t he immensely popular 128-bit "next-generation " game consoles
(e.g., XBOX, PlayStation 2 and Ga meCube), Midway started to transition exclusively into the next-
generation home video game market .
33 . However, prior to . une 2001, Midway had only produced 5 next-generation games .
Traditionally, Midway relied on it ; coin-op games as a testing ground for potential new home video
game releases . If a coin-op game proved successful, Midway would manufacture and distribute the
game for home release. This process allowed for expedited home release, usually within six to
twelve months, in part, because prior to the advent of next-generation games, the transition fro m
-9- Midway's coin-op games to the home market involved a dramatic step down in technology an d sophistication.
34. By the start ofthe C ass Period (which commences with Midway' s sale of$60 million of stock in a public offering), as detailed herein, Defendants knew or recklessly disregarded that the
Company's entry into the home video gaming market was a complete disaster . During the Class
Period, Defendants concealed the fact that Midway could not meet its publicly-announced produc t release schedules. Indeed, according to numerous former employees of the Company, Midway' s production schedule was completely unrealistic . Although Defendants purported to "warn" investors that Midway might not be able to complete production of its games in a timely fashion, the true fact s were much more severe and pronounced than Defendants' boilerplate warnings - Midway was experiencing production delays a,,ross virtually all of its product lines and the games that it wa s producing were of poor quality.
35 . Furthermore, the Company's inability to timely produce its titles placed it in a precarious position given the fav.-changing nature of the home video game market . As product release deadlines came and went' :, the market for video games and what was considered "hot" changed radically . This dynamic placed the Company in a never-ending struggle to complete its games in a timely fashion. Often when the Company would belatedly complete a game and brin g it to market, the title was no longer in the "hot" segment of the market . Midway, however, was still stuck with an inventory of the gan me and its production costs for the game (which in many instances it had capitalized as an asset on ii s balance sheet, as detailed below) .
36. Finally, Midway':; inability to produce its games in a timely manner negatively impacted the Company's revenues and earnings, thereby causing the Company to experienc e
-10- declining demand for its pros ucts. By the start of the Class Period, as detailed herein, Defendant s knew, but concealed, that the Company was in financial trouble .
Defendants Knew That Midway Could Not Deliver Games On Time and Meet Its Stated Earnings Projections
37. During the Class Period, as confirmed below by numerous former Midwa y employees, Defendants knew that Midway would be unable to meet its game production and distribution goals. Nonetheless;, throughout the Class Period, Defendants repeatedly issued projected release dates without disclosing material facts which undermined the Company's ability to meet those dates. In particular, Deff,ndants knew that the Company lacked the ability to produce games in a timely manner given the light time schedule mandated by Defendants and that many of the games that were in fact completed were not commercially viable.
38. Numerous formor employees of the Company, many of whom were involved in th e production of the Company's games, confirmed the Company' s production problems. For example, a former Games Artist employed by the Company from October 2000 to December 2002 ("W-1 "), stated that the Company `vas always late" with respect to projected game releases and that Midway senior management received ad% anced notice of delays because they had to personally approve th e releases. W-I further stated that "we knew that Midway was in deep trouble. Financial trouble.
Everyone kind of knew that, esp,;cially after they [asked] us to take a 10% pay cut ."
39. Similarly, a former Website Producer, ("W-2"), employed with Midway from 200 0 to October 2003 confirmed that management issued projections based on unrealistic release dates for video games. W-2 stated that the release dates slipped in 2002 because project teams "did not have enough time" to create and develop the games.
-11- 40. A former Quality Assurance Manager, ("W-3"), employed by Midway from 1998 through 2003 further confirmed that management issued projections based on unrealistic release times for video games. W-3 ex;,lained that the average game production life cycle at Midway wa s two years. However, "what marketing usually did is cut production times in half. So basically what happened to the product team is that they had about two years of work that they had to complete in about a year, and that's generall y why" release dates were not met throughout the Class Period .
41 . A former Vice P resident of Quality and Market Support, ("W-4"), employed wit h
Midway from 1998 to 2001 cont. rmed that Nicastro mandated that unrealistic projections be issued
Indeed, when asked ifMidway's release dates were reasonable when made, W-4 stated that Nicastr o would ask how long it would tale to develop a title and then mandate that it be done quicker, an d
"he did have a tendency to be unrealistic."
Midway Engages In Improper And Fraudulent Accounting In Order To Conn,-al Deterioration Of Its Business
42. As noted above, Defendants engaged in accounting fraud to artificially inflate
Midway's revenues and the price :)fMidway stock. Indeed, Midway knowingly falsified its publicly issued financial statements, manipulating reserves associated with the Company'!price concessions,- sales returns, and/or sales discouits and failed to timely writedown knowingly impaired CPDC's , in violation of GAAP and its owi i stated accounting policies.
Manipulation ofReserves
43. Midwayimproper] y and fraudulently manipulated its reserves during the Class Period in order to conceal the true state c fits financial condition. In fact, when asked about the propriety of Midway's reserves, a former M dway employee who accounted for such reserves during the Clas s
-12- Period, ("W-5"), stated "reserves fc r the sales returns were out ofwhack" and compared the process of computing reserves to "throwing; a dart at a board."
44. W-5 was hired speci icallyto establish reserves at Midway. However, Midway senior management often ignored W-5's :-ecommended reserves because they were too high . On other occasions, Midway senior mana.;ement set the Company 's reserve for sales returns, price concessions and mark down money without waiting for W-5's recommendation . W-5 also stated that Midway senior management purposely understated sales return reserves so that the Company could overstate its projections and s ales revenue, stating "Midway was kind of throwing out any kind of [reserve] number out there to get the kind of [revenue] number they wanted it to be for that quarte r or year." W-5 also recalled that "tie decisions in establishing the reserve went to the CFO level," and he thought that Nicastro was also involved in establishing Company reserves .
45. W-5 recalled that the Company inadequately funded the Marketing Developmen t
Fund reserve, which was used to su Dsidize in-store promotions of Midway products. W-5 stated that the Company established a reserve : at 2% of sales to fund the promotions, but the Company spen t much more.
46. W-5 also stated ft l he worked on the Company' s internal investigation in response. to the SEC's July 2003 informatioi i request . He confirmed that the SEC is investigating to see, inter alga, whether Midway's reserves `*ere adequate."
Failure To Timely Writeaown Capitalized Product Development Costs
47. As the following ci.art illustrates, Midway's CPDC skyrocketed throughout the class period.
-13- 4. 6
Midway Games Inc. Capitalized Product Development Costs
In MiIIiom $50
sa a7 $40
s3 s $3 1 7 $30
si 3 $20 48 . s is
CPDC's $10 are costs $ associated $0 with the Mar 31, 2001 Sept 30 2001 Mar 31, 2002 Sept 30, 2002 Mar 31 . 2003 research Jun 30, 2001 Dec 31, 2001 Jun 30, 2002 Dec 31, 2002 Jun 30 . 2003 a n d
development of a video game once it has attained "technological feasibility," i.e., when the game
becomes a viable concept suitable: for mass production. The advantage of characterizing costs as
CPDC' s rather than ordinary research and development expenses is that a company need not-
recognize the CPDC's as expense:; on its income statement until the game is released to the market,
at which point the company may incrementally amortize the CPDC 's. In the event that Midway
determines that a game previously deemed technologically feasible is no longer commercially viable ,
they are required to record an imr zediate writedown of the CPDC's attributable to that game.
-14- t. 6
49. According to W-6, a f )rmer Supervisory Accountant employed with Midway during th e
Class Period, these costs were expressly approved by upper level management. Specifically, W-6
stated, "the V.P. of Internal Development or the CEO would ultimately review a game demo,
technical specifications or designs and conclude that the game is one that they wished to further
develop . At that point, technol bgical feasibility has been established and additional costs are
capitalized."
50. Like the decision to ca Ditalize in the first place, according to a former Assistant Producer ,
W-7, employed with Midway from n 1997 to 2003, Nicastro had the "last word" on which games got
cancelled.
51. Midway's CPDC cost i ballooned to approximately $40 million during the Class Period
(from a beginning Class Period balance of approximately $19 million) . Unbeknownst to investors,
the games for which the CPDC's were incurred were unviable and defendants knew and/or recklessly
disregarded this fact. In fact, Midway should have written off more th an $20 million in CPDC's by
early 2003, but told the public that the games were still viable, keeping the CPDC's off Midway' s
income statement.
52. During an April 29, 2003 conference call, a stock market analyst asked defendan t
Nicastro whether the Company ai iticipated writing down any of its inflated CSC balance:
Michael Wallace - UBS Warburg - Analys t
"OK. The capitalized software, with canceling projects, that sort of thing, do you think there's a charge coming there ? Because, that balance is pretty h .gh? At least relative to the revenue run, right? "
Neil D. Nicastro Games Chairman, President, CEO & COO
-15- Well, we have gong: through and examined all of our products in the pipeline. And, as an outcome of that, we've taken some of the products out. And we've taken charges for that . So, right now what's on the balance sheet reflects products that we believe strongly in, and feel have commercial viability. So, we don't see anything forthcoming at thi:; time. And that represents, Mike, games that are going to be ret!ased not just in 2003, but 2004.
53. Despite this unequivocal representation that no writedown would occur, a mere thre e months later (and conveniently after Midway effectuated a $35 million fund raising effort), the
Company announced an unprecede ated $23 million writedown of CPDC's, which caused Midway's . stock to plummet almost 30% . In so doing, Midway's recently appointed CEO, President and
Chairman David Zucker refused to issue any guidance regarding game releases for 2004 - a stark contrast to Nicastro's assertion above that the Company "believed strongly" in those games .
54. Tellingly, this acknow, edgment by Defendants that Midway's CPDC's were impaire d came only after the SEC notified Midway that it was investigating Midway's accounting of thes e costs .
Materially False and Misleading Statements Made During the Class Period
55 . The Class Period Begins on December 11, 2001. On that date, the Company issued a registration statement (the "Registration Statement") and filed it with the SEC on Form S-3/A wit h respect to its offering of 4.5 million shares. Therein, the Company stated, among other things :
Our game develo .,ment personnel are organized in teams . The producers manage the work of the other team members and are responsible for th 3 overall design of the game . Each concept is reviewed initially for technical feasibility and evaluated relative to several factors, inuluding whether the proposed product fits within our general strategy and profitability objectives . Our management team meets regularly to formally review and evaluate th e
-16- progress and qua lity of each title in development. (Emphasis added.)
56. On December 19, 2001, Midway announced the successful launch of its Public Offerin g
("Offering") of 4,500,000 shares of common stock at $15.00 per share, wherein it obtained net proceeds of approximately $63 .3 million. The Company also stated its intention to use the net proceeds of the offering for product development, working capital and other general corporate purposes .
57. The Registration Statement created broad duties of disclosure for Midway which th e
Company violated by failing to di,;close its inability to produce game titles in a timely manner and the Company's improper accounting for its product reserves, as detailed herein.
Fourth Quarter 2001 Results at d First Quarter/Year End 2002 Projections
58. On February 25, 20021, the Company issued a press release wherein it reported that revenues during the quarter ended December 31, 2001 were $43,720,000, down from $76,995,000 in the prior year period . The net less during the December 31, 2001 quarter was $305,000 or $0 .01 per share excluding preferred stock charges, compared with a net loss of $3,011,000 or $0 .08 per share, in the prior year period .
59. The Company also provided the following guidance as part of the press release:
For the quarter e iding March 31, 2002, Midway expects to ship six new home video game products and anticipates net sales of $33 million to $;16 million. Midway expects a pre-tax loss of between $5.5 million and $7.0 million in the quarter ending March 31, 2002 excluding a one-time charge associated with the consolidation of administrative facilities from Corsicana, Texas estimated to be between $1 .5 million and $2.5 million for the quarter and prior to estimated preferred stock charges of $2,525,000,
-17- For the fiscal year ending December 31, 2002, Midway expects to ship over forty nevi, home video game products, including highly anticipated games such as Mortal Kombat: Deadly Alliance, Freaky Flyers, MLJI SlugFest 20-03, and Defender. The company anticipates net sales of $330 million to $340 million for the full year. (Emphasis at ded .)
60. In addition , the Company reiterated the foregoing financial results and guid ance in
Midway' s March 28, 2002, Annual Report filed on Form 10-K, and announced the following release schedule for 2002 :
Quarter PlayStation 2 GameCube Xbox Game Boy Ending Advanc e
3/31/02 NFL Blitz 20-02 Gauntlet Dark Legacy NFL Blitz 2002 NFL Blitz 2002 SpyHunter SpyHunter
6/30/02 Fireblade Gravity Games BMX Gauntlet Dark Legacy SpyHunter Gravity Games BM:C Red Card Soccer Gravity Games BMX Legion: Legend of Red Card Soccer Excalibur MLB SlugFest 2003 Red Card Soccer
9/30/02 Mortal Kombat : MLB SlugFest 2003 MLB SlugFest 2003 NFL Bliz 2003 Deadly Alliance Mortal Kombat : Mortal Kornbat: NFL Blitz 20-03 Deadly Alliance Deadly Alliance NHL Hitz 20-03 NFL Blitz 2003 NFL Blitz 2003 NHL Hitz 2003 NHL Hitz 200 3
12/31/02 Defender Defender Defender Mortal Kombat: Dr. Muto Dr. Muto Freaky Flyers Deadly Alliance Freaky Flyers Freaky Flyers NBA Basketball NBA Basketball NBA Basketball
61 . The statements referen -ed in IM 54-59 above, were materially false and misleading whe n made because they failed to disclo w and misrepresented the following material adverse facts which were known to Defendants or recklessly disregarded by them:
-18- (a) that, given the tight time schedules dictated by Defendants, the Company wa s unable to produce its game titles according to the schedule that it had publicly released ;
(b) that Midway was experiencing production delays across virtually all of its product lines and the games that it was prod icing were either riddled with bugs or of such poor quality that they were unlikely to be a commercial success;
(c) that Midway's in ability to timely produce its game titles was negativelyimpacting its sales and, accordingly, demand .:or its products was declining ;
(d) that Midway's fi aancial results reported on Form 10-K were materially misstated for the reasons set forth in 11 42-4! below because defendants knew and/or recklessly disregarded that they failed to adequately accotnt for product reserves . Accordingly, the Company's financial statements were not prepared in as ordance with GAAP, as detailed herein in ¶1116-125 ; 130-136; and
(e) based on the fcregoing, Defendants lacked a reasonable basis for its earning s projections and schedule of release ; dates, which were therefore materially false and misleading .
First Quarter 2002 Results and Second Onarter/Year End 2002 Projections
62 . On April 30, 2002, the Company issued a press release wherein it reported its results for the quarter ended March 31, 2002 . Therein, the Company reported that revenues during the quarte r were $31,007,000, up from $23,723,000 in the prior year period . The pre-tax net loss during the
March 31, 2002 quarter was $5,01 6,000 excluding preferred stock dividends and one-time charge s associated with the consolidation of administrative facilities, compared with a pre-tax net loss o f
$22,213,000, excluding $3,639,0,)0 of one-time restructuring and other charges, in the prior year period.
-19- 63 . The Company also provided the following guidance as part of the April 30 press release:
For the quarter ending June 30, 2002, Midway expects to ship nine new home vid :o game console products and anticipates net sales of $40 million to $50 million. Midway expects a pre-tax loss of between $5 millic n and $10 million in the quarter ending June 30, 2002 prior to estimated preferred stock charges of $2,687,000 and excluding a one-time charge associated with the consolidation of administrative facilities from Corsicana, Texas estimated to be between $1.0 million and $1 .7 million.
For the full year eiding December 31, 2002, Midway reiterates the previously statzd guidance of net sales between $330 million and $340 million. The Company also reiterates previously stated guidance for pre-ta.+ income of between $49 million and $54 million for the full year, e occluding one-time charges associated with the consolidation of alministrative facilities from Corsicana, Texas estimated to be between $2 .3 million and $3.0 million for the year, and prior to estimated preferred stock charges of $11 .1 million. Due to net operating lose carry forwards, the Company does not anticipate incurring income tax expense in 2002 .
The Company expects to ship at least 32 new home video game console products during the remaining three quarters of 2002 across multiple platforms and genres . Midway believes these products comprise the strongest home video game lineup in the Company's history and that these products will produce record home video game results in 2(02 . Midway believes that the lineup of games it will present at the Electronic Entertainment Exposition (E3) convention in May to be among the strongest in the industry and include Mortal Ko nbat : Deadly Alliance, NFL Blitz 20-03, Freaky Flyers, Dr. Muto. Emphasis added.)
64. Further, the Company announced the following release schedule (bolded titles indicate insertion of a delayed product; parenthetical titles indicate either cancelled products or product s delayed until the next fiscal year)
-20- Quarter PlayStation 2 GameCube Xbox Game Boy Ending Advanc e
6/30/02 Fireblade Red Card Soccer Gauntlet Dark Legacy Spyffunter Gravity Games 3MX Gravity Games BMX Legion: Legend of Red Card Soccer Excalibur MLB SlugFest :0-03 Red Card Socce r
9/30/02 Mortal Kornbat: Gravity Games MLB SlugFest 20-03 NFL Bliz 20-03 Deadly Allianc a BMX Mortal Kombat : NFL Blitz 20-03 MLB SlugFest 20-03 Deadly Alliance NHL Hitz 20-03 Mortal Kombat : NFL Blitz 20-03 Deadly Alliance NHL Hitz 20-03 NFL Blitz 20-03 NHL Hitz 20-0 3
12/31/02 Defender Defender Defender Mortal Kombat : Dr. Muto Fireblade (Fireblade) Deadly Alliance Freaky Flyers Freaky Flyers (Dr. Muto) Gauntlet: Dark TBA: Traveler's (NBA Basketball) Freaky Flyers Legacy Tales Title (NBA Basketball) Justice League (NBA Basketbal l) NHL Hitz 20-03
65 . The Company' s earrings release was followed by an April 30' conference call during which defendants reiterated the ibove guidance and release schedule. Regarding product reserves, the Company stated:
Turning to the balance sheet, we have the March 31 total cash and equivalents totale 1 approximately $56m, current assets minus current liabilities amounted to approximately $90m with a current ratio of 3.6. Looking at receivables, gross trade receivables were $42 .7m in comparison to $6:1 .9m at the end of the December quarter. Provisions for price protection and bad debt were $10.6m or 25% of gross trade receivables for the March quarter. This compares to $12.4m or 19% of gross trade rect ivables for the December quarter .
We believe that the established price protection reserves are adequate, based on our comprehensive evaluation of the field inventory levels, and product sell through rates .
66. Regarding the Company's outlook, defendant Nicastro represented the following to investors:
-21- Looking more broadly at the industry's performance in the March quarter, w(! believe the results were solid and bode well for the rest of the year. According to NPD group, software sales in the first quarter rose 26% while combined hardware and software dollar sales climber . 20% versus the same period last year . Sony's PlayStation 2 conti.iues to be the hardware market leader, selling through approximately 370,000 units in the first quarter compared to approximately 140,000 Xbox units and approximately 115,000 GameCube units. For the full year 2002, we expect hardware and software sales growth consistent with most analysts ' expectations . (Emphasis added.)
Over all, we project video game software sales will grow between 20% and 30% in 2002. Midway is well position to do capitalize on this industry growtl ., with a broad portfolio of products all three next generation platforms and the GameBoy Advance . This portfolio includes market-proven franchises and brands together with exciting new procucts which we expect will develop into new franchises for the future. This portfolio is deep. We plan on introducing over 38 new home video game releases during the next three-quarters. It is also broad covering the most profitable genres in the industry including baseball, soccer, hockey, football, fighting, action, extreme games, racing adventure, RPG, and platform adventure. And perhaps most importantly, it is full of high-quality, innovative and fun games. We expect that a number of these products can becc me breakaway hits . (Emphasis added .)
67 . With respect to games scheduled for release in the second quarter 2002, Nicastro stated that, "the data that we're getting i„ that all products we have in our plan will ship before the end o f
[] June."
68 . In response to analyst .,oncerns regarding Midway's ability to promptly deliver Mortal
Kombat, one of its most important products during the Class Period, defendant Nicastro stated :
There's a handful of titles that as we're getting closer and closer to their introduction, our level of excitement and confidence in their ability to be strong sellers has been going up . Mortal Kombat is clearly one of then;. I think that as time has gone by our managemen t
-22- group is become eiren more bullish on what Mortal Kombat can ultimately do in the marketplace . It's looking terrific.
Mortal Kombat is going to ship at the end of September, and that's been the plan . . . since the beginning . (Emphasis added).
69. Moreover, in response .o analyst concerns about whether the Company would meet it s year-end revenue targets, defendar t Nicastro responded :
I think that the simple answer . . . is look at the product you sell, because that's -- the; product is what's going on generate the profits . If we have good product and it sells well, we're going to generate strong revenues and strong profits . And I think that that's kind of an easy one for you and for those who are at least able to attend the [upcoming Electroi iic Entertainment Exposition] show.
70. On May 14, 2002, the Company filed with the SEC, on Form 10-Q, its quarterly report for the first quarter ended March '2 1, 2002, which reiterated the above financials and projections.
71 . Regarding its accounti:ig practices, the Company stated:
The accompanyin, ; unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Fors n 10-Q and Article 10 of Regulation S-X... In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
72 . The statements referei .ced in 1161-70 above, were materially false and misleading for the reasons stated in ¶ 60 above.
Revised Second Ouarter/Year Ind 2002 Projections
73 . On July 2, 2002, the Company announced that it was reducing its previously issued revenue and earnings guidance for its second quarter and full-year 2002 results . More specifically,
-23- the Company reported that it expected revenues for the quarter ended June 30, 2002 to be between
$28 and $30 million, as op?osed to the previous guidance of $40 to $50 million. Further, Midway reported that for the year ending December 31, 2002, it expected revenues between $295 and $31 0 million, as opposed to the Previous guidance of $330 to $340 million.
74. Midway stated that the revised guidance was necessary due to, inter alia, the purported unanticipated delay of produ;.ts originally scheduled to ship during the quarter, Included among th e delayed products was Mortal Kombat, which defendants pushed back from the previously announced release date of September 2002, to the first half of the quarter ending December 31, 2002.
75. During a July 2, 2002 conference call to discuss the revised projections, defendant Powell informed investors, inter alia, that management was beginning a search for a new Chief Operatin g
Officer in order to "to better manage the execution of Midway's goals ."
76. Also on the July 2"d conference call, defendant Nicastro assured investors that, "we expect every game we bring oi.t for the remainder of this year will be a strong performer. . ."
77. The material importance of the missed game release dates was clear as Midway's stock price fell over 51 %, or $4 .14 a share, in response to the July 2, 2002 announcement to close at $3 .85 per share. Defendants, however, continued to conceal the true state of the Company's business.
78. The statements referisnced in Iff 72-76 above, were materially false and misleading for the reasons stated in 1 60 above.
Second Quarter 2002 Results And 30/Year End 2002 Projections
79. On July 31, 2002, the 2ompany issued a press release wherein it reported its results for the quarter ended June 30, 2002 . Wherein, the Company reported that for the quarter ended June 30,
2002, revenues were $28.1 million and the pre-tax loss was $10 .7 million excluding approximately
-24- $16 .7 million of preferred stock charges and $0 .5 million of charges associated with the consolidation of administrative f"ilities from Corsicana, Texas . Moreover, the Company issued the following guidance:
For the quarter en-ling September 30, 2002, Midway expects to ship ten new home video game products and anticipates net sales of between $50.0 million and $55.0 million. Midway expects a pre-tax loss of between $ 5.0 million and $7.0 million in the quarter ending September 30, 2(02 prior to estimated preferred stock charges of approximately $0 .3 million and excluding charges associated with the consolidation of aftinistrative facilities estimated to be between $0.2 million and $0.4 million.
For the year ending December 31, 2002, Midway reiterates the previously stated guidance of net sales between $295.0 million and $310.0 million.
Midway expects to ship 29 new home video game products during the remaining two quarters of 2002 across multiple platforms and genres . The Company believes these products comprise the strongest home video gan;.e lineup in Midway's history and that these products will produce record home video game revenues in 2002 . (Emphasis added).
80. The Company reiterai ed the foregoing financial results in its quarterly results filed on
Form 10-Q with the SEC on Augt st 13, 2002. Furthermore, the Company announced the following game release schedule in the Fora i 10-Q and July 31 ' press release (bolded titles indicate insertion of a delayed product; parenthetical titles indicate either cancelled products or products delayed until the next fiscal year) :
Quarter Ending I PlayStation 2 1 GameCube I Xbox Game Boy Advanc e
-25- 9/30/02 NFL Bliz 2 )03 MLB Slugfest 2003 Gravity Games NFL Bliz 2003 NHL Hitz 2003 NFL Bliz 2003 Bike: Street. NHL Hitz 2003 Vert. (Gravity Games Dirt. BMX) MLB Slugfest 2003 NFL Bliz 2003 NHL Hitz 2003
12/31/02 Defender Defender Defender Defender Dr. Muto Fireblade Dr. Muto Gauntlet: Dark Legacy Freaky Flyer . Mortal Kombat: Freaky Flyers Justice League Haven: Call of the Deadly Alliance Mortal Kombat: MLB Slugfest 2003 King Deadly Alliance Mortal Kombat: Mortal Konfbat : Deadly Alliance Deadly Allis ice NHL Hitz 2003
81 . The Company held a conference call with analysts and investors on July 31, 2002 during which defendants, inter alia, rt iterated the above guidance and release schedule, and commented o n
Midway's product reserves as follows:
Looking at reccivables for the home business, home growth trade receivables were $29 million in comparison to $30.5 million at the end of the Marc] i quarter. Provisions for price protection and bad debt in the home business were $7,053,000 or 24.3 percent of gross trade receivables forte June quarter as compared to $5,365,000 or 17 .6 percent of gross trade receivables for the March quarter.
82. On August 13, 2002, the Company filed with the SEC, on Form 10-Q, its report for the quarter ended June 30, 2002 . The Company's Form 10-Q, signed by defendant Powell, reaffirmed the Company's previously announced results .
83 . Regarding its accounting practices, the Form 10-Q provided :
The accompanying unaudited condensed consolidated financial statements have b den prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Fo.- n 10-Q and Article 10 of Regulation S-X. .. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
-26- 84. The statements referenced in 1178-82 above, were materially false and misleading for the reasons stated in 160 above.
Third Ouarter 2002 Results And 40/Year End 2002 Projections
85 . On October 29, 2002, the Company issued a press release announcing its results for the period ended September 30, 2002 . Therein, Midway reported that revenue for the quarter ended
September 30, 2002 was $52.6 mil .ion. The pre-tax loss for the quarter ended September 30, 2002 was $11 .3 million excluding $0.2 million ; of charges incurred with the consolidation of administrative facilities from Corsicana, Texas.
86. The October 29' press release also contained the following guidance :
For the quarter ending December 31, 2002, Midway expects revenue of between $105.0 million and $155 .0 million, a 140% to 250% increase ovtr revenue from the prior year period of $43 .7 million. Midway e.:pects pre-tax earnings of between $15 .0 million and $40.0 million ini the fourth quarter compared to a pre-tax net loss in the prior year period of $0 .3 million excluding preferred stock charges.
For the year endir .g December 31, 2002, Midway expects revenue of between approximately $217.0 million and $267 .0 million, and pre-tax earnings of between a loss of approximately $12.0 million and a gain of approxirr ately $13.0 million. . .
87. Furthermore, the Company announced the following release schedule as part of th e
October 296' press release, again announcing delays of various titles from prior announcements
(bolded titles indicate insertion of a delayed product ; parenthetical titles indicate either cancelled products or products delayed until the next fiscal year):
-27- Quarter Ending PlayStation 2 GameCube Xbox Game Boy Advanc e
12/31/02 Defender Defender Defender Defender Dr. Muto Dr. Muto Fireblade Dr. Muto Gauntlet: Dark Legac y (Freaky Flyers) Freaky Flyers) Justice League Mortal Kombat: Haven: Call of Deadly Alliance Mortal Kombat: (MLB Slugfest 2003) the King Deadly Alliance Mortal Kombat : Mortal Kombat: Deadly Alliance NHL Ritz Deadly Alliance 2003
88. The Company' s press release was followed by an October 29' conference call during which defendants reiterated the ibrgoing quarterly financial results and projections . Indeed,
defendant Nicastro, stated "eve expect revenue for the December quarter will grow to $105 to
$155 million, or 140 percent to 250 percent higher than last year ." (Emphasis added.)
89. The Company also stated the following on the call concerning Midway's price protectio n
and bad debt reserve:
Looking at home receivables . Gross trade receivables were 42.8 million, in comparison to 29 million at the end of the June quarter . Provisions for prico protection and bad debt were 8 .8 million, or 20.4 percent of gross trade receivables for September quarter . Day sales outstanding for the September quarter is 60 days, down from 71 days in the June quarter and also down from 75 days in the prior September quarter. If you look at the weighted average aging of receivables, you would see that Midway's home trade receivables were on average, o ttstanding for approximately 29 days at the end of the September quarter. The September quarter, inventories were approximately $7 .5 million.
90. On November 14, 20(2, the Company filed with the SEC, on Form 10-Q, its report fo r the quarter ended September 30, 2002. The Company's Form 10-Q, signed by defendant Powell, reaffirmed the Company's previcusly announced results.
91 . Regarding its account ing practices, the Company stated:
-28- The accompanying unaudited condensed consolidated financial statements have beer i prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Fong 10-Q and Article 10 of Regulation S-X... In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessa ry for a fair presentation have been included.
92. The projections referenced in¶¶ 84-90 above, were materially false and misleading when made as described in ¶ 60 above.
Revised Fourth Ouarter/Year Eiid 2002 Projections
93. On December 23, 20W, the Company issued a press release, once again announcing a revised guidance, stating that it exl ,ected revenues for the fourth quarter ending December 31, 2002 to be between $78.0 million and $83 .0 million, compared to the Company's previous revenue guidance of between $105.0 million and $155.0 million. The Company attributed this decrease to lower than expected demand for Defender, Dr . Muto and Haven: Call of the King, which was only partially offset by higher than expected demand for Mortal Kombat : Deadly Alliance. Moreover, the Company announced that fo- the full year ending December 31, 2003, Midway expecte d revenues of between $250 and $2 75 million.
94. Tellingly, Midway hesitated to provide specific guidance regarding the release of titles for 2003, but claimed it accounted adequately for returns :
Analyst OK. The -- just on.- of the numbers in the revenue shortfall, it looks like even around 8 0, if the expenses were kind of around you would have made money, should I assume that the gross margins are going to be a lot lower b',cause you've got to increase reserves for some of the returns? Neil Nicastro - Midway Games - Chairman and CEO
-29- We took very -- the se numbers reflect what we considered to be extremely healthy and substantial reserves.
I gave earlier a corunentary on the types of games . We're not yet ready to be announcing the specific titles that were going to be introducing in'03 . I think we'll give much better visibility on that in our earnings call at the end of February .
Analyst
Is it fair to say thei L that the numbers that you're giving us as your initial guidance assume the same kind of conservative ship-ins that people have been rt :porting for the December quarter?
Neil Nicastro - Midway Games - Chairman and CEO
Yes, we've taken into account a ll the data we possibly can to make sure that we refine our 2003 model to be the most accurate we can make it. (Emphasis added) .
95 . The statements referenced in 1192-93 above, were materially false and misleading for the reasons stated in ¶ 60 above .
Fourth Ouarter/Year End 2002 Results And 10/Year End 2003 Projections
96. On February 20, 2003, the Company issued a press release announcing its results for th e quarter ended December 31, 2002 . Therein, the Company reported revenue of $80 .2 million and a loss applicable to common stock c f $25.0 million or $0.54 per share in the quarter ended December
31, 2002 . Revenue for the year en led December 31, 2002 was $191 .9 million, and a loss applicable to common stock of $73 .6 million or $1 .61 per share in the twelve months ended December 31 ,
2002.
97. Importantly, the Company announced the following guidance:
For the quarter Biding March 31, 2003, Midway expects revenue of between $40.0 million and $45.0 million, approximately a 29% to 45% increase o rer revenue of $31 .0 million in the first quarter of 2002. The Company expects a pre-tax loss of between $3 .0 million
-30- k J!
and $5.5 million in the quarter ending March 31, 2003, excluding approximately $6 .2 million of restructuring charges associated with the consolidation of product development operations in California . The Company experts two major product introductions in the quarter ending March 31, 2003 including the European launch of Mortal Kombat: Deadly Alliance for all platforms and the domestic launch of MLB SlugFest 2 3-04 for all platforms. The successful launch of Mortal Kombat: Deadly Alliance in Europe last week represented Midway's largest sh ,p-in sales volume for one title since the Company opened its European office in 1999 . The Company also expects the launch of MLB SlugFest 20-04 to be very successful as preliminary consumer and retailer interest in the follow-up to last year' s top-performing PlayStation 2 baseball title is very strong. For the year ends ag December 31, 2003, Midway reiterates its previous guidance of revenues of between $250 .0 million and $275.0 million, ar approximate 30% to 43% increase over 2002 revenues, with pre-tax earnings of between $20.0 million and $30.0 million, excluding any restructuring charges .
On March 28, 2003, the Company filed with the SEC, on Form 10-K, its report for the fiscal year ended December 31, 2002. The Company's Form 10-K, signed by the Individual Defendants, reaffirmed the Company's previously announced results.
98 . Regarding its accounting practices, the Company stated :
The accompanying unaudited condensed consolidated financial statements have ben prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Forn 10-Q and Article 10 of Regulation S-X ... In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
99. The statements referenced in 1195-97 above, were materially false and misleading for
the reasons stated in 1 60 above.
First Quarter 2003 Results And. 201Year End 2003 Projec tions
-31- 100. On April 29, 2003, the Company issued a press release announcing its results for the firs t
quarter ended March 31, 2003, wherein it reported revenues of $45 .8 million. In terms of
projections, the Company stated that it only expected revenues of $7 to $11 million for the second
quarter of 2003 . Moreover, Midway once again slashed its previous guidance for the year ending
December 31, 2003, estimating revenues of only $200.0 million and $230.0 million, as opposed to
the $250 to $275 it had previously announced .
101. The Company's earnings release was followed by an April 29, 2003 conference call
during which defendants reiterated the above projections and release schedule and commented o n
product reserves, the Company stated :
Looking at receivables, gross trade receivables were $42 .7m in comparison to $65 .9m at the end of the December quarter . Provisions for price protection and bad debt were $10 .6m or 25% of gross trade receivables for the March quarter. This compares to $12.4m or 19% of gross trade recei vables for the December quarter. We believe that the established price protection reserves are adequate, based on our comprehensive evaluation of the field inventory levels, and product sell through rates .
102. Commenting on CPDCC's, defendant Powell stated :
The balance of capitalized product development costs, at the March 31st, stood at $30 . lm, up slightly from the December 2002 balance, of $28.8m.
The total product levelopment expenditures , which would include both the expensed and capitalized costs, totaled $16.4m for the quarter, vs . $26.7ri, for the December quarter. The $10m reduction in the product dev:lopment quarterly run rate is largely attributable to actions that we've taken to reduce overall product development costs, while focusii ig our resources on those p roj ects that demonstrate the greatest potential for commercial success, and to an extent, the timing of certain = milestone payments on third party development initiatives.
-32- J
103. Additionally, during April 29' conference call defendant Nicastro vehemently affirmed
that the Company would not writedown any additional CPDC's for the games scheduled to be
released in 2003 and 2004.
Michael Wallace - UBS Warburg - Analys t
"OK. The capitalized software, with canceling projects, that sort of thing, do you think there's a charge coming there ? Because, that balance is pret .y high? At least relative to the revenue run, right? "
Neil D. Nicasti o Games Chairman, President, CEO & COO
Well, we have gone through and examined all of our products in the pipeline. And, as an outcome of that, we've taken some of the products out And we've taken charges for that. So, right now what' s on the balance sheet reflects products that we believe strongly in, anJ feel have commercial viability. So, we don't see anything forthcoming at this time . And that represents, Mike, games that are going to be released not just in 2003 , but 2004. (Emphasis addeJ) .
104. On May 15, 2003, the Company filed with the SEC, on Form 10-Q, its report for th e
quarter ended March 31, 2003 . 7 hebe Company's Form 10-Q, signed by defendant Powell, reaffirmed
the Company's previously anno arced results.
105 . The statements refer need in 1199-103 above, were materially false and misleading for
the reasons stated in ¶ 60 above. _n addition, Midway's CPDC's were inflated and should have bee n
written down by more than $20 million because certain of Midway's games in development were
unviable and unsalable as described in IN 46-53.
Private Stock Placement and SROC Investigation
106. On May 7, 2003, Mid, vay fired Nicastro as CEO, COO and President and replaced him
with David Zucker. Nicastro retained his role as Chairman .
-33- •_
107. Less then two weeks later, on May 19, 2003, Defendants completed the private placement
of 3,500 shares of Midway prefer-ed convertible stock, thereby raising over $35 million in much
needed working capital . The pr.vate placement was converted to a "public offering" through
subsequent registration of the shares .
108. On July 21, 2003 Miiway disclosed that the SEC requested information from the
Company as part of a formal investigation, i. e., In the Matter of Certain Video GameManufacturers,
into the video game market. Media sources later reported that the SEC investigation centered aroun d
the adequacy of company product reserves and the propriety of capitalization expenses.
THE TRUTH EMERGES
109. On July 29, 2003, Defendants held a conference call with investors to discuss the
Company's second quarter results. Newly appointed CEO David Zucker provided, in part, the
following:
Let's start with the Q2 results . Revenues for the second quarter were $5 million down from $28 . lmillion in the same quarter last year primarily due to a much higher, much lighter product release schedule. During the second quarter, we released only one new game, Freestyle Metal X on the PlayStation 2 platform compared with seven new games introduced in the same period last year. The net loss for the second quarter was $54 .8 million, compared with a net loss of $11 .2 million last year. The loss applicable to common stock in the second quarter 2003 was $55 .7 million, or $1 .20 per share, cc mpared with $27 .9 million or 61 cents per share in 2002.
Included in our s':cond quarter 2003 results are $23 million of noncash charges relating to the writedown of capitalized product developc.zent costs.
During the quartet, we completed a $35 million private placement of Series C convey able Preferred shares that allowed us to pay down the outstanding Se. ies B Preferred stock that was due this November and to add to our cash assets. As of June 30, our cash and cash
-34- a
equivalents i .tood at approximately $68 million up from where we started the yt:ar and up from the QI ending balance .
at June 30 our cash and cash equivalents stood at $67 .7 million up from $49 mil . ion from where we started the year as well as up from the QI ending balance $56 million. (Emphasis ad Jed).
110. Zucker conceded that the Company's prior projections concerning the timing of video
game releases were false and misleading because they were issued without any reasonable basis:
First, over the past two years, we have been undisciplined in our approach to selecting which games to develop. In some instances, we have made gar.ies for niches that were trending out of favor or too small.
In some instances we made games that we had no differential expertise or technological advantage in . And in some instances, we made games that were (sic] me, too, products, that chased the competitor's sue cess, albeit too late and with too little innovation .
Another reason i br our mixed track record is that we simply have not developed enough high quality games. Too many of our games have been average or below average in quality during a current console cycle that has become less and less forgiving of average quality content.
In number of cases we ended up releasing games that weren't ready for prime time y -,t, in terms of quality . It is absolutely critical, or crucial that we produce games that stand out from the crowd and achieve critical ;,uccess before we can expect them to achieve commercial succt ss .
Our goal ask to eliminate the need to delay games going forward, do better planning ux front and better execution throughout the game development process . Not everything we are producing or releasing right now is first c . ass.
-35- I 11 . Also on the July 29" conference call, Defendant Powell provided:
Midway's June 30 cash balance stood at $67 .7 million, an increase of approximately $19 million from the 2002 year-end balance . The increase is largely attributable to the completion of a $35 million private placement that netted approximately $21 million of additional cash , after deducting for fees and expenses and after deducting $13 .1 million of the full redemption of the remaining Preferred Series B shares then outstanding .
Turning to receivables, gross trade receivables ended the quarter at $9.2 million, reserves for price concessions, returns and uncollectible ac .-ounts were $8.3 million or 90% of the gross receivable balance. We believe the established receivable reserves are adequate but riot excessive, based on a comprehensive review of field inventory levels and product sell through rates .
As already addre,;sed by David, the balance of capitalized product development cost i is $15 .3 million a reduction of almost $15 million from the $30.1 million balance as of the end of March. The reduction is largely the result of a writedown of $23 million in capitalized cost.
(Emphasis added).
112. Powell also provided the following in response to an analyst question :
Edward Williams - Harris, Nesbit, Gerard
A couple of quest ions for you. Tom, can you give us an idea as to how many games were involved in the writedown? And specifically if you can looking at the balance sheet at this point, how much of the cap software on the balance sheet is related to games already shipped?
Thomas Powell -- Midway Games, Inc. - CFO
Well, there are a number of games involved in this, as mentioned we canceled two, sonic were related to acceleration of amortization writedown given cl ranges in sales forecasts . So there are a number o f
-36- 4k I
games and I don't have it in front of me the exact number that was involved in the writedown .
However, I can tell shat you of that total writedown, the majority that was related to 2004 launches so over 60% was related to games launching in 2004 . And as discussed, the remaining balance, the majority of that cap Italized balance of the $15 .3 million is related to products either in th : market now, or selling, or being released during the rest of 2003 . So close to 70% is related to titles currently in the market or being relcased through the end of the year.
113 . Midway's July 29" announcement shocked the markets, causing the Company's already
depressed shares to slide downwarls more than 28% on July 30, 2003, or $0 .97 a share, to close at
$2.42 per share - the biggest perce atage loser on the market that day.
UNDISCLOSED ADVERSE INFORMATIO N
114. The market for Midway's publicly traded securities was open, well-developed an d
efficient at all relevant times . As a result of these materially false and misleading statements an d
failures to disclose, Midway's publicly traded securities traded at artificially inflated prices during
the Class Period. Plaintiff and othc r members of the Class purchased or otherwise acquired Midway
publicly traded securities relying upon the integrity of the market price of Midway's publicly trade d
securities and market information relating to Midway, and have been damaged thereby .
115. During the Class Peri- xd, defendants materially misled the investing public, thereb y
inflating the price of Midway's publicly traded securities, by publicly issuing false and misleading
statements and omitting to disclose material facts necessary to make defendants' statements, as se t
forth herein, not false and misleaiing. Said statements and omissions were materially false and
misleading in that they failed to di 3close material adverse information and misrepresented the truth
about the Company, its business end operations, as alleged herein .
-37- A
116. At all relevant times, th .- material misrepresentations and omissions particularized in this
Complaint directly or proximately caused or were a substantial contributing cause of the damages
sustained by plaintiff and other me tubers of the Class . As described herein, during the Class Period,
defendants made or caused to be i Wade a series of materially false or misleading statements about
Midway's business, prospects and operations . These material misstatements and omissions had the
cause and effect of creating in the market an unrealistically positive assessment of Midway and it s
business, prospects and operations, thus causing the Company's publicly traded securities to be
overvalued and artificially inflated at all relevant times . Defendants' materially false and misleading
statements during the Class Period resulted in plaintiff and other members of the Class purchasing
the Company's publicly traded securities at artificially inflated prices, thus causing the damages
complained of herein.
THE COMPANY'S CLASS PERIOD FINANCIAL STATE MENTS WERE MATERIALLY FALSE AND MISLEADING AND VIOLATED GAAP
117 . At all relevant times during the Class Period, the Defendants represented that Midway' s
financial statements when issued were prepared in conformity with GAAP, which are recognized by
the accounting profession and the SEC as the uniform rules, conventions and procedures necessary
to define accepted accounting pra,:tice at a particular time. However, in order to artificially inflate
the price of Midway's stock, the defendants used improper accounting practices in violation of
GAAP and SEC reporting requirements to falsely inflate the Company's reported assets,
stockholders' equity, revenue and earnings during the Class Period .
118. Regulation S-X [17 C .F.R. § 210.4-01(a)(1)] states that financial statements filed with
the SEC that are not prepared i i conformity with GAAP are presumed to be misleading and
inaccurate.
-38-