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Consolidated Complaint for Violation of the Securities Exchange Act of 1934
Source: Milberg Weiss Date: 04/10/02 Time: 3:08 PM
MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH (68581) THOMAS E. EGLER (189871) 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax) - and - PATRICK J. COUGHLIN (111070) RANDI D. BANDMAN (145212) SYLVIA WAHBA (197612) ELI R. GREENSTEIN (217945) 100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax)
Lead Counsel for Plaintiffs
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
OAKLAND DIVISION
In re APPLE COMPUTER, INC. ) Master File No. C-01-3667-CW SECURITIES LITIGATION ) ______) CLASS ACTION ) This Document Relates To: ) CONSOLIDATED COMPLAINT FOR ) VIOLATION OF THE SECURITIES ALL ACTIONS. ) EXCHANGE ACT OF 1934 ______) DEMAND FOR JURY TRIAL
TABLE OF CONTENTS
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I. INTRODUCTION
II. JURISDICTION AND VENUE
III. PARTIES
IV. BACKGROUND TO THE CLASS PERIOD
V. DEFENDANTS' WRONGFUL COURSE OF CONDUCT AND FALSE AND MISLEADING STATEMENTS
A. MacWorld New York
1. July 18-19, 2000: Media and Investor Presentations
2. July 20: Media Reaction
3. July 20: Investment Analyst Reaction
4. July 25-31: Magazine Reaction
B. The MacWorld Statements Were False and Misleading When Made
1. Apple's Product Development Problems
(a) The G4 Cube
(b) The Power Mac G4 Dual Processor
(c) The iMac
2. Inventories of Finished Goods and Component Parts
3. The K-12 Education Market Debacle
(a) The Role of Apple's Agents
(b) Firing Apple's Agents
(c) The Aftermath
C. After MacWorld: Further False and Misleading Statements
1. August Reports
2. Late August Analyst Conferences
3. August 25-30: Top Apple Executives Bail Out http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 3 of 70
4. Early September Reports
5. September 13, 2000: Jobs in Paris and CNBC
6. September 21, 2000: Questions Start
7. September 28, 2000: Morning - All Is Rosy
VII. THE ADVERSE FACTS COME OUT
VIII. INSIDER STOCK SALES
A. Apple's Senior Officers' Stock Sales Were Unusual and Suspicious
B. Options Valuation Provides Additional Evidence of Scienter
C. Statistical Analysis Provides Additional Evidence of Scienter
IX. CLASS ACTION ALLEGATIONS
X. NO SAFE HARBOR
XI. CLAIM FOR RELIEF
XII. PRAYER FOR RELIEF
XIII. JURY DEMAND
I. INTRODUCTION
1. This is a class action on behalf of all purchasers of the common stock of Apple Computer, Inc. ("Apple" or the " Company") between 7/19/00 and 9/28/00, inclusive (the "Class Period"), seeking to pursue remedies under §§10(b) and 20(a) of the Securities Exchange Act of 1934 (the "1934 Act") and SEC Rule 10b-5.
2. On July 18 and 19, 2000, defendant Steve Jobs ("Jobs"), CEO of defendant Apple, kicked off a public relations blitz to promote the Company and its newest line of personal computers: the Power Mac G4, a new line of "iMacs" and the Power Mac G4 Cube ("G4 Cube"), a fully-powered computer encased in what Jobs described as a "stunning crystal clear enclosure."
3. Beyond introducing the new computers, however, Jobs and Apple representatives used the product introductions, which followed the announcement of flat 3Q 2000 results, to prop up and encourage investor confidence in Apple. During Jobs' on-stage presentation and in a stock analyst conference call later that day, defendants used the new products as part of a "turnaround story" to position Apple as a "genuine growth company."
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4. Defendants claimed that sales of the new computers would result in Apple achieving strong revenue and earnings per share ("EPS") growth in its 4Q 2000 (to end 9/30/00) and for its full fiscal year 2001 ("FY 2001"). The Company advised analysts to increase the forecasts for Apple's revenue (and EPS) for these periods to $2.0+ billion ($0.40+ EPS) and $9.7+ billion ($2.10-$2.15 EPS).
5. As Apple's 4Q 2000 unfolded, Apple advised analysts that its new products were being well received and selling very well, that back-to-school sales and sales to its K-12 education market had accelerated as expected, that its vaunted component part and finished goods inventories were under control and that the Company would "hit" its financial forecasts. As a result, Apple's stock climbed to a Class Period high of $64-1/8 in early September 2000. Right at the peak of this PR drive, four top Apple officers unloaded 370,000 shares of their Apple stock for $22 million.
6. Suddenly, just 20-25 trading days later, on September 28, 2000, Apple shocked investors by revealing a huge revenue and EPS shortfall for 4Q 2000 as a result of very poor K-12 education market sales and poor consumer acceptance of its new personal computer products (some of which had been late to market, had defects and lacked features which were essential for market success). The lack of computer sales resulted in Apple accumulating excessive inventories of finished goods in its distribution channel and caused the Company to cancel component part orders and to incur large financial penalties.
7. As rumors of Apple's troubles circulated prior to and then following Apple's shocking disclosure, Apple's stock collapsed from $61-3/64 on 9/20/00 to $25-3/8 on 9/29/00, continuing to fall to as low as $17 and then to $13-5/8, as investors absorbed the full impact of these shocking revelations - a stock decline that wiped out over $10 billion of Apple's market capitalization in just a few days! The Company felt reverberations from this disaster through the entire FY 2001, taking a loss of approximately $250 million in the 1Q 2001 and ultimately losing $37 million for the FY 2001 (a loss of $0.11 per share).
8. When Jobs told the assembled media representatives and Macintosh faithful that the G4 Cube he presented on stage was a "brain in a beaker" hanging in a "stunning crystal clear enclosure," he misrepresented the fact that the G4 Cube he used did not have the noticeable "mold lines" and cracking that plagued the G4 Cubes coming off the Company's manufacturing lines. While Jobs bragged about the parallel processing speeds achieved by the new Power Mac G4 Dual Processor tower computer, he failed to note that Apple's then-current Operating System, O/S 9, could not take advantage of the dual processor architecture. Rather, the products potential would be largely wasted until the next-generation operating system, O/S X caught up with the hardware advance. When Jobs ladled out the thesaurus full of superlatives about the G4 Cube, he failed to mention a known design defect Apple faced with the computer's on/off switch. Jobs also neglected to mention that Apple's new generation of iMacs lacked features demanded by back-to-school and other purchasers that fall: CD- rewritable drives and 17 inch monitors. Finally, while Jobs asserted that Apple expected to start selling the G4 Cube in volume in August 2000, he failed to mention the known problems with the production lines that made the August 2000 ramp-up date impossible. Less than a year later, on July 3, 2001, Apple completely abandoned its attempt to manufacture the G4 Cube.
9. Apart from Apple's product problems, a wholesale change in the Company's key K-12 educational sales process was already taking its toll when Jobs gave his speech on July 19, 2000. Three months earlier, on April 15, 2000, Apple had told its long-standing group of independent K-12 sales agents they would be terminated, in favor of an Apple-only "direct sales" model as of June 30, http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 5 of 70
2000. While Apple, throughout the Class Period, asserted this transition was progressing nicely and education sales had accelerated, this was simply not the case. The terminated agents cannibalized 4Q 2000 sales in favor of the last round of commissions - an impact Apple began to recognize immediately in July 2000. Jobs subsequently acknowledged Apple knew this in July 2000 explaining that the terminated agents "did absolutely nothing to build for sales in the July quarter. So when our new sales folks got there, they found there was no pipeline work at all; they had to start from scratch."
10. Thus, this action involves the dissemination of false and misleading statements by defendants concerning the state of demand for Apple's newest personal computer products - upgraded iMac and Power Mac G4 personal computers and its completely new G4 Cube personal computer - the quality and appearance of the G4 Cube, as well as its availability, the state of Apple's component part and finished goods channel inventories, changes in Apple's product distribution network for its vitally important K-12 education market and the very negative impact the undisclosed adverse conditions relating to these matters were having on Apple's business operations and financial results.
11. As late as two weeks before the end of the 4Q 2000, Apple continued to mislead the market. On 9/13/00 Jobs appeared on CNBC and was questioned about a shortage of the Company's G4 Cube. Jobs asserted Apple had shipped "many tens of thousands." Jobs ended by stating: "I think we're going to hit our forecasts this quarter so if they're hard to find, I think that's because demand is greater than we thought it would be ...." Apple's 4Q 2000 revenues (net sales) were only $1.87 billion with EPS of only $0.30 - far below the levels previously forecast for the quarter that typically is Apple's best.
12. The financial hardship visited on the Company after the devastating 4Q 2000 is further shown by Apple's dismal financial performance in FY 2001. Saddled with underperforming products and the failure of the direct sales schools model, the Company suffered a huge loss in 1Q 2001, which it could not overcome. The 1Q 2001 debacle led to a $37 million loss for the entire FY 2001:
FY 2001 12/30/00 03/31/01 06/30/01 09/29/01 Year Net Sales $1,007 $1,431 $1,475 $1,450 $5,363 Operating Income (Loss) ($420) ($8) $31 $53 ($344) Investment Gains $71 $5 $11 $1 $88 Net Income (Loss) ($247)* $43 $61 $66 ($37)* Earnings (Loss) Per Share ($0.73)* $0.12 $0.17 $0.19 ($0.11)*
* Excluding investment gains and effects of new accounting pronouncement.
II. JURISDICTION AND VENUE
13. The claims asserted herein arise under and pursuant to §§10(b) and 20(a) of the 1934 Act [15 U.S.C. §§78j(b) and 78t(a)] and SEC Rule 10b-5 [17 C.F.R. §240.10b-5].
14. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C. §§1331 and 1337 and §27 of the 1934 Act [15 U.S.C. §78aa]. Apple used the means and instrumentalities of interstate commerce and the facilities of the national securities markets.
15. Venue is proper in this District pursuant to §27 of the 1934 Act, and 28 U.S.C. §1391(b). http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 6 of 70
Many of the acts alleged herein occurred in this District.
III. PARTIES
16. Lead Plaintiffs Hawaii Structural Iron Workers Pension Trust Fund, D. Oscar Fuster, and Gary and Peggy Thompson purchased the common stock of Apple at artificially inflated prices during the Class Period, as detailed in the certifications previously submitted to the Court, and were damaged thereby.
17. Defendant Apple has its executive offices in Cupertino, California. Apple designs, manufactures and markets personal computers, primarily to education, creative, consumer and business customers. Substantially all of Apple's sales are derived from the sale of personal computers from its Apple Macintosh line of computers. Apple manages its business primarily on a geographic basis, including segments in the Americas, Europe (including the Middle East and Africa), Japan and Asia Pacific (including Australia). Apple's common stock traded in an efficient market.
18. Defendant Steven P. Jobs is the CEO of Apple. Jobs controls Apple and is therefore liable as a controlling person under §20(a) of the 1934 Act.
19. Jobs, Apple and its representatives made false and misleading statements, engaged in a scheme to defraud and pursued a course of business that operated as a fraud and deceit on purchasers of Apple common stock.
20. The top executives of Apple run the Company on a day-to-day basis, dealing with important issues facing Apple's business, i.e., demand for its products, product sales, orders, supply and inventory, as well as the design, testing and final pre-shipment validation of its new products, the manufacturing effectiveness and efficiencies of its products, and the quality of those products. Apple maintained a system of internal controls that was organized and directed on a day-to-day basis under the supervision of defendant Jobs, Apple's CFO, Controller, Treasurer and six senior vice presidents (collectively, the "Senior Officers"):
(a) Jobs was at all relevant times Chief Executive Officer and a director.
(b) Fred D. Anderson ("Anderson") was at all relevant times Executive Vice President and Chief Financial Officer.
(c) Peter Oppenheimer ("Oppenheimer") was at all relevant times Corporate Controller.
(d) Gary Whistler ("Whistler") was at all relevant times Treasurer.
(e) Jonathan J. Rubinstein ("Rubinstein") was at all relevant times Senior Vice President- Hardware Engineering.
(f) Avadis Tevanian, Jr. ("Tevanian") was at all relevant times Senior Vice President-Software Engineering.
(g) Sina Tamaddon ("Tamaddon") was at all relevant times Senior Vice President-Service and Support.
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(h) Nancy R. Heinen ("Heinen") was at all relevant times Senior Vice President and General Counsel.
(i) Timothy D. Cook ("Cook") was at all relevant times Senior Vice President-Worldwide Operations.
(j) Mitchell Mandich ("Mandich") was at all relevant times Senior Vice President-Worldwide Sales.
21. Each of the Senior Officers, by virtue of their high-level positions with Apple, directly participated in the management of Apple, was directly involved in the day-to-day operations of Apple at the highest levels and was privy to confidential proprietary information concerning Apple and its business, operations, products, growth, financial statements and financial condition and was aware of or deliberately disregarded that the false and misleading statements were being made by and regarding the Company.
22. Apple's day-to-day operations are dominated by Jobs, its founder and CEO. Jobs and the small tight-knit group of top executives listed above run Apple with an obsessive attention to detail and secrecy, as they control all aspects of Apple's operations. As Business Week reported during the Class Period:
Jobs now runs every aspect of the company with a quintet of trusted top executives .... Jobs quickly stripped out vestiges of bureaucracy, eliminating the administrative officer and chief technologist. Now, each exec is responsible for everything related to his specialty rather than a narrow product group or market segment. Hardware Chief, Jon Rubinstein, for example, can make sure every new Mac is built with parts that can be leveraged across as many models as possible.
This tight-knit management structure is crucial. Since almost all big decisions are made at Monday morning executive committee meetings, it's easy for various parts of the company to work closely together. And it lets Jobs easily impose his perfectionism on everything the company produces, from press releases to software to new PCs.
Business Week also reported on Apple's top executive team's obsession with secrecy:
Jobs has even managed to impose his insistence on total secrecy at a company where leaks were once rampant.... Indeed, only a few hundred of Apple's 10,000 staffers had heard of the [G4 Cube] when Jobs took the stage for his July 19 keynote [at the MacWorld Conference]. "We have cells like a terrorist organization," laughs Rubinstein. "Everything is on a need-to-know basis."
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IV. BACKGROUND TO THE CLASS PERIOD
23. Apple, as a company was "left for dead" in 96-97 when it experienced management upheaval, market rejection of its products, mounting losses and shriveling market share. The Company's stock fell to less than $10 per share. When Apple's co-founder, Jobs, returned as Apple's CEO in 97, however, Apple appeared to recover. By mid-00, Apple had reported 11 consecutive quarters of EPS growth, largely due to the success of its new colorful iMac line of personal computers. As a result of Apple's turnaround, its stock recovered, soaring to its all-time high of $75-3/16 in mid-3/00.
24. By May and June 2000, Apple had not introduced new products or significant product upgrades for many months. Investors were concerned that Apple's sales momentum was slowing due to its aging product line and due to customers holding off purchases of older PCs while awaiting the release of Apple's new products. In fact, in 4/00, PaineWebber had cautioned the investment community that growth in sales of Apple's flagship iMac line of PCs was probably limited due to the aging of that product line and dominance of WinTel products. As a result of these concerns, Apple's stock fell from its all-time high of $75-3/16 on 3/23/00 to as low as $40-3/16 in early 6/00 - eliminating $5.4 billion of Apple's market capitalization. The huge drop in Apple stock cost Apple's top insiders millions of dollars based on their Apple stock ownership and vested options. The drop also caused significant concerns among institutional investors who owned Apple stock and analysts http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 9 of 70
who followed and recommended that their customers purchase Apple stock. Thus, Apple and its Senior Officers were under tremendous pressure to announce and introduce upgraded, refreshed and new products at Apple's upcoming MacWorld Conference in mid-7/00 in New York City. Apple's stock recovered to $57-$60 by mid-7/00 however, as Apple told analysts to anticipate better than expected 3Q 2000 EPS and the release of upgraded and/or new products at the upcoming MacWorld Conference, both of which would drive strong revenue and EPS growth for Apple in its 4Q 2000, FY 2000 and FY 2001, as well.
25. By mid-7/00, investors eagerly anticipated two important Apple events. First, the release of Apple's 3Q 2000 results on 7/18/00. Second, the semi-annual MacWorld Conference on 7/19/00 in New York City, at which Apple was to announce and introduce several new products to spruce up or refresh its aging iMac and Power Mac product lines. The product presentations would be followed by a conference for analysts during which top Apple officials would provide detailed information about Apple's business, new products and outlook. On 7/17/00, Bloomberg reported:
Apple Computer Inc. Chief Executive Steve Jobs may show off faster iMac personal computers, high-end Power Macs and new monitors at the MacWorld Expo conference in New York this week.
Jobs will give the keynote speech at the gathering of Macintosh developers and users ....
Apple co-founder Jobs traditionally uses the semiannual MacWorld shows to make a splash by unveiling products .... Analysts are expecting Jobs to introduce new machines ....
"He likes to surprise people," said Jeff Westerfield, director of merchandising at ComputerWare, a Mac retailer.
* * *
"They maximize the anticipation and it builds a huge amount of excitement," said analyst David Bailey of Gerard Klauer Mattison ....
On 7/17/00, PaineWebber issued a report on Apple stating:
* Apple is scheduled to report fiscal third quarter (June) earnings on Tuesday, July 18 after the market closes, with the MacWorld conference to take place starting the following day....
* During May, Apple appears to have made very good progress in bringing down its retail inventory and presently stands out as the only vendor among the major retail vendors that has brought its inventory level under control....
* Sales of Apple's iMac were less robust than originally planned for the current quarter. Since the iMac was last upgraded in October, it appeared sales had slowed as consumers/channel anticipate an upgrade at the upcoming MacWorld conference in July.
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MISLEADING STATEMENTS
A. MacWorld New York
1. July 18-19, 2000: Media and Investor Presentations
26. On 7/18/00, after the close of the market, Apple reported its results for the 3Q 2000, ended 7/1/00. Excluding gains from investments, Apple earned $163 million, or $0.45 per share, with revenues rising to $1.83 billion. While 3Q 2000 results were in line with or actually beat the EPS expectations announced by analysts following the Company, these results - as expected - showed declining revenue growth due to slowing iMac sales. Yet, rather than admit that demand for Apple products was waning, the Company took steps to condition investors to believe the Company was on the verge of strong growth. On 7/18/00, Apple CFO Fred Anderson, Corporate Controller Peter Oppenheimer and Treasurer Gary Whistler held a conference call and gave a glowing report about the Company's prospects. During the conference call, Kurt King, an analyst with Bank of America, specifically asked about growth expectations for the fourth fiscal quarter. CFO Anderson responded "Yeah, I would say we're targeting over 10% sequential growth." When pressed, Anderson said "I'm saying over 10%, so I think it will be double digits." Based on the 3Q 2000 numbers just released, this equated to revenue exceeding $2 billion for the 4Q 2000. In addition, while Apple CFO Anderson stated during this conference call that margins would decline 2-3% to 26.8%-27.8% and operating expenses would increase by $15 million with a flat tax rate, due to the revenue increase this equated to a $0.40+ EPS. There was simply no basis for these statements when made. As detailed herein, sales of the older iMac had already fallen below expectations in the 3Q 2000 (450,000 units sold versus 500,000 expected) and the new products were riddled with defects. The G4 Cube could not be mass manufactured without cracks in its purportedly crystal clear enclosure, the new G4 Dual Processor could not, with the current operating system, take advantage of the dual processor configuration, a defectively designed on/off switch was erasing data and the new generation of iMac's lacked CD rewritable drives and 17 inch monitors.
27. Apple also made false and misleading statements during the conference call with respect to its education market. When asked about education sales both CFO Anderson and Controller Oppenheimer stated "we had a good quarter in education." Oppenheimer further stated "about a year ago we transitioned our agent sales force in high-ed ... and we started that last quarter in K-12 and that's progressed nicely for us." This statement was false when made. As detailed herein, the sales transition was a complete failure from the beginning. According to Jobs himself:
The problem was, we were very straightforward and told these third-party salespeople ahead of time that 'Hey in four months we're going to switch and you're going to be out of a job.' Obviously these folks did everything they could to sell as much as they could by June 30, when we let them go, and did absolutely nothing to build for sales in the July quarter. So, when our new sales folks got there, they found there was no pipeline work at all; they had to start from scratch. And, duh, this was during the peak buying time for schools. It was just stupid on our part to do this then and that was my decision. It was a train wreck, and it was totally my fault.
28. Despite these facts, in an effort to maintain Apple's share price and get the products out the door, Apple never wavered from its $2 billion+ revenue guidance or the gross margin guidance equating to an EPS of $0.40+ per share throughout the quarter. As to the educational market, the Senior Officers continued to assert throughout the Class Period that educational sales were http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 11 of 70
accelerating. CFO Anderson also spoke to Associated Press, which reported the statement regarding sequential growth providing wide distribution:
"The turnaround is over," said Fred Anderson, Apple's chief financial officer. "We're now in the early stages of a strong growth story." "We're targeting over 10 percent sequential (revenue) growth".... "It's been about nine months since we have had any major product introduction. We're going to change that tomorrow, and we think you will be impressed."
29. On 7/19/00, The San Francisco Chronicle reported:
[B]oth company officials and analysts said products to be unveiled today should push sales growth back onto the fast track.
* * *
Anderson blamed the iMac slowdown on the fact that Apple hasn't introduced new models in nine months, but he said that would change today, when company chief executive Steve Jobs delivers the keynote address at the East Coast edition of MacWorld Expo, the semiannual Mac trade show, in New York. "I think you'll be impressed," he told analysts, adding that the company has "a very strong pipeline of products"....
30. Notwithstanding these positive statements, analysts were disturbed by the iMac short fall in 3Q 2000 and Apple's stock fell sharply from $58-7/8 on 7/18/00 to $51-3/4 early on 7/19/00. This sharp decline put pressure on Apple's executives to present a very bullish picture at the MacWorld Conference and corresponding analyst meeting to reassure the investing community that Apple's new products would be quickly introduced, resulting in strong 4Q 2000 financial results and continued revenue and EPS growth during FY 2001. Apple, Jobs and the other Senior Officers knew that without such hype, Apple's stock would continue to fall.
31. On 7/19/00, Apple held its MacWorld Conference in New York City. The MacWorld Conference is a media extravaganza - attended by thousands of people, broadcast live over the Internet and closely covered by the press. For the 7/19/00 MacWorld Conference, hundreds of people lined up all night outside the Jacob Javitz Convention Center waiting to get in. Jobs gave the "keynote" speech at MacWorld, introducing an improved, less expensive line of iMac personal computers, upgrading the Power Mac G4 line of personal computers (including models with dual microprocessors), and an entirely new product - the G4 Cube - an 8" square, clear sided computer with the dual microprocessor feature. In addition, Apple demonstrated several new products at the MacWorld show, including:
• Four new iMacs in five additional colors. Four new iMacs were introduced, including a new entry level machine with a suggested retail price of $799.
• The Power Mac G4 Dual Processor. In its high-end line of computers Apple introduced several new machines which adopted a dual processor architecture.
• The G4 Cube. The Cube was hailed as Apple's "pièce de résistance" and was, purportedly, a revolutionary computer which incorporated dual processor G4 chips in an eight-inch clear sided cube containing a DVD drive. The Cube, sheathed in a crystal clear plastic casing, boasted the same power http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 12 of 70
as the Power Mac G4s in a configuration one-fourth the size. Two versions of the G4 Cube were to be made available in early 8/00 at a cost of $1,799 and $2,299, without a monitor.
32. During his address at MacWorld, Jobs introduced the new Apple products and explained that these products were expected to drive Apple's revenues and earnings in the near-term and throughout FY 2001 - FY 2002. Jobs stated:
• "Power Mac G4 is an awesome product.... [A] 500 megahertz G4 is as fast as a 1.2 gigahertz Pentium ... it's pretty amazing ... we've got ourselves a really fast chip here .... We have a Dual Processor G4 here ... because two brains are better than one ... this is going to be the best Power Mac ever ...."
• "But today, for the first time in 2-1/2 years we are expanding our product strategy.... What is it? We are combining the power of the Power Mac G4, the awesome power of this machine, with the desktop elegance, the styling and the miniaturization that we learned from doing the iMac. To make a whole new class of machine."
• "What's so new and special about this? ... Because if this is the size of a Power Mac G4, we have miniaturized all that power into ... an 8-inch cube. An 8-inch cube. Unbelievable!... Our engineers have done some brilliant work ...."
• "The G4 Cube is ... the most beautiful product [Apple] ever designed. The computer is in an 8-inch cube and it's suspended in a stunning crystal clear enclosure.... Now, our engineers spent an enormous amount of energy figuring out how to get this amazingly powerful G4 technology into this 8-inch cube .... [T]he G4 Cube, it's amazing.... [T]he system is really beautiful."
• "You can just go to the Apple Online Store and order this. All models are available in early August, just a few weeks to go. Power Mac G4 Cube. We are so proud of this thing."
33. In order to generate additional favorable publicity for the G4 Cube personal computer at the time it was attempting to release the product, Apple provided carefully selected G4 Cubes to analysts, members of the financial press and technology writers at key newspapers/magazines to obtain favorable reports and/or recommendations for the G4 Cube. These hand-picked G4 Cubes were cosmetically perfect, even though Apple knew many of the G4 Cubes coming off the assembly line were imperfect, having mold lines or tiny cracks in their supposedly perfectly clear, pristine crystal cases. The "amazing," "really beautiful," "stunning," "crystal clear," "perfect," "pristine" G4 Cube promotional computers were not products of Apple's mass production process, but rather, were hand- picked G4 Cubes with none of the cosmetic blemishes plaguing many of the G4 Cubes coming off the assembly line. Indeed, Apple was never able to successfully mass produce the Cube throughout the Class Period and completely abandoned it by the middle of the next year.
34. Apple, Jobs and Apple's other Senior Offices made positive statements just prior to and during the MacWorld New York conference on July 18-19, 2000 that were false and misleading when made:
(a) When Apple's CFO Anderson stated on July 18, 2000 that the Company was "now in the early stages of a strong growth story," he disregarded the facts about the G4 Cube manufacturing disaster, the facts about the G4 dual processor's inability to maximize the two processors' abilities, the on/off switch problem and that the Company had failed to equip its new iMacs with features sought by http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 13 of 70
consumers, all of which contradicted his rosy predictions. He further failed to disclose or account for the impact of the overhaul of Apple's K-12 educational sales process and that the former sales agents had cannibalized 4Q 2000 sales in the previous quarter. In giving specific guidance as to sales growth of 10% ($2 billion) and margins equating to an EPS exceeding $0.40 per share, Anderson did so with actual knowledge that there was no basis for these estimates.
(b) When Apple's Controller Oppenheimer stated on July 18, 2000 that Apple's sales force transition in the K-12 education market "progressed nicely for us," he failed to disclose that the transition was a complete disaster. Apple's third party sales agents had already cannabilized 4Q 2000 K-12 education sales by booking orders early at the end of 3Q 2000 to lock in commissions before they were terminated at the end of 3Q 2000. Thus, Apple's new in-house agents had - according to CEO Jobs - no pipeline of education orders to work with in the July quarter causing a $60 million education sales shortfall in 4Q 2000.
(c) On July 19, 2000, when Jobs unveiled the G4 Cube at the MacWorld conference, he presented the audience with a purely aspirational product, knowing that the Company was not then producing and could not produce the "crystal clear," "perfect," and "pristine" Cube, even at the premium price point he announced. Jobs knew that neither Apple's production system nor its partners and/or suppliers were able to produce the plastic casing at the rate required without huge numbers of the casings suffering from "mold line" problems or succumbing to cracks after assembly. Further, Jobs knew about the defective power switch plaguing the G4 Cube models, which caused the machines to unexpectedly shut off without saving data. Jobs was aware of the severe design and manufacturing problems plaguing the G4 Cube and Dual Processor based on monthly Project Status Reports and the Project Risk and Opportunity Reports written by CW2,(1) the Cube's Lead Project Designer. In addition, Jobs had acknowledged and discussed the manufacturing problems during an address to campus representatives a month before MacWorld. Further, as discussed below, Apple carefully hand- picked and hand-polished G4 Cubes without any of the cosmetic blemishes or defects present in at least 75%-80% (according to CW1) of the G4 Cubes and displayed and provided samples of these unrepresentative hand-picked G4 Cubes to the press and public for inspection or test use.
(d) Similarly, when Jobs introduced the G4 Dual Processor, he knew that Apple's then-current operating system, O/S 9, lacked multi-processor capabilities, and therefore, until the next generation O/S X was released, purchasers would see no noticeable performance benefit from the computer unless they also purchased special programs specifically designed for the dual processor.
(e) Finally, when Jobs introduced the new line of iMac computers, he knew that regardless of any target-point price issues, the new iMacs lacked key features customers wanted, including a rewritable CD drive and a 17" screen, making the new iMacs unappealing on a retail level.
2. July 20: Media Reaction
35. The events at the MacWorld Conference had a tremendous impact on members of the financial press, analysts and Apple investors, and was widely reported by the media on 7/20/00:
Dow Jones News Service:
If you had happened to be driving past New York's Jacob Javitz Convention Center at around 3:30 a.m. Wednesday morning, you might have wondered why all those people were lined up outside.... Steve Jobs is in town. http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 14 of 70
The Chief Executive of Apple Computer flew to New York City this week .... [H]is fans came with him. People started lining up in the middle of the night to ensure prime spots for his 9 a.m. address.... This isn't celebrating a charismatic CEO. It's guru worship.
Jobs himself knows this. He's a master at turning the cult of personality into a marketing opportunity. MacWorld is the Apple love fest where the company typically launches new products and generates plenty of buzz. Jobs didn't disappoint.
This year ... the big news came in the form of an eight-inch clear-sided cube called the G4 Cube - launched with typical Apple fanfare....
When it was wheeled out, a frenzy of camera flashes lit up the dimmed room.
USA Today:
Apple Computer CEO Steve Jobs took his dazzling show to the Big Apple on Wednesday ....
* * *
With enough fanfare and flair to satisfy the most exacting Broadway producer, Jobs literally unveiled the Power Mac G4 Cube, a 17-pound box that combines the horsepower of Apple's top-of-the-line G4 with the aesthetics of the iMac.
* * *
The Cube was the centerpiece of a busy day for the PC pioneer, which refreshed and expanded its desktop product line at MacWorld Expo, a hybrid of a trade show and an evangelical revival meeting for Apple's most loyal customers and enthusiasts.
The Wall Street Journal:
When co-founder Steve Jobs returned to rescue Apple Computer Inc. in 1997, he pared the company's product lines to the core. Now, the company has shifted strategy and started to expand again.
Yesterday, Mr. Jobs ... unveiled the ... computer maker's first new hardware line in more than two years. The new product - the Power Mac G4 Cube, known simply as the G4 Cube - is a sleek eight-inch processor ....
* * *
The introduction of the new G4 Cube and upgrades in the rest of the computer lineup signal that Apple now believes it's ready to capture more market share. "We got very focused when we were fixing things a few years ago," Mr. Jobs said in an interview following his MacWorld keynote speech. "We've proven we can stay focused and can refresh our product lines. Now we can expand ...."
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The New York Times:
Apple Computer introduced a flurry of new products yesterday ....
Apple has enjoyed a remarkable corporate revival the last three years under the leadership of Steven P. Jobs, who returned to take the helm of the company he co- founded in 1975.
* * *
"The question some people have had about Apple is, 'Can we keep it up?'" Mr. Jobs, the chief executive, observed in an interview. "Well, we've answered that question here today. Innovation keeps coming from Apple."
* * *
"We want Apple to stand at the intersection of art and technology."
Perhaps the most visually striking innovation announced yesterday was a new line of Power Macintosh called the G4 Cube.
San Jose Mercury News:
Apple Computer Inc. introduced its latest design innovation: a cube-shaped version of its Power Mac G4.... [W]hat [Jobs] called "the coolest computer ever" ....
* * *
"I think the products exceeded our expectations, especially the G4 Cube," said Rob Follis, a London-based consultant. "Steve Jobs is a real showman.... [T]here was a lot more product than I anticipated."
* * *
The product announcements pleased analysts ....
"This gives me a great deal more confidence in my estimates going forward," [an analyst] said. "It gives a very viable plan of how they're going to grow their units by 25 or 30 percent next year."
The Boston Globe:
You've probably seen it on TV already - that vaguely shocking white cube with a supercomputer inside, the most gorgeous desktop machine that Apple Computer Inc. has ever produced.
When Apple CEO Steve Jobs waved his arm, and the computer was rolled out onto the stage at MacWorld Expo yesterday, there was a sound in thousands of throats - a http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 16 of 70
cheer, a gasp, a groan of lust, all mingled.
Nobody else makes computers like this, and they waste their time and money when they try....
* * *
By the time Jobs was done, you could feel the heat rolling off the show floor in waves.... The people here are stoked with a confidence I haven't seen at a MacWorld in years. The decade of exile is over, and Apple is once again in a position to take on the world.
36. These statements, based on defendants' presentation at MacWorld, reflected the false image defendants sought to portray for Apple. As detailed above, the MacWorld presentation orchestrated by Jobs and Apple misrepresented the real products the Company could sell and misled the media regarding the quality and availability of the new computers.
3. July 20: Investment Analyst Reaction
37. In addition to making false claims about the quality and availability of products at the MacWorld Conference, Jobs and other members of Apple's senior management (including Anderson) also hosted an analyst conference with securities analysts and the financial press, reinforcing the importance of the new products to the Company's revenue and EPS growth. At the analyst meeting, Anderson, Jobs and other Apple executives spoke with members of the financial press and analysts from S.G. Cowen, Prudential Securities, Bear Stearns, DLJ Securities, A.G. Edwards, PaineWebber and Gerard Klauer Mattison, telling them:
• The slowdown in iMac sales during the 3Q 2000 was not the result of any saturation of Apple's "installed base" of loyal customers. Customers' anticipation of the revamping of Apple's product family had been the "primary factor" in iMac sales falling short, as potential customers waited for a new version of the iMac and other new Apple products to be released.
• Based on the introduction of Apple's new products in the 4Q 2000, Apple expected to report better revenue and EPS growth going forward than earlier forecast.
• Increased sales volume resulting from lower priced machines would allow Apple to increase revenues and gain market share with only a slight decline in gross margins, the effect of which should be mitigated by the higher profits resulting from sales of the more expensive Power Mac G4 machines and G4 Cubes.
• Apple expected to sell 800,000 G4 Cubes in its first year and 150,000 G4 Cubes in the 4Q 2000, with quarterly shipments to occur in 8/00.
• The G4 Cube, together with the other new products, would bolster top-line growth, leading to 20+% year-over-year revenue growth in FY 2001.
• Because Apple had executed by delivering 11 consecutive profitable quarters, the G4 Cube and upgrades to the rest of the Company's product line-up signaled that Apple http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 17 of 70
could capture more market share with its expanding product line.
• The success of the G4 Cube would be driven by its "revolutionary" design, which incorporated aesthetics that were as pleasing to Apple's customers as the G4 Cube's dual processors were functional.
• These new products were all to be made available in the 4Q 2000 (some at the quarter's inception and some soon thereafter) and would drive a resurgence of revenues and earnings in the 4Q 2000 and beyond. The G4 Cube would expand Apple's product offering into a new category of computer sales and, therefore, be a very significant part of the driving force behind the Company's continued growth and profitability.
• Apple expected 4Q 2000 revenues and EPS of $2.0+ billion and, based on a 27.2% overall margin, $0.40+, respectively.
• Apple expected FY 2000 of $1.83 and revenue and EPS growth in FY 2001 of 20% and 15%, respectively.
• Analysts should raise earnings estimates for FY 2000 from $1.80 to $1.84-$1.85 and for FY 2001 from $1.92 to $2.10-$2.15, to reflect the positive sales momentum to be generated by new products, and based on management's better sense of timing and ramp of new products.
Analysts following Apple were suitably impressed and dutifully raised their EPS forecasts for Apple based on this unabashedly bullish presentation.
38. On 7/20/00, Prudential Securities issued a report on Apple by Kimberly Alexy, which was based on and repeated the positive statements and information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS for Apple to $1.84 and $2.10, respectively, and increased the 4Q 2000 EPS forecast to $0.45. It also stated:
* Yesterday, at Apple's annual MacWorld event in NYC Steve Jobs delivered the key note address in which Apple announced a suite of new product offerings. Following the key note, Apple hosted a analyst meeting with management executives - including Steve Jobs (for the first time).
* We view the most significant product announcements from MacWorld as ... the Cube - a revolutionary new product category in an 8 inch cube form factor which blends the advantages of the G4 with the design attributes of the iMac ....
* * *
The biggest announcement ... was the Cube, an entirely new desktop product offering which combines the power of the G4 with the design features of the iMac. Specifically, the Cube is one-fourth the size of the G4 and is packaged in an 8-inch cube encased in a clear shell.... We believe the product is both exceptionally designed and very unique, providing a good balance of the strengths of the feature sets from both offerings.... The Cube will be available in early August....
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We believe the Cube is the most significant new product offering since the iMac .... The form factor will appeal to both those conscious of space constraints as well as those in search of a more ascetically [sic] pleasing alternative to the traditional desktop PC.
39. On 7/20/00, Bear Stearns issued a report on Apple by Andrew Neff, which was based on and repeated the positive statements and information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS for Apple to $1.84 and $2.15, respectively, and the 4Q 2000 EPS to $0.45. It also stated:
*** The key messages we came away with after the Steve Jobs keynote and the analysts meeting are: Apple is in a growth mode, it has extended (and perhaps solidified) its reputation for innovation, the company combines innovation and discipline to translate into superior financials ....
*** ... [W]e were impressed with the G4 Cube, an 8" cube .... The key takeaway was innovation ... the products were very cool and will clearly generate demand from [Apple's] installed base and possibly beyond....
*** As noted, from a product standpoint, the company is well-positioned for the second half, starting in July (three new iMacs, new Power Macs, new displays), August (G4 Cube) ....
*** ... [W]e raised our estimate ... for FY2000 from $1.80 ... to $1.84 ... and for FY01 from $1.92 to $2.15 .... We now have a better sense of how the company will get there but note that the company has been conservative in its outlook in the past.
* * *
G4 Power Cube - this 8" cube is a real blow-away innovation from its size to its features.... The product ... is set to launch in early August.
* * *
In Steve Jobs' comments, he noted the company priority: to make the best personal computers. In his view, the PC industry has been in a coma - devoid of innovation - which Apple is bringing back.
* * *
CFO Fred Anderson reiterated Apple's guidance for FY01 (25-30% unit growth, 20% revenue growth, gross margin around 27% ...). The main drivers for this growth in Q4 and FY01 include new iMac power point, expanded distribution, dual-CPU Power Macs and the G4 PowerCube.
40. On 7/20/00, DLJ Securities issued a report on Apple by Kevin McCarthy, which was also based on and repeated information provided at the 7/19/00 conference. The report increased Apple's forecasted FY 2000 and FY 2001 EPS to $1.79 and $2.10, respectively. It also stated: http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 19 of 70
Apple introduced several way cool products at MacWorld yesterday. The new G4 Cube small-footprint desktop received standing accolades from the MacWorld audience, as it redefines the look and feel of desktop computing. The 8-inch square graphite-and- smoke cubic PC packs tremendous horsepower in a small package ....
We believe these new products ... will provide upside revenue and earnings potential for Apple during the next 2-4 quarters.
41. On 7/20/00, A.G. Edwards issued a report on Apple by Jimmy Johnson, which was also based on and repeated information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS to $1.84 and $2.09, respectively, and the 4Q 2000 EPS to $0.45. It also stated:
MacWorld certainly wasn't short of its usual surprises as Steve Jobs not only introduced new iMacs, but a whole new kind of computer as well.
* * *
* The biggest surprise of the show was a whole new kind of product .... [G]eared for the pro customers (a new consumer product will follow later) that is an 8-inch cube! Yes, it's shaped completely like a cube and is basically a G4 desktop that has been miniaturized into a completely new form factor. As Steve put [it], it has all the features of a G4 but the elegance of the iMac. The Cube ... will ship in early August ....
* * *
Q4 guidance is for revenues up over 10% sequentially .... We have left our Q4 estimate unchanged with revenues of just of $2 billion and EPS of $0.45.
The company also gave guidance for 2001 which is for revenue growth of 20%, unit growth of 25 to 30% and gross margins in the range of 26.5% to 27.5%.... This all boils down to EPS growth of 15% ....
42. On 7/20/00, PaineWebber issued a report on Apple by Don Young, which was also based on and repeated information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS to $1.85 and $2.10, respectively, and forecasted 4Q 2000 EPS of $0.46. It also stated:
* ... [A]fter spending the day at the MacWorld conference we are taking up our 2001 revenue and EPS estimates ....
* * *
For FY2001 we are modeling for 20% revenue growth, gross margins of 27.4% .... Our 2001 revenue and EPS estimates are $9.77 Bil. and $2.10/share, up from $9.68 Bil. and $2.00/share.
43. On 7/20/00, S.G. Cowen issued a report on Apple by Richard Chu, which was also based on http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 20 of 70
and repeated information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS to $1.85 and $2.15, respectively, and the forecasted 4Q 2000 EPS to $0.46. It also stated:
Apple's new products shine and are likely to prove to be impossible to resist ....
... With prospects for 20%+ annual growth ... AAPL stock is compellingly cheap ....
* * *
- Plainly, Q3, in retrospect, took a meaningful hit from anticipation of new product; of the $100+MM shortfall relative to consensus revenues, management attributes perhaps $25MM to the weak Euro, some unit shortage (i.e., 450K vs. 500K in iMacs), but the primary factor that pushed revenues down were lower ASP's due to larger than normal contra revenue/price protection provisions - we estimate this may have been about 250 basis points on the revenue line. Effectively, Apple management took very conservative reserves for price cuts on old lines ....
44. On 7/20/00, Gerard Klauer Mattison issued a report on Apple by David Bailey, which was also based on and repeated information provided at the 7/19/00 conference. The report increased the forecasted FY 2000 and FY 2001 EPS to $1.85 and $2.15, respectively, and the forecasted 4Q 2000 EPS to $0.46. It also stated:
Complete refresh of its desktop product line, announced at MacWorld Expo, increases our confidence in Apple's ability to deliver strong revenue and EPS growth going forward.
* * *
INVESTMENT CONCLUSION
We believe Steve Jobs' MacWorld Expo keynote and Apple's analyst meeting highlight many of the company's strengths. Introduction of the G4 Cube and refresh of the company's iMac and Power Mac product lines demonstrate the company's continued ability to create innovative products with features targeted at Apple's core customer segments (consumer, education and design/graphics professionals).
45. The uniform affirmative "guidance" that Apple gave the various analysts is demonstrated in the similar gauges by analysts of Apple's calculated results for upcoming periods:
7/20/00 Analyst Report 4Q 2000 FY 2000 FY 2001 Prudential Securities $0.45 $1.84 $2.10 Bear Stearns $0.45 $1.84 $2.15 DLJ Securities $0.40 $1.79 $2.10 A.G. Edwards $0.45 $1.84 $2.09 PaineWebber $0.46 $1.85 $2.10 S.G. Cowen $0.46 $1.85 $2.15 http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 21 of 70
Gerard Klauer Mattison $0.46 $1.85 $2.15
46. Utilizing the announced 10% revenue growth rate and gross profit margin range of 26.8%- 27.8% with operating expenses increasing by $15 million with a flat tax rate, as disclosed in Apple's July 18, 2000 conference call, analyst expectations ranged from $0.40-$0.46 for Q4 2000, with the consensus at $0.45.
47. Apple had scheduled its semi-annual MacWorld Conference for mid-7/00 in New York many months earlier in order to announce and introduce the much awaited new products. However, due to design and production problems, the new products were not ready for market and Apple had already committed itself to a new iMac platform without a rewritable CD drive and with 15" monitors. Apple could not reverse those decisions in time for MacWorld. Admitting these negative conditions and mistakes at the MacWorld Conference would have been a horrible embarrassment to Jobs, who is a master of hype, and would have had a crushing impact on Apple's stock - the very kind of impact that occurred when these true facts later came out at the end of September 2000. So Jobs lied. He went on stage at the MacWorld Conference and displayed a hand-picked and hand-polished G4 Cube that was not the result of mass production while pretending that similar products were being mass produced. He made wildly exaggerated claims about the power and performance of the Power Mac G4 Dual Processor when he knew the dual processors could not be effectively utilized. Finally, he hyped the new iMac personal computers even though he knew from Apple's pre-market studies and consumer sampling that the product lacked at least two essential features for consumer acceptance and success. To top it off, Apple executives gave specific guidance during conferences with analysts as to revenue growth of $2+ billion and $0.40+ EPS growth. Due to the foregoing problems, there was no basis for this guidance and in fact revenue was essentially flat from the 3Q 2000 to the 4Q 2000 and earnings per share ended at just $0.30 for the 4Q 2000.
4. July 25-31: Magazine Reaction
48. After the MacWorld new product announcements and analyst conference on 7/19/00, Apple continued to bombard the markets with extremely positive information about the current state of its business, its new products and its prospects - all designed to support and inflate the price of Apple's stock.
49. On 7/25/00, USA Todayran an article on Apple, arranged by Apple to appear in conjunction with Apple's new product announcements at MacWorld. After interviewing Jobs, Anderson and Philip Schiller (Apple's VP of worldwide marketing) and obtaining information from them, USA Today stated:
Last week, [Apple] introduced a flurry of products, from a restyled mouse and keyboard to a striking 8-inch computer called the Power Mac G4 Cube. Apple overhauled the iMac line, adding colors, and introduced a line of warp-speed Power Mac desktops with two microprocessors.
* * * "The G4 Cube is simply the coolest computer ever," Apple's triumphant CEO ... told the adoring masses at MacWorld Expo ....
* * * Philip Schiller, Apple's vice president of worldwide product marketing [said,] "The http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 22 of 70
whole new (Power Mac) line and refreshed iMacs should maintain sales through the back-to-school season and Christmas."
50. The 7/31/00 edition of Business Week, issued on or about 7/25/00, also included an article on Apple, arranged by Apple and its public relations agents to appear in conjunction with Apple's new product announcements at MacWorld. Jobs and other top Apple executives were interviewed and providing information to the author of the article. In order to generate favorable publicity for the G4 Cube as it was attempting to release the product, Apple provided specially and carefully selected G4 Cubes to technology writers at key newspapers/magazines to obtain favorable reports and recommendations. These hand-picked G4 Cubes were cosmetically perfect, even though Apple knew many of the G4 Cubes coming off the assembly line were imperfect, having lines or tiny cracks in their supposedly perfectly clear, pristine crystal cases. As part of Apple's scheme and fraudulent course of business throughout the Class Period, the "perfect" G4 Cube personal computer demonstrated to Business Week was not the result of an effective mass production process. Rather, the G4 Cube given to Business Week was hand-picked to ensure that none of the blemishes (lines and/or tiny cracks) plaguing many of the G4 Cubes coming off the assembly lines were present. The Business Week article stated:
It's 10 days before the July 19 MacWorld trade show in New York, where Apple Computer Inc. Chief Executive Steven P. Jobs will once again try to wow the masses .... I'm the reporter he has anointed to get an exclusive sneak peek at this year's lineup of new computers. Clad in shorts and a designer T-shirt, he greets me like an old pal, warmly shaking my hand and ushering me into Apple's boardroom. Scattered around are a dozen or so objects, each hidden coyly beneath a black shroud.
Then comes the climax: an 8-inch, cube-shaped Mac that packs Apple's most powerful technology into a clear plastic case about the size of a toaster.... [T]he Cube's design is a showstopper. "Isn't that beautiful?" he gushes like a dad over his newborn. "It's the most beautiful thing we've ever done."
* * *
For years, Apple seemed to define gravity. Now it's defying it. Credit Jobs's Midas touch with design and marketing. Both Dell and Compaq recently scrapped colorful iMac knockoffs just months after they were introduced, proving that only Apple knows how to make fashion count when it comes to a computer. And, thanks to the coolness factor, Apple gets away with charging up to 25% more than its competitors for a machine with similar capabilities. That helped give it a juicy gross profit margin of 29.8% in the most recent quarter, tops in the PC segment.
* * *
Jobs says the company can deliver years of sizzling growth and hefty profits.... Jobs says the company's product pipeline is bulging with goodies that will make this possible .... "There are so many exciting things in our headlights that will take us through the next two to three years...."
* * * All told, Apple execs figure this lineup will goose market share. The company already http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 23 of 70
has jumped from a 3.8% share in 1997 to 6% in the combined markets of consumer, education, and artistic professionals. Now Apple execs figure they can hit 10% in five years - growing from $6.1 billion last year to $20 billion.
* * * The most striking change has been in operations. When Jobs took over, Apple ended each quarter with some 70 days' worth of finished products sloshing around its factories and warehouses, a $500 million-plus drag on profits that was the worst in the industry. Jobs quickly streamlined. He outsourced manufacturing of half of Apple's products to contractors who could do it far more efficiently, say analysts. That got inventory down to about a month by early 1998. Jobs still wasn't satisfied.
* * * [Apple's] biggest claim to fame is getting the inventory of parts down to less than a day - obliterating the record in an industry where weeks or even months is the norm. One reason: Apple has persuaded key suppliers to set up shop close to Apple facilities, for just-in-time delivery. Another benefit of the new system: The entire production process has dropped from almost four months to just two, so Apple can more quickly move to the latest, fastest parts.
* * * A clear plastic cover holds the Cube off the desktop. Apple built special injection molding tools to avoid imperfections. "Manufacturing hated us for this," says Jobs.
51. The 7/31/00 edition of Newsweek, published on or about 7/24/00, contained articles about Apple that were arranged by Apple and its public relations agency to appear in conjunction with Apple's new product announcements at MacWorld. The articles were based on interviews and conversations with Apple executives Jobs and Anderson, who also provided information for the authors of the articles. In order to generate favorable publicity for the G4 Cube as it was attempting to release the product, Apple provided Newsweek with a carefully hand-picked G4 Cube to obtain favorable reports and recommendations. The hand-picked G4 Cube was cosmetically perfect, even though Apple knew many of the G4 Cubes coming off the assembly line were imperfect, having lines or tiny cracks in their supposedly perfectly clear, pristine crystal cases. Unbeknownst to Newsweek the "perfect" G4 Cube provided to Newsweek technology writers was not the result of an effective mass production process, but rather, was hand-picked with none of the blemishes (lines and/or tiny cracks) plaguing many of the G4 Cubes coming off the assembly lines. The 7/31/00 Newsweek contained an interview with defendant Jobs where he stated:
[Q] The G4 Cube reminds a lot of people that your previous company, Next, also made a cube-shaped machine.
[A] Yeah, we did one before.... What makes this one [special] for me is not the fact that it's a cube but it's like a brain in a beaker. It's just hanging from this perfectly clear, pristine crystal enclosure. That's what's so drop dead about it. It's incredibly functional. The whole thing is perfect.... It's wonderful to make a pure expression of something and then make a million copies.... There will be a million copies of this out there.
Elsewhere, the 7/31/00 edition of Newsweek stated: http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 24 of 70
It is a week before last Wednesday's public unveiling of Apple's new line of desktop computers, and Steve Jobs is stretching his charisma muscles. In a two-hour preview for NEWSWEEK, he displays infomercial skills that would put Cher, Chef Emeril and Ron Popeil to shame. He introduces a new set of iMac colors (Indigo! Ruby! and Snow, which looks like the inside of a light bulb).
* * *
By the time he pulls back the sheet on the G4 Cube, his intensity gauge has hit the red zone. If computer customers indeed judge books by their covers - and are willing to pay a premium for high style - the $1,800 Cube will hit the best-seller list.
* * *
To Jobs, the point is to make a computer so perfect both outside and in that it satisfies the roughest customer imaginable: himself. And the culmination of his own desires seems to be the G4 Cube. The idea for the product, he says, came "from a user - it was me."...
... But the G4 Cube's most striking visual effect is transparency, in its shell and its components .... Entire teams of engineers had to work on its specially molded plastic, going with an optical-grade polymer that would resist scratches and modulate the way light would refract through the surface. "We were defining details on a chemical level," says [Jonathan Ive, Apple's Chief Engineer]. "It's a sign of where we are as a company that we don't have debates on whether it's an appropriate use of energy to get the right tolerances, to get exactly the right color."
Steve Jobs can go on for quite a while about what he calls "the coolest computer ever."
B. The MacWorld Statements Were False and Misleading When Made
52. As set forth above, Apple's, Jobs' and Apple's other Senior Officers' positive statements between 7/18/00-7/31/00 were false and misleading when made. They failed to disclose negative conditions which were adversely impacting Apple's business and operations at that time as further detailed below. This information was based, in large part, on information provided by 22 confidential witnesses either employed by Apple, its agents and/or its business partners. The confidential witnesses are listed and described by job title below:
CW1: Former Apple Senior Production Supervisor CW2: Former Apple Lead Product Designer CW3: Former Apple Design Manager employed by Apple third-party manufacturer CW4: Project Manager for Apple third-party manufacturer/developer CW5: Former Apple Senior Project Design Manager CW6: Former Vice President of AppleCare at Worldwide Service CW7: Former Apple Campus Representative CW8: Former Apple Senior Global Supply Manager CW9: Former Apple Frontline Technical Support Representative http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 25 of 70
CW10: Former Apple Customer Service Manager CW11: Former Apple Support Service Manager CW12: Former Apple Campus Representative CW13: Former Apple Campus Representative CW14: Former Apple Senior Manager for Developer Support Team CW15: Former Apple Retail Demonstration Representative CW16: Former Apple Rework Technician CW17: Former Apple third-party education sales agent CW18: President of Apple third-party education agent CW19: Former Apple K-12 Education Account Executive CW20: Former Sales Manager for Apple third-party education agent CW21: Former President for Apple third-party education agent CW22: Former K-12 Education Account Executive for Apple third-party education agent
1. Apple's Product Development Problems
53. Apple is engaged in a rapidly advancing field of technology in which its ability to successfully compete depends upon its ability to constantly improve its products and develop new products to meet changing customer requirements and keep up with competition. The industry in which Apple operates is characterized by very short product life cycles and Apple's continued success is dependent on technological advances, including timely development and implementation of new products.
54. During the first part of FY 2000, Apple was under tremendous competitive pressure to complete the final development of it new products so that it could begin commercial production and execute a timely release. Part of this pressure was due to the aging and slowing sales growth of Apple's existing Power Mac and iMac product lines, which had not been "refreshed" or upgraded for nine months. The slowing sales were not only due to the success of competitive products from Dell and Compaq, but also because Apple had largely saturated its base of Macintosh customers. Thus, Apple had to quickly introduce improved or upgraded versions of its existing Power Mac and iMac lines, and also introduce new products to attract new customers from outside Apple's existing customer base.
55. Apple's Senior Officers were very focused on the development of Apple's newest personal computers and constantly received reports on the status of the products' final design and pre- production validation testing (which identified the precise status of each new product), the bugs encountered, the attempted design and production solutions and the impact these events were having on Apple's attempt to bring these products to market in a timely fashion.
(a) The G4 Cube
56. Apple intended to pursue a premium pricing policy with respect to its new G4 Cube personal computer, which was to be radical in design and appearance, contained within a small cube made of pristine, crystal clear polycarbonate plastic. A copy of an Apple advertisement for the G4 Cube, which purportedly showed the physical appearance of the product, is attached hereto as Exhibit A. Apple intended the G4 Cube to retail for approximately $1,800-$2,300 without a monitor, an extremely high price for the G4 Cube's actual performance capabilities compared to competitive products. Apple knew that in order for the G4 Cube to succeed at this otherwise uncompetitive price level, it would have to sell in large part due to its strikingly unusual physical appearance.
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57. Apple had never before manufactured a product like the G4 Cube, a product that demanded rigid and unforgiving tolerances to fit in the "form factor" of a clear case surrounding the central processing unit. Also, the polycarbonate plastic Apple used for the G4 Cube possesses features making it extremely difficult to produce corners or bends without getting mold lines, tiny cracks or crazing which spoil the "crystal clear," "pristine" appearance. Defendants knew, however, that producing defect-free, cosmetically perfect G4 Cubes was indispensable to the success of the product, as customers would be purchasing the product based on its strikingly unusual look and would be turned off by even the most minor cosmetic blemishes or imperfections.
58. According to one of Apple's Senior Production Supervisors, CW1, in attempting to manufacture the G4 Cube, Apple was forced to use new and different manufacturing techniques than it had used in the past, including special molds and injections processes, which were exceptionally difficult to achieve. CW1 explained that during the final design and test manufacturing processes for this new G4 Cube computer, Apple discovered that due to an overly demanding design, Apple was not able to effectively control or manipulate the difficult raw material and manufacturing process involved. As a result, significant numbers of the G4 Cubes coming off the assembly line had mold lines, crazing or tiny cracks, which spoiled their appearance.
59. In fact, as Apple was well aware, during the injection molding process, when the liquid polycarbonate plastic flowed into the case mold and around the opening for the rivets on the top of the case and the DVD drive opening and then came back together, it formed mold lines, crazing and tiny cracks. According to CW2, the Lead Product Designer for the G4 Cube, the mold lines were impossible to eliminate. This problem was exacerbated by the thickness of the case walls. Also, because of the weight of the enclosed computer hardware, excess stress was placed on these areas of the case, causing or exacerbating existing small cracks after completion of the assembly process. In fact, Apple was never able to reach true commercial production of perfectly clear pristine G4 Cubes during the Class Period.
60. Further, according to CW1, due to the Cube's small "form factor," all of the various components, including the processor, memory, video boards and port connectors, had to be connected to a newly-designed motherboard and chassis that was very different from any other Macintosh product. Conversely, for all of the other "tower" G4 models that Apple produced, all of the components were placed in the same location during manufacturing, regardless of whether the ultimate computer was a high-end model or a low-end model. According to CW1 the atypical physical placement of the internal components in the G4 Cube required significant adjustments to several of Apple's automated assembly machines and instruments. Additionally, CW1 stated that various hand- held tools were specially designed and built to work with the Cube's unique components, increasing the unit cost for the product.
61. According to CW3, a former Apple Design Manager now employed by one of Apple's third- party manufacturers/developers, the unique manufacturing problems with the G4 Cube casing resulted in a "reject rate" of over 50%. CW3 stated that such a reject rate was "extremely high" and resulted in project delays of up to 6 months. According to CW4, a Project Manager for Shinei Int'l., one of Apple's third party developers/manufacturers of the G4 Cube, Apple sent design teams to Taiwan to monitor the G4 Cube Project. The design teams requested changes to the project at various steps along the development process, causing serious tool manufacturing problems and project delays. Indeed, CW3 confirmed that Apple's Vice President of Industrial Design, Dan Ricco, and Vice President of Product Design, Jonathon Ive, were in Singapore for one month personally approving http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 27 of 70
each part. Indeed, CW2 confirmed that manufacturing delays caused the G4 Cube project to last 12 months when it was originally scheduled for 6-8 months. As a result, Apple had to rush production and was never able to resolve the defects in the G4 Cube.
62. As to the cosmetic issues, CW1 recalled that at least 75% to 80% of all the Cubes CW1 saw had some "cosmetic imperfection." CW1 recalled witnessing technicians assembling and polishing Cubes by hand to remedy the imperfections, and believed that because of this labor-intensive process, the Cube was not amenable to Apple's planned mass production.
63. According to CW5, a former Apple Senior Design and Project Manager, Apple knew of the severe design and manufacturing problems through monthly Project Status Reports and the Project Risk and Opportunity Reports written by CW2. According to CW5, as late as late June/early July 2000, CW2 was having problems with the highly-complex low-tolerance manufacturing process called for in making the G4 Cube enclosure, due to the problematic heat injection molding process.
64. Further, CW6, Vice President of AppleCare for Worldwide Service, confirmed that Apple used a "bug" tracking system known as "Radar" to log, track and rank known problems. The known problems were reviewed during engineering meetings and were ranked according to urgency. CW6 noted that defendant Jobs was notified of the "Class A bugs," or bugs that were considered to be of "line-stopping urgency." According to CW6, Radar continued to track bugs 90-120 days after product release. He stated that the "Vantis" call center application would maintain case-specific information. The cracks in the G4 Cube were listed as a Class A bug.
65. Also, according to CW7 and CW12, both Apple University Campus Representatives, Apple held a "boot camp" in late June 2000 for its college campus sales representatives where the Company introduced all new products, provided technical training, organized seminars and presentations on sales and marketing and facilitated programs with account executives. According to CW12, defendant Jobs spoke at the meeting and addressed the Cube's production and performance problems, but told the campus reps that the problems would be solved before release of the product. This did not happen.
66. Thereafter and throughout the Class Period, Apple continued to have difficulties in mass producing the G4 Cube personal computer, due to imperfections and defects in the manufacturing process. The difficulties resulted in the production of excessive numbers of imperfect G4 Cubes with cosmetic blemishes in what was supposed to be the crystal clear, pristine, perfect plastic casing. The defects were so serious that many of the G4 Cubes produced were not commercially acceptable. As a result, G4 Cubes could not be shipped in quantity in August 2000 as planned and the product was late to market in quantity. This delay meant Apple would not sell anywhere near the 150,000 G4 Cubes it needed to reach its announced revenue projections for 4Q 2000 even if there was strong demand for the G4 Cube.
67. Despite the manufacturing problems, the G4 Cube was finally introduced to the public at the July 19, 2000 MacWorld conference in New York City. The product's revolutionary design and appearance made it the most widely publicized of the new products introduced at MacWorld. Apple stated in its July 19, 2000 conference call that it would sell 150,000-200,000 Cubes per quarter which would drive overall revenues for 4Q 2000 and FY 2001.
68. To conceal the G4 Cube's defects and to generate favorable publicity for the new product, Apple provided the press and the public with carefully hand-picked and hand-polished G4 Cubes without any of the cosmetic blemishes and defects present in most of the G4 Cubes. Unbeknownst to http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 28 of 70
the press and the public, the average G4 Cube available to consumers suffered from cracks in the casing, molding lines, and a defectively designed touch switch. The false representation to the media further inflated the lower-than-expected demand for the G4 Cube and deferred the truth until customers actually received the G4 Cubes in quantity, in mid-September and October. Immediately, customers noticed the cosmetic defects in the G4 Cube and the defects in the touch switch design and demanded refunds and/or replacements.
69. During July-August 2000, Apple continued to struggle with the manufacturing problems, but the Company was never able to mass produce G4 Cubes that were pristine and crystal clear as represented and as necessary for commercial success. Indeed, according to CW8, an Apple Senior Global Supply Manager, soon after the MacWorld New York presentation in July 2000, Apple's manufacturing line for the Cube was completely shut down for 1-2 weeks in the hopes of re-tooling the line and solving the mass-production problems the computer faced. According to CW8, the manufacturing obstacles were so great that mass producing G4 Cubes became virtually impossible and Apple debated whether or not to ship the G4 Cube at all. Apple publicly abandoned its attempt to mass produce the G4 Cube on July 3, 2001.
70. According to CW1, in early August 2000, Jon Rubinstein, the Senior Vice President of Hardware Engineering, sent a "call to arms" memorandum to supervisors in production and engineering to ramp up production of the Cube despite the defects. As discussed infra, later that month, Rubinstein unloaded all the Apple shares he held (100,000 shares) for proceeds of $5.9 million - his largest single sale of Apple stock ever.
71. Ultimately, in order to have any kind of quantity of G4 Cubes hit retail shelves before the end of the 4Q 2000, Apple was forced to ship G4 Cubes that it knew were imperfect and were likely to encounter extreme consumer resistance. Instead of the "perfect" crystalline cube Jobs promised on the MacWorld stage and Apple promoted in literature, buyers received computers with mold lines and growing cracks. Because the G4 Cube's main selling point was its "crystal clear" appearance, the defects in the plastic casing immediately became commercially unacceptable, resulting in numerous customer complaints and demands for returns or replacements.
72. Even more distressing, buyers received computers that unintentionally shut themselves down because of a defectively-designed switch on top of the computer. Unbeknownst to customers, the G4 Cube's on/off "touch switch" would shift during shipment, resulting in the product unexpectedly "powering down" (off) during operation. Customers also complained that the location of the touch switch (top of the G4 Cube) caused it to frequently and spontaneously shut off when slight movements or heat passed over it. This defect resulted in further customer complaints and demands for returns or refunds.
73. According to CW9, one of Apple's "Technical Support Representatives," the customer complaints began just after the G4 Cube's release, with owners calling to complain that the G4 Cube was too expensive to "look like a piece of crap," and that it regularly shut itself off, causing owners to lose data. CW9 was required to keep a daily call log with detailed journal entries of each customer call. The daily log was submitted to his supervisor and Director of the Customer Support Center, Dave Thornton, at the end of each shift. CW9 handled 25 complaint calls per week related to cosmetic imperfections in the G4 Cube.
74. According to CW9, almost concurrent with the G4 Cube's preliminary release, Apple took the unusual step of sending a memorandum to its front-line "Technical Support Representatives" who http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 29 of 70
fielded calls from irate customers. The 8/00 memo detailed the appearance and switch problems. The memorandum also told the representatives to "expect" a larger than usual number of calls from G4 Cube owners due to the problems Apple knew about when the product was released.
75. CW10, a Customer Service Manager at Apple's Elk Grove, California plant and call center, further stated that shortly after the introduction of the G4 Cube, the Elk Grove Call Center began receiving customer complaints regarding cracks or molding lines in the G4 Cube's casing. The complaints were internally classified as a "known issue," meaning Apple had received enough complaints to be fully aware of a problem and "anyone who had a reason to know, knew."
76. To make matters worse, according to CW9, the "fix" for the faulty power switch could only be performed at a service center for Apple, requiring individual Cube owners to ship their "perfect" new computer back to Apple for service, causing even greater frustration with the high-end product.
77. CW11, an Apple Support Services Manager for the Pacific Northwest Region, confirmed that initial customers were having problems with the G4 Cube's "hypersensitive" touch switch from very early on. CW11 explained that when any form of electricity was passed over the switch - such as a metal pen or a hand - the switch would be turned on/off. Apple attempted to remedy the problem with "depot only" solutions, i.e., the customer was required to send the G4 Cube back for repair (corporate customers exempted). CW11 stated that customers were extremely unhappy about the solution because they did not have access to their computers for over a week and dealers could not order replacement parts ahead of time.
78. Apple also had problems with some of the G4 Cubes used in product demonstrations to potential customers. For example, CW12 received a demonstration G4 Cube in September 2000 to present to his higher education customers. According to CW12, the G4 Cube quality problems were immediately apparent to both the Company's campus representatives and potential customers. CW12's demo Cube suffered from cracks in the casing and two other manufacturing defects. CW12 eventually determined that the demo Cube was unfit for presentations to the educational institutions, and communicated his concern to his immediate supervisor, Gary Dauphin. CW12 was then told that Apple could not immediately replace the machine. He could not recall why the Company could not replace the machine, but vaguely recalled Dauphin explaining that the Company was aware of the case problems and was working to resolve them. In the meantime, Dauphin told CW12 to use the defective demo for the presentation and to convey to the institutions that the Cube was not reflective of what the customer would receive.
79. Another University Campus Representative, CW7 (mentioned above), received a demonstration G4 Cube in September 2000. CW7's G4 Cube also suffered from several minor hairline flaws along the side and top of the casing. CW7 stated that his supervisor, Laurie Coiclithero, arranged for a replacement demo G4 Cube which arrived approximately three weeks later.
80. A third University Campus Representative, CW13 described the G4 Cube casing as a "PR nightmare" for him because of the cosmetic flaws and the delay in receiving replacement products. The G4 Cube demo CW13 received in September 2000 had three small imperfections in the casing. Two of the flaws were on the front right side of the casing. One flaw was on the top of the casing near the vent fan.
81. As a result of the countless problems, the G4 Cube was a failure. There were not enough commercially viable G4 Cubes available to meet Apple's projections to sell 150,000 Cubes by the end http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 30 of 70
of 4Q 2000. Further, because of the problems and defects in the product, demand, in fact, was very weak. Indeed Apple was unable to sell even the G4 Cubes that it was able to produce - because many of them suffered from cosmetic blemishes, mold lines, crazing and tiny cracks as well as the touch- switch defect which caused the product to unexpectedly turn off during operation - obviously the defects were unacceptable to customers. When customers complained about the problems during September 2000, Apple attempted to cover up the defects and keep complaining consumers quiet so that word of the defects would not spread.
82. Throughout the Class Period, therefore, Apple, Jobs and Apple's other Senior Officers, failed to disclose the following facts regarding the problems they were having with production and shipment of the G4 Cube:
(a) The G4 Cube plastic cases were not "perfectly clear, pristine crystal enclosures" nor were they "perfect." Apple's "special" injection molding processes were never perfected to resist cosmetic defects, such that most of the G4 Cubes were produced with visible molding lines, cracks, scratches and other cosmetic defects; many Cubes also developed small cracks under the stress caused by the weight of the computer hardware suspended in the casing;
(b) Apple's inability to perfect the manufacturing process to prevent mold lines, cracks and other cosmetic defects resulted in thousands of initial customer complaints and demands for refunds and/or exchanges;
(c) The G4 Cube's "touch switch" was defectively designed in that it would shift and become misaligned during shipment, causing the Cube to suddenly "power down" during use without warning;
(d) The defective location and placement of the touch switch (on the top of the Cube) was hyper-sensitive to any heat or movement causing frequent and spontaneous shut-downs without warning;
(e) Apple's production problems with the casing and touch switch resulted in 1-2 weeks of manufacturing downtime to reevaluate the commercial viability of the G4 Cube. During that time Apple debated whether or not to even ship the G4 Cube with its known defects;
(f) To meet Apple's already behind-schedule production deadlines, Apple decided to push defective G4 Cubes into the channel and to retailers knowing that many would be returned and/or replaced;
(g) Retailers were reporting slower demand for G4 Cubes because of its high price; decreasing demand was exacerbated by the unavailability of the G4 Cube - shipments were several weeks late into the channel and did not generally hit retail shelves until mid-September;
(h) To conceal Apple's inability to mass produce commercially acceptable G4 Cubes and to generate favorable product reviews by technology writers and the public, Apple displayed and provided samples of carefully hand-picked and hand-polished G4 Cubes that were unrepresentative of the majority of Cubes shipped to average customers; and
(i) Apple was unable to mass produce and deliver commercially viable G4 Cubes in quantity early enough in the 4Q 2000 to meet its 4Q 2000 sales forecasts of 150,000 Cubes and revenue and EPS targets of $2.0+ billion and $0.40+, respectively. http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 31 of 70
(b) The Power Mac G4 Dual Processor
83. One of Apple's new computer products introduced at MacWorld was the Power Mac G4 Dual Processor. The Power Mac G4 Dual Processor contained two microprocessors which purportedly could perform dual tasks simultaneously (this technology was also contained in higher-end versions of the G4 Cube). Apple and Jobs represented that the dual microprocessor architecture allowed the Power Mac G4 Dual Processor to operate faster than any competing line of personal computers. According to Jobs, the Power Mac G4 Dual Processor had "awesome power," was a "whole new class of machine," because "two brains are better than one."
84. What Jobs knew and didn't disclose however, was that the Power Mac G4 Dual Processor suffered major operating defects that would ultimately drastically reduce demand and sales of the product in the 4Q 2000. First, the Power Mac G4 Dual Processor came equipped with an operating system (O/S 9) that lacked the software applications to effectively recognize and take advantage of the dual processor technology. O/S 9 could not recognize the dual processors without special software, and very few software applications were written to take advantage of multiple processors. CW14, a Senior Manager for Apple's Developer Support Team during the Class Period, stated that Apple faced a Catch-22; customers were not purchasing Power Mac G4 Dual Processors because they could not utilize the multiple processor function, and it was unprofitable for software developers to write applications for the dual processors because they were not selling.
85. According to CW11, Apple's new operating system O/S X (released to the public in 2001) could purportedly take advantage of the dual processor technology without additional software applications. CW11 stated that Apple originally planned to release O/S X in 2000 to coincide with the Power Mac G4 Dual Processor launch, but could not get it to market in time. Thus, many customers deferred purchasing the Power Mac G4 Dual Processors until the release of O/S X, well after the Class Period.
86. Further hampering sales of the Power Mac G4 Dual Processor was its slow clock rate of 500 MHz. The dual processor could not make up for the slow speeds because the architecture of the Power Mac G4 Dual Processors could not utilize Symmetrical Multiprocessing. Customers realized that without the ability to utilize the dual processing function, the capabilities of the Power Mac's G4 Dual Processor were nearly the same as the previous version of the single processor Power Mac G4, yet were priced much higher. This caused a severe decrease in demand for the Power Mac G4 Dual Processors, as customers shifted to buying the less costly single processor Power Mac G4s.
87. On August 10, 2000, Appleinsider.com published an article confirming that Apple was suffering from chip speed problems well into the Class Period: "Come Seybold San Francisco this month, Apple's Power Mac G4 systems will have officially been stuck at an industry trailing 500 MHz clockspeed for an entire year."
88. Thus, Apple and Jobs knew that the speed of the Power Mac G4 Dual Processor was behind the competition prior to MacWorld. Apple and Jobs also knew however, that due to lower-than- expected 3Q 2000 financial results, they needed to impress the MacWorld crowd with an array of new products. So Apple and Jobs concealed the speed and operability defects in the Power Mac G4 Dual Processor during MacWorld demonstrations by using Adobe Photoshop, one of the only software programs capable of capitalizing on the dual processing function. Thus, the public was misled into believing the dual processor function worked seamlessly. http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 32 of 70
89. Indeed, CW15, a Retail Demo Representative for Apple during the Class Period, noted that strong initial demand for the G4 Dual Processor generated by Apple's promotions and media hype greatly diminished after customers made serious evaluations of the product. CW15 recalled many customers questioning the speed of the G4 Dual Processor, its compatibility with complex software applications and the high price for a product no more technically advanced than its competition. Apple and Jobs knew of this because CW15 prepared an "event report" at the conclusion of all demonstrations, documenting customer concerns and complaints about the G4 Dual Processor. The event report was submitted to Apple's headquarters 48 hours after each event.
90. CW9, and CW16, a Rework Technician for Apple during the Class Period, also acknowledged large numbers of customer complaints about the performance of the G4 Dual Processor immediately upon its release. CW16 noted that the two processors were slow to respond to user commands and did not operate in a coordinated fashion. CW16 also stated that the dual processors would "knock each other out" when performing multiple functions, causing the computer to shut down.
91. Apple and Jobs acknowledged the problems by issuing a memo in early August 2000 to all frontline technicians about handling the problems with the G4 Dual Processor and G4 Cube. Apple and Jobs were also aware of the problems plaguing the G4 Dual Processor because CW9 and all front line technical staff documented daily logs of complaints, which were then forwarded to Apple management at the end of each shift.
92. The Power Mac G4 Dual Processor's slow clock speed compared with competing products, and the software and operating system compatibility problems caused a severe reduction in demand, furthering Apple's 4Q 2000 shortfall.
(c) The iMac
93. Apple does extensive market research to determine customer/consumer response to new products. As Jobs said at MacWorld, "we do a lot of market research." During research for its upgraded iMac line of personal computers, Apple learned that for a personal computer in the iMac's price range, consumers would demand a rewritable CD drive - a feature necessary for users to create customized music collections and to store home movies, two increasingly "hot" personal computer uses. However, the new iMacs lacked this feature and Apple did not have time to add the feature prior to MacWorld. Also, Apple had learned that consumers increasingly preferred and demanded a 17" monitor of the type then being offered by Dell and Compaq. The iMacs, however, came with 15" monitors - a fact Apple could not change prior to MacWorld because the monitor was integrated into the unit.
94. Thus, defendants knew that Apple's new iMac line lacked two features which were indispensable to consumer acceptance and success. As a result, demand for Apple's new iMacs was much lower than Apple led the market to believe, and below the levels necessary for Apple to meet its 4Q 2000 revenues and EPS forecasts.
2. Inventories of Finished Goods and Component Parts
95. During 1996-1999, Apple pursued a restructuring plan. It reduced its product line to focus primarily on two lines of redesigned computers: (i) the "Power Macintosh" line of personal computers, http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 33 of 70
introduced in 8/99 and marketed to business and professional users; and (ii) the "iMac" line of personal computers introduced in mid-98, coming in assorted brightly colored computer cases designed for students and home users.
96. A key part of Apple's restructuring was improving its operating efficiencies, lowering its costs and, most importantly, reducing Apple's inventories of finished goods and component parts. By mid- 00, Apple purported to have the most effective component part and finished goods inventory control system of any personal computer manufacturer, greatly increasing Apple's profitability. A 7/31/00 Business Week article details these changes:
The most striking change has been in operations. When Jobs took over, Apple ended each quarter with some 70 days' worth of finished products sloshing around its factories and warehouses, a $500 million-plus drag on profits that was the worst in the industry. Jobs quickly streamlined. He outsourced manufacturing of half of Apple's products to contractors who could do it far more efficiently, say analysts. That got inventory down to about a month by early 1998. Jobs still wasn't satisfied. He hired former Compaq procurement executive Timothy D. Cook to meet a higher goal: to get more efficient than Dell, the industry's best.
* * *
But Cook's biggest claim to fame is getting the inventory of parts down to less than a day - obliterating the record in an industry where weeks or even months is the norm. One reason: Apple has persuaded key suppliers to set up shop close to Apple facilities, for just-in-time delivery. Another benefit of the new system: The entire production process has dropped from almost four months to just two, so Apple can more quickly move to the latest, fastest parts.
97. As a result of its purported restructuring, Apple represented that it was now much better able to control and manage its finished goods and component part inventories, manufacturing and sales. As a result, Apple represented that its restructuring had caused a substantial turnaround, resulting in a 25% rise in Macintosh unit sales during 99 - primarily attributable to the success of iMac. The Company pointed to sales of approximately 1.8 million iMac units in 1999 (an increase of approximately 730,000 units or 68% over unit sales of similar products in 1998) as well as a significant quantity of Power Mac computers introduced in 8/99, as evidence that the restructuring had been successfully completed by the 3Q 2000.
98. The slowdown in sales of Apple products created a crisis inside Apple as early as 7/00, as Apple's channel inventories began to balloon due to the slower than expected retail sell-through of the new products as they were introduced. At the same time, inventory levels of these products that Apple had on hand also increased. As a result, Apple's top executives knew that Apple was accumulating millions of dollars in excessive inventories. This problem was exacerbated by the fact that Apple still had in its distribution channel older models of the iMac and Power Mac personal computers which were selling very poorly. This meant that Apple would have to take severe pricing action during the 4Q 2000 to remove inventory out of its distribution channel and would also have to curtail shipments into the distribution channel, all of which would have a terribly negative impact on Apple's revenues and EPS.
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Apple, which its top executives were immediately aware of. Earlier in FY 2000, in an effort to assure itself of a sufficient quantity of component parts to manufacture its new products in quantity, Apple had entered into unusual purchase agreements with component parts suppliers which provided that Apple would have to pay substantial financial penalties if it cancelled component parts orders. Normally, a company of Apple's size is such a desirable customer that it can obtain component parts without exposing itself to the risk of financial penalties upon cancellation. However, during the time period when Apple was attempting to secure commitments to supply it with component parts for its new computers, demand for personal computers was so strong that component part manufacturers were able to force Apple to agree to unusual penalty terms. Thus, the slow sale of Apple's new products created a double-whammy. In addition to depriving Apple of revenue needed to meet its revenue and EPS forecasts and causing its finished goods inventories to balloon, Apple was now faced with the prospect of being overwhelmed by a tsunami of unneeded component parts which would, of course, further exacerbate its already seriously deteriorating inventory position. Therefore, Apple began as early as 8/00 to cancel component parts orders even though Apple's top executives knew this would result in Apple incurring substantial financial penalties which would very adversely affect its 4Q 2000 and its 1Q 2001 results.
3. The K-12 Education Market Debacle
100. Less than three weeks before Jobs took the stage at MacWorld, Apple had jettisoned all of its independent K-12 educational sales agents in favor of an untested "direct sales" model that was in the process of killing the Company's leadership position in educational sales. On April 15, 2000, Apple had told the agents, some of whom had represented Apple in their geographic regions since the 1980s, that they had until June 30 to make their final sales commissions. After that date, they would be out of jobs.
101. As defendant Jobs ultimately stated in the Wall Street Journal, after disclosing the disastrous 4Q 2000 results, "[t]he timing certainly wasn't [smart]."(2) Defendants' "timing" cost the company $60 million in lost revenue. It is not, however, the stupid business decision about which plaintiffs are complaining, nor is it the terrible treatment given to Apple's long-time educational agents - although this treatment is reprehensible. The important point here is that by mid-July 2000 Apple knew, as Jobs also subsequently admitted, that its April 15, 2000 decision was going to have a tremendous negative impact on 4Q 2000.
102. Indeed, by the time Apple's representatives were touting its "comeback" quarter in New York, defendants knew that many of the schools previously served by the sales agents had made their annual "back to school" purchases early, at the behest of their long-time agents who were trying to lock in commissions, effectively draining the pipeline of these key 4Q 2000 sales. Defendants also knew that other schools and school districts had simply abandoned Apple products altogether, because although they were loyal to the Company, the agents had provided a total computing solution, including installation help, consulting on which non-Apple software and peripherals to buy, and long- range personalized planning on the school's specific computing needs. Conversely, Apple's new direct sales model offered only computers. Finally, defendants knew that the changeover to the direct system and the loss of the personal, long-term agent relationships with schools, combined with general slowing growth for Apple would cripple their K-12 educational sales for the key back to school quarter, as well as many quarters thereafter.
(a) The Role of Apple's Agents
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103. Kindergarten through 12th grade educational sales regularly accounted for up to 30 percent of Apple's revenue, and historically had been one of the main reasons for the Company's success. Apple relied on the fact that some children trained on the Macintosh system would adopt it, even in the face of 97% adoption of the PC system in the business world. For decades, Apple had used regional "sales agents" to promote its products to the general K-12 market. The agents sold Apple computers exclusively, "adding value" to their school customers by installing the computers and servicing the installed base, and then consulting on issues such as which computers and software were right for each individual school. Each of the independent agents were contractually limited to sales in a distinct geographic area around the United States or Canada, and renewed its contract at the end of Apple's fiscal year. The independent sales agents were extremely experienced, had been very successful for themselves and for Apple, and had substantial relationships with public school districts and individual private school purchasers in this important market.
104. The Apple/agent relationship was symbiotic. Although Apple sold only the computers and some software, the agents provided a "turnkey solution" to schools above and beyond just the Apple computers. Agents would develop a personal relationship with the schools, selling them the switches and hubs for routing data and networking printers, helping them with developing installation and upgrade strategies, and identifying third party peripherals and software that met their needs. The contract between Apple and the agents required agents to sell Apple computers exclusively guaranteeing that the agents would promote only Apple's interests.
105. This relationship was especially important with the larger schools and school districts that the agents represented. According to one agent who worked for Apple's agent representative for the Northeastern United States, CW17, schools with larger IT departments typically purchased all Windows-based computer systems (rather than a mix of Apple products and Windows products) because a Windows-only system was easier to maintain. According to the agent, the "instructional departments," i.e. the teachers, wanted the Apple products, and the agents helped to keep the Apple products viable for the IT people.
106. The agent companies benefitted from representing Apple and earned revenue from providing other services to education customers. For example, one of the agent companies, Holcombs Education Resources ("Holcombs") offered its schools access to an entire division of engineers and problem solvers, with more than 90 people (including the sales people) actively supporting the schools' needs after the sale of computers was completed. According to Holcombs' President, CW18, K-12 school administrators typically are not as sophisticated as higher education administrators, and reacted very positively to the offer for technical help. The "hand-holding" process of ensuring that the schools were receiving not only the computers, but also the non-Apple hardware and software they required was "critical" to the schools' allegiance to the Macintosh platform, according to CW18. While Apple handled a small group of "core accounts" representing larger customers who bought only computers, the agents made contacts with and sold to the vast majority of schools buying Apple products.
107. Indeed, according to CW19, a former internal Apple Account Executive for the K-12 education market, prior to June 2000, while he was responsible for roughly 20 to 25 "core accounts" in one state, the independent agent company that served his area handled 225 to 250 accounts, consisting of individual school or school districts, depending on the individual contract. The list of "core accounts" was controlled by Apple, and could change each year based on the customer and its relationship with Apple.
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108. CW19 further explained that Apple gave each agent a quota based on past history and projection of future revenue growth, and occasionally had goals for specific product categories. Each school represented by an agent had an account number, which Apple used to track and report the revenue generated by each school for commission purposes. Apple generated a commission report on a monthly basis, but could run the report at any time in the interim.
109. Apple also used a reporting/sales goal system known specifically as the "Tool" to communicate product and sales information back and forth with the agents. According to one of the employees of an agent company, CW20, who was responsible for communicating with Apple using the Tool throughout the quarter, the agent companies would transfer sales data to Apple in the form of purchase orders. At the end of the quarter, Apple would compile the data using the "Tool" and send out a physical compact disk for the agent companies containing summary data for the previous quarter as well as goals and quotas for the current quarter.
110. Although the quarterly Tool CD contained global data for all the agent companies, individual agent companies were given the password for their company data only.
111. According to CW18, Apple's revenues from the K-12 educational market had been progressively decreasing prior to the shift in sales force. Indeed, CW20 noted that Apple had slashed the agent companies' commissions from 3% in 1999 to 1.7% in 2000.
(b) Firing Apple's Agents
112. According to CW21, the President of one of the agent companies, the K-12 agents suspected that Apple might move to reduce or eliminate their role in educational sales because Apple had eliminated many of its higher education agents in December 1999, when Apple's VP for education, Mike Lorion, left. The agents however, thought that Apple would not take the step until at least September 2000, after the agents had finished sales for the 2000-2001 school year. According to CW19, almost every school in the country received their "budget money" for the new school year in July, and would make purchases between July and September, when school started. Therefore, Apple's fourth quarter (July through September) was the key time for both Apple and its agents.
113. But instead of waiting to dismiss the agents until after the annual purchasing rush, Apple struck early. On April 15, 2000, Apple sent all of its K-12 sales agents a letter notifying them that they would be cut off from all Apple sales as of June 30, 2000.
(c) The Aftermath
114. Knowing that CW21's company would not likely survive the impending changes, and knowing that June 30, 2000, was the last day that their sales efforts would recoup any money for the agent company, the Texas agent sought to convince her company's clients to buy as much product as possible before the June 30, 2000 cut-off date. Other agents took the same approach. According to data submitted to Apple by Holcombs, although the agent company missed Apple's sales goals throughout 1999 and for the first two quarters of Apple's FY 2000, it surpassed the goals for the April-June period by more than 10 percent.
115. Even before June 30, 2000, according to CW18, a number of his soon-to-be former clients notified him that they were dropping Apple in favor of companies that offered more personalized http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 37 of 70
service.
116. The new direct sales regime offered by Apple, according to CW21, left out the cable, router and installation services components that was as important to the schools as the computers themselves. The vast majority of non-core, agent-represented school customers were not savvy enough (or did not have the incentive) to go to a web site, select new computers and software and take delivery of a large number of boxes to be set up when they were delivered by UPS. Rather, the schools had stuck with the Apple platform through the years because their agents were willing to reach out to them, show up at their doorstep, and help them not only select the right computers, but also get the computers up and running. Also, according to CW22, Apple did not offer a wide variety of third-party hardware and software or services for configuring and implementing computer systems, forcing the individual non-core schools to go out for the first time and seek these services from a vendor separate from the computer vendor.
117. According to CW18, while his company continued to support Apple products after June 30, 2000, a large number of his client schools and districts cut back or abandoned their Apple purchases. CW18 noted that while teachers and administrators in the K-12 market supported Apple, they felt pressure from school districts and parents to use Windows-based computers. According to CW18, the ending of the agent program accelerated the K-12 market shift to Windows.
118. By way of example, CW18 described one small Catholic school in the Detroit area that typically ordered computers before the summer break. The school depended on Holcombs to install and configure the systems. When the school was ready to issue a purchase order in July 2000 and was notified that CW18's company was no longer authorized to support its needs, the school switched to PCs immediately after years of loyalty to Apple and having built their businesses around Apple products.
119. Other fired independent agents resented Apple's attempt to get rid of them. After years of loyalty to Apple and having built their businesses around Apple products, the independent agents let their hard feelings be known to key K-12 education market buyers. Some agents signed contracts with Dell or other Apple competitors to promote their products.
120. Moreover, Apple's new internal sales people were inexperienced and inadequately trained and did not have pre-existing relationships with purchasers in the K-12 education market. Indeed, at a 10/18/00 conference call with analysts after the truth came out, defendant Jobs ultimately admitted that during the quarter, "40 percent of our sales representatives were new to Apple and half of our customers had new account managers." Also, Apple sales people lacked necessary supervision and guidance as Apple's VP of Education Sales left Apple earlier in FY 2000 and was not replaced. As a result, Apple immediately lost sales in the K-12 education market and it was immediately apparent to Jobs and Apple's other top executives that the switch to an entirely internal sales force for the K-12 education market was a disastrous mistake.
121. Having made the change and fired its external sales agents for the K-12 education market, Apple was stuck with a disastrous and irreversible situation on its hands, i.e., an inexperienced, ill- trained, inadequately supervised and thus ineffective internal sales force that was attempting to sell products in the K-12 education market during the peak and most vital back-to-school selling season. As a result of this situation, Jobs and Apple's other top insiders knew by 7/18/00 that the switch to an internal sales force was a terrible mistake which would badly hurt Apple's 4Q 2000 results and would in and of itself cause Apple to miss forecasted 4Q 2000 and FY 2000 revenues and EPS, regardless http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 38 of 70
of whether Apple's new products got to market on time and were well received. As Jobs himself ultimately stated at the 10/18/00 conference call, "the July quarter was clearly a poor time to execute this transition."
C. After MacWorld: Further False and Misleading Statements
1. August Reports
122. On 8/9/00, based upon conversations with several of Apple's senior officers, PaineWebber issued a report on Apple which forecast 4Q 2000 and FY 2000 EPS of $0.46 and $1.85, respectively, for Apple and stated:
We are upgrading to Attractive based on the company's great retail (inventory) position [and] new product focus .... Apple's retail inventory management is unprecedented. Apple has managed its retail inventory levels exceptionally ... and maintains less than three weeks of supply, the best among the major retail vendors.
123. On 8/21/00 the San Francisco Chronicle published a favorable article about the G4 Cube. The article was based upon a carefully selected, hand-picked Cube having none of the cracks or cosmetic blemishes plaguing most of the Cubes coming off the assembly lines. Apple was careful to provide such misrepresentative Cubes to technology writers to generate false publicity for the defective product. Apple's cover up worked:
APPLE INGENUITY CUBED
* * *
Steve Jobs and company continue to put the PC industry to shame ....
The latest example is the Power Mac G4 Cube, a new model that began reaching dealers and users last week .... For the last 10 days I've been trying out a unit that Apple loaned me for evaluation.
In another couple of weeks, I'll have to give it back, and I'm not looking forward to that day .... [T]he Cube is one I really wish I could keep....
... What it offers above all is a quality all too rarely associated with desktop computers: elegance.
That's partly a matter of appearance. Its design - a silvery box about 7.7 inches on each dimension, suspended inside a clear plastic stand that holds it a couple of inches off the desk ....
2. Late August Analyst Conferences
124. On 8/23/00, senior officers of Apple, including Apple's CFO, Treasurer, Head of Operations and Head of Desktop Products, met with analysts at Prudential Securities to discuss Apple's business. In addition to telling the Prudential analysts that Apple was "operating according to plan" and it "remained on track to deliver fourth quarter results," they stated: http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 39 of 70
• Both back-to-school and education sales had accelerated as seasonally expected.
• New iMac and G4 product offerings had largely filled the channel and the Cube would be hitting the shelves shortly.
• Initial orders for the G4 Cube were strong.
• Pricing actions had already been booked to clear inventory of older products and additional actions would not be necessary.
• Apple remained comfortable with expectations for 4Q 2000 revenue and EPS of $2.0-$2.1 billion and $0.44-$0.46.
• Apple was forecasting FY 2001 revenue growth of 20%, yielding EPS of $2.10+.
125. On 8/23/00, Prudential issued a report on Apple by Alexy, which was based on and repeated information provided by Apple officials. The report forecast FY 2000 and FY 2001 EPS of $1.84 and $2.10, respectively, and 4Q 2000 EPS of $0.45 for Apple. It also stated:
Yesterday, we met with several members of Apple's senior management team including the company's CFO, Head of Operations, Head of Desktop Products and Treasurer. At the meetings, we discussed general business trends and the outlook for the next 1-2 years. Overall, the tone of the meetings was positive, and management remains comfortable with expectations for >10% Q/Q growth. We are modeling 14% Q/Q to $2.07B and EPS of $0.45 per share.
Management noted that both back-to-school and education sales have accelerated as seasonably expected. The company's new iMac (excluding the $799) and G4 products have already hit the distribution shelves while the Cube is just being stocked now and the $799 iMac will hit shelves in September. Pricing actions on older inventory have already been taken (which management estimates negatively impacted Apple's FQ3 margins by 2.3%), and the company does not anticipate needing to take additional actions in FQ4. Apple remains comfortable with its ability to meet demand despite continued component tightness.
Apple characterized initial order data on the Cube as strong ....
* * *
Longer-term, management reiterated guidance for its financial model for FY01 which includes:
1) Unit growth 25-30% 2) Revenue growth of 20% 3) G[ross] M[argins] of 27%
* * *
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Beyond FY01, management continues to expect that the company will be able to deliver revenue growth of approximately 20% ....
* * *
We believe Apple remains on track to deliver better than expected EPS in its September quarter. Specifically, we believe that revenue guidance is tracking to plan and that G4 guidance will again prove overly conservative.
We expect that new product cycles, seasonal demand strength and favorable margin trends will drive >25% operating income growth in FY01.
126. On 8/30/00, Jobs attended the Seybold computer conference and presented the keynote address, which included a report on Apple and the introduction of Apple's new products. During conversations with analysts at the conference, Jobs told analysts:
• There had been no change in shipment rates across product lines and component availability. Apple was on its shipment and availability plan. Components availability was tracking according to Company expectations.
• Inventory was being effectively managed by Apple.
• Consumer acceptance of the Cube was good. Apple was now ramping production from the vicinity of 3,000 units per day to 5,000.
• Apple's target was 150,000 Cube units in the 4Q 2000; "tens of thousands" of Cube units had already been sold in the 4Q 2000.
• Apple was operating according to plan, and it remained on track to deliver 4Q 2000 results in line with expectations.
127. On 8/30/00, J.P. Morgan issued a report on Apple by Daniel Kunstler, written after discussions with Jobs and which was based on and repeated information provided to Kunstler by Jobs at the Seybold conference. The report forecast FY 2000 and FY 2001 EPS of $1.85 and $2.12, respectively, and 4Q 2000 EPS of $0.46 for Apple. It also stated:
Steve Jobs' speech at Seybold was a little bit of a non event, since 99% of what he had to say had already been said at MacWorld New York on July 19th.... [M]ost of our attention these days is on shipment rates across the product lines, component availability, and the valuation of stock. On the first two points, the big news is that there isn't any. The company is on its shipment and availability plan, and components are as tight and pricey as the company has been expecting. The stock after getting stuck below $50 per share at the end of July and into August has regained the ground lost in the wake of MacWorld New York. That's the good news....
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ago. The reason for any trepidation was simply that Apple had refreshed its entire desktop product line, adjusted pricing and added the Cube. With the new products shipping three weeks into the quarter and an unfilled channel - Apple had, of course, ceased production of older models in anticipation of the new stuff - it looked a little like Apple was walking a tightrope, especially when you add to that component availability worries. But our fears have been calmed:
* Customer acceptance of the Cube appears to be quite good.... Apple is now ramping production from the vicinity of 3,000 units per day to 5,000.... Needless to say, it is pleasing to the eye ....
... [T]he Cube will drive the quarter. Again, shipments are now just ramping, and the new product is just hitting the shelves in Japan. The company target is 150,000 Cube units in the quarter, and Steve talked about "tens of thousands" having been sold already....
* The quality of the desktop product line-up remains very good .... The Cube is not just a great work of aesthetics, but is very powerful ....
128. As detailed above, defendants' positive statements between 8/9/00-8/30/00 were false and misleading when made. Specifically, the following statements were misleading: (1) Apple's target of 150,000 cube units remained on track because tens of thousands of cube units had already been sold and initial orders were strong; (2) both back-to-school and education sales had accelerated as seasonally expected; (3) Apple remained comfortable with expectations of >10% Q/Q growth equating to 4Q 2000 revenue and EPS of 2.0+ billion and $0.40+, respectively, and (4) pricing action had already been booked to clear inventory of older products and additional actions would not be necessary. These statements were all false and misleading. These statements failed to disclose negative conditions which were adversely impacting Apple's business and operations, including the massive G4 Cube production problems and design defects, the operability problems with the PowerMac G4's dual processor, the new iMac's failure to include features consumers wanted, and Apple's resulting inventory problems. Defendants also failed to disclose the impact that their new methods for K-12 educational sales were having on sales.
3. August 25-30: Top Apple Executives Bail Out
129. As a result of the extraordinarily bullish positive statements made by defendants at the MacWorld Conference and during 8/00, Apple's stock gained momentum. By 8/25/00, Apple stock hit $57-1/2, its highest price since 7/18/00. On 8/31/00, Apple's stock hit $61-1/2; on 9/1/00 it hit $63- 5/8; and on 9/5/00 it hit its Class Period high of $64-1/8. Just as Apple's stock was moving to its Class Period high, four of Apple's six Senior Vice Presidents took advantage of the artificial inflation in the price of Apple stock caused by defendants' false and misleading statements, by exercising options to acquire Apple stock at cheap prices and then immediately selling almost $22 million of Apple stock into the open market:
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% of Shares Actually Name Position Dates Shares Owned/ Sold Proceeds Rubinstein Senior VP-Hardware 8/31/00 100,000 100% $ 5,944,000 Engineering Tamaddon Senior VP-Service and 8/31/00 70,000 100% $ 4,214,000 Support Tevanian Senior VP-Software 8/30/00 150,000 100% $ 8,887,500 Engineering Heinen Senior VP-General 8/25/00 50,000 100% $ 2,856,500 Counsel TOTAL N/A 370,000 100% $ SALES 21,902,000
130. As detailed above, these massive sales demonstrate that Apple's high-level insiders knew about the problems at Apple and bailed out before the Company released the information to non-inside investors.
4. Early September Reports
131. On 9/6/00, Prudential issued a report on Apple by Alexy, written after discussions with Apple officials (including Anderson), which was based on and repeated information they provided. The report stated:
• Apple's new product offerings appear to have taken somewhat longer than initially expected to reach the channel. However, August sales checks suggested new iMac and G4 offerings reached the shelves by mid-month while Cube products are still in transit.
• Apple remains comfortable with consensus FQ4 revenues expectations for $2.05B in revenues. Back-to-school demand appears to have accelerated as expected ....
* * *
Retailers surveyed noted that the Cube is generally not available yet but is expected to be on the shelves in early to mid-September.
The Prudential report was the first indication that Apple's new products were delayed in reaching retailers' shelves in full quantities. Apple's stock fell to as low as $57-3/4 on 9/6/00 from $64-1/8 on 9/5/00. The stock continued to trade at inflated levels however, based on Apple's false assurances to analysts that Apple was on track to meet its 4Q 2000 forecasted results, its failure to correct previously made false statements, and its continuing concealment of material adverse facts.
132. On 9/8/00, Merrill Lynch issued a report on Apple by Steven Fortuna, written after discussions with Apple officials (including Anderson), which was based on and repeated information they provided. The report continued to forecast Apple's FY 2000 and FY 2001 EPS of $1.84 and $2.08, respectively, and 4Q 2000 EPS of $0.45. It also stated:
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Apple Q4 Tracking On Plan
• We believe that Apple's September quarter (4Q00) is tracking on plan. We are expecting revenue of $2.015 billion (up 50.8% yr/yr), and earnings per share of $0.45.
5. September 13, 2000: Jobs in Paris and CNBC
133. On 9/13/00, Jobs appeared at the Paris computer trade show where he again extolled Apple's new products, their beneficial effect on Apple's 4Q 2000 revenues and EPS and their overall availability. Jobs said Apple's new products gave it "the strongest product line that Apple has ever had." Jobs also said he was "extremely happy" with sales of the G4 Cube, but declined to reveal actual shipment/sales figures. Jobs' remarks were reported in the National Post and USA Today.
134. On 9/13/00, Jobs also appeared on the financial news channel CNBC - watched by millions of viewers. During this interview, when asked about rumored shortages of the Company's G4 Cube, Jobs stated that Apple had already shipped "many tens of thousands" of units of the product and concluded the interview by stating: "I think we're going to hit our forecasts this quarter, so if they're hard to find, I think that's because demand is greater than we thought it would be ...."
135. Thus, during its 4Q 2000, Apple presented a picture to the investment community that it was successfully introducing new, revolutionary, beautiful, powerful and extraordinarily fast personal computers, was facing overwhelming demand for its new products all over the world and that Apple's principal business problem was getting enough component parts to produce enough product to meet this demand. At this time, Apple also indicated that it was successfully manufacturing enough product to meet demand, while continuing to efficiently control its inventories, and that the Company was enjoying a strong seasonal rebound in back-to-school sales and in its vitally important K-12 education market. As a result of this strong demand and flow of new, higher priced products, Apple was forecasting very strong revenue growth leading to strong EPS growth going forward. In short, Apple "guided" the investment community to conclude that its business had never been stronger, its outlook had never been brighter and its 4Q 2000 would be exceptionally strong - over $2.0+ billion, with EPS of $0.40+ to be followed by 20% revenue growth and 15% EPS growth in FY 2001.
6. September 21, 2000: Questions Start
136. On 9/21/00, The Wall Street Journal carried an article about Apple that hinted that there were quality problems with Apple's G4 Cube:
Earlier this week, Kevin Pedraja, a public-relations executive ... was startled to receive an early-morning call from [Steve Jobs] the mercurial Apple founder. Mr. Pedraja recently had purchased one of Apple's stylish new Power Mac G4 Cube computers, but found some cracks in it and got no help when he called ... to complain.
Mr. Pedraja finally faxed a strong letter to Mr. Jobs that also threatened to spill the beans to the media. The letter yielded immediate results. Apple's executive-relations team promptly offered to replace Mr. Pedraja's Cube with a new one.
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was "inconclusive" as to whether or not Apple had its new product transition "in the bag," and indicating that remaining inventories of the older Power Mac line were impacting sales of the new Power Mac line. Despite these concerns however, Morgan Stanley stated, "we do not believe Apple will miss our EPS estimate of $.45." Also on 9/21/00, Intel announced it would not meet its forecasted revenues, profit margins and EPS for the quarter to end 9/30/00 due to weak demand in Europe, an important market for Apple as well. As a result of these unsettling revelations, Apple's stock fell in sympathy from $61-3/64 on 9/20/00 to as low as $50 on 9/22/00 before closing at $52- 3/16. Apple's stock continued to trade at inflated levels however, based on Apple's false assurances to analysts that it was on track to meet its 4Q 2000 forecasted results, its failure to correct previously made false statements, and its continuing concealment of material adverse facts.
7. September 28, 2000: Morning - All Is Rosy
137. On 9/28/00, The Wall Street Journal ran an article on Apple and its G4 Cube, based on a carefully hand-picked and hand polished cosmetically perfect G4 Cube that was loaned to Walter Mossberg, a technology writer for the Journal. Mossberg's piece stated:
Apple's Design Delight: The Cube Is Beautiful, Silent and Powerful
* * *
APPLE HAS DONE it again. The company that has long stood for style and innovation in a sea of industrial, me-too computers has now introduced a top-of-the-line, powerful machine that is simply the most gorgeous personal computer I've ever seen or used. And I've seen most of them.
The new Power Mac G4 Cube packs a fast Macintosh into a beautiful, silvery case that's just 7.7 inches on a side and 9.8 inches tall. It weighs just 14 pounds, not much more than some bulky laptops. And it looks like a museum piece ....
* * *
SO THE CUBE isn't for value buyers. You are definitely paying more for a design with style and elegance. But that design delights.
* * *
What the Cube proves is that great design isn't inconsistent with strong technology.
VII. THE ADVERSE FACTS COME OUT
138. After the close of trading on 9/28/00, Apple revealed that its 4Q 2000 revenue and EPS would be much worse than previously forecast - revenues of only $1.85-$1.9 billion and EPS of just http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 45 of 70
$0.30 - a huge shortfall from the previously forecast EPS of $0.40+ on revenue exceeding $2 billion. According to the Company's statement, 4Q 2000 results would be "substantially below expectations" due to slower than expected sales across all geographies, a "slower than expected start" in the sale of the G4 Cube and slower than expected sales into the K-12 education market.
139. The market's reaction to Apple's shocking revelation was immediate. Apple stock collapsed by over 50% from $53-1/2 on 9/28/00 to just $25-3/8 on 9/29/00 on astonishing volume of 129.8 million shares. This was the largest one-day price decline on the largest one-day trading volume in Apple's history as a public company. As the market digested the full gravity of Apple's business and product problems, and that Apple would shortly cut back its forecasts for FY 2001 as well, Apple stock continued to plunge, falling to as low as $17 and then to $13-5/8. Over $10 billion of Apple's market value had been wiped out.
140. Apple has now revealed that it was unable to get its inventories under control, would suffer $115 million in component part cancellation charges, and $135 million in promotional costs to try to clean out its inventory. Apple's 1Q 2001 and FY 2001 revenues showed huge declines, suffering a $250 million loss in the 1Q 2001 and a loss for the full FY 2001.
141. Apple's surprise revelation, which wiped out over half of Apple's market capitalization in one day, created an outburst of criticism and anger from analysts and investors, as reflected in media reports of the debacle:
• "Apple's bombshell ...." - The Independent.
• "Apple's comeback is over." - Don Young, an analyst at PaineWebber.
• "They should have made this announcement already. Management was saying two weeks ago that everything is fine. When they knew there were problems, they should have come out and said it then." Venu Reddy, analyst.
• "Half an Apple, anyone? That's not even quite what somebody who owned the stock Thursday night ended up with at Friday's close .... If it's any consolation to those sadder and poorer souls, not all Apple shareholders were blindsided. Several officers, we're happy to report, exercised options in late August and immediately unloaded the stock at prices ranging up to $60 a share. Altogether, they pocketed a cool $19 million." - Barron's.
• "Thursday's after hours warning sent Apple almost back to square one ... [and] delivered a sharp blow to Apple's revival under Mr. Jobs.... Charlie Wolf, an analyst at UBS Warburg, said: 'This raises a red flag for the future.'" - Reuter's.
• This reaction "borders on brutality, but we must stop short of dubbing it an over- reaction given the amplitude of the shortfall, overall slowing of the company's growth plans for the next fiscal year, and the absence of any explanation beyond a lack of customers." - J.P. Morgan.
• "Most analysts appeared to be taken by surprise by the Apple statement .... Apple has recently been basking in glowing reviews of its sleek new Power Mac G4 Cube computer, and has increasingly come to be recognized for its fiscal discipline. Several http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 46 of 70
quarters of consistently strong results had finally started to erase the memory of the execution problems it had had years ago. As recently as last week, many analysts had reiterated their confidence in the company and said they saw strong demand for a slew of new products ...." - Los Angeles Times.
• "Tim Bajarin, president of consulting firm Creative Strategies Inc., Campbell, Calif., said the loss came as a surprise. 'We're not seeing any slowdown in demand across any other sector in the PC industry .... Most other PC players are expecting their fourth quarters to be strong.'" - The Wall Street Journal.
• "Apple['s] earnings warning appears to signal the company has more than just one quarter worth of problems.... [A]nalysts said Thursday's fiscal fourth-quarter warning, which sent Apple shares plummeting, may be evidence the company has saturated its loyal user base with products over the last few years and may have trouble attracting new users to its Macintosh platform. 'We think in many ways that Apple has milked its installed base dry over the past few years, particularly in the education and publishing markets, but also to a large degree, in the consumer market,' wrote Merrill Lynch & Co. Steven Fortuna in a research note." - Dow Jones News Service.
142. On 10/2/00, SmartMoney.com ran an article on the Dow Jones News Service headlined "Apple Computer Gets Halved," which stated:
[The 9/28/00 revelations were] a bitter come down from the wave of iMac euphoria that had boosted Apple stock .... $9 billion in market value evaporated in one day.
The problem is broad and deep....
* * *
The latest refresh of Apple's iMac has been disappointing, says Stephen Baker, vice president of technology products research for PC Data.
Sure, there were new colors offered ... [b]ut the machines were still being shipped with 15-inch monitors when comparable Wintel PCs from Dell computer and Compaq Computer feature the 17-inch variety. Baker was also surprised when Apple didn't include a CD-RW drive, a popular feature that allows the computer to write data (read: MP3 files) to CD-ROMs.
* * *
As for the G4 ... early sales data seem to indicate that it may be priced too high. The Cube sells for $1,799 to $2,799, depending on its features - and that's without a monitor....
And a comparably priced PC invariably comes with much more memory and hard- disk space.
143. In early 10/00, Business Week also reported:
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[T]he magic Jobs had spread over Wall Street evaporated, as investors ruthlessly drove the stock down 52% .... Why so vicious a reaction? ... There's ... growing concern that the Jobs formula for recapturing lost market share - pump up the profits by selling sexy- looking, premium-priced products to a core market of Apple freaks - was little more than a short-term fix.
* * *
Apple's 2000 crop of products is little more than eye candy. Sure, the Power Mac G4 Cube ... looks great. But consumers recoiled at the $2,300 base price that Jobs figured they would pay.... The ... units sold are only about half what Apple insiders had expected, say analysts. And it's not likely the Cube will be a late bloomer. Net message boards are filled with customer complaints about such things as mold lines in the plastic casing.
More important, Jobs needs to avoid the hubris that has stopped Apple's gold eras in the past. That means lowering the price of the Cube - and improving the iMac. It now lacks basic features many shoppers want, such as a rewritable CD- drive for creating custom song compilations or storing home movies and larger 17-inch monitors. Rather than invest to make these changes, Jobs opted to add new colors and cut prices. It didn't work ... iMac sales in the U.S. dropped 30% in the most recent quarter.
144. In early 10/00, Barron's also published an article entitled "Apple's Troubles Lie at it's Core," which exposed the fiasco in Apple's K-12 education market. The article stated:
The educational market has long been dominated by Apple .... Now, however, there is evidence that Apple's commanding share of the education market is starting to erode.
* * *
Last June, Apple quietly decided to fire some 50 educational resellers and shift distribution to a company-run, direct-order Website.... It would have been far wiser for the company's impatient chief executive, Steve Jobs, to have waited until after the critical summer and fall quarters before announcing the transition. Here's why: Jilted resellers appear to have stopped pitching Apple, working instead to solidify their administrative contacts at the schools in hopes of saving their businesses. The result: a lousy quarter.
For a decade or so, the educational reseller program had been a winner for Apple.... The brokers would sell the machines and servers, and Apple would ship direct from its warehouses .... The arrangement worked well.
* * *
"I would never had made that move during the school buying season," an industry source said.
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* * *
That Apple salesmen stopped knocking at a time when school districts are pouring dollars into computer hardware is a misstep that could inflict permanent damage.
* * *
Apple's stumble in the school segment is coming against the backdrop of an expanding market for educational sales - not a market slowdown. Competitors are taking a bite out of one of Apple's core businesses, and new avenues of future growth remain unclear. The threat to Apple's impressive turnaround is elementary.
145. In mid-10/00, The Wall Street Journal also published an article about the breakdown in Apple's education market headlined, "Dwindling Education Sales Take a Bite Out of Apple's Bottom Line." The article stated:
To understand why Apple ... warned that its quarterly earnings ... will disappoint investors, listen to Brad Lichtman.
Mr. Lichtman, principal of Grossmont High School in El Cajon, Calif., considers himself an Apple fan....
But when Mr. Lichtman authorized the purchase of 40 new computers over the summer, the bulk of the order went to Apple rival Dell Computer Corp. "Ten years ago, most teachers used Macs, but now that's definitely changing," says Mr. Lichtman....
Many schools and universities - the mainstays of Apple's customer base for years - are phasing out their Macs in favor of personal computers based on the rival Windows operating system. The trend has accelerated over the past 12 months....
This past July, Baltimore County Public Schools in Baltimore switched from Apple to the Windows platform.... "We've got to prepare students for the workplace, and most companies and the private sector now uses Windows, not Macs," [said the Superintendent].
The shift is hurting Apple's bottom line. Education accounted for 40% of Apple's total U.S. sales over the past few quarters....
* * *
When the big push to wire classrooms began more than a decade ago, Apple jumped on the market and Macs became educators' top choice because of their ease of use and friendly graphical interface. The company deluged the market with special marketing programs, often at a discount, and created a widespread network of education sales agents. http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 49 of 70
* * *
Since the start of the year, Apple's education sales team has also undergone confusing changes, many schools complain. Mike Lorion, an Apple executive overseeing education sales, left the company .... After his departure, Apple eliminated its contracted education sales force and brought the team in-house....
The upshot: Apple now has far less direct contact with schools than it used to.... And that has left many educational districts displeased. At School District 135 in Orland Park, Ill., technology coordinator Rich Kalinski says he sees Apple representatives only occasionally ....
"There's no love lost between us and Apple," he says. "Apple killed off the education dealers and now we basically have to deal with Apple only. There are no alternatives," and there is no local tech support, he says. Mr. Kalinski says District 135 will pick a new tech platform next year, and he believes the schools will switch to Windows-based computers.
After Apple disclosed its large 4Q 2000 revenue and EPS shortfall and revealed that very poor sales into the K-12 education market were a prime reason for the shortfall, Jobs was questioned about this shortfall. According to The Wall Street Journal:
As for sales to schools and universities, Mr. Jobs attributed slower sales to a change in Apple's sales system. In July, the company transitioned from using a contracted sales force to working with a bigger in-house sales team. "The timing certainly wasn't [smart]," said Mr. Jobs ....
146. According to Business Week, in a 12/4/00 article entitled "How Steve Jobs Failed At School":
The truth is that Steve Jobs is at least partly to blame. He made a big mistake earlier this year when he canned the company's longtime freelance educational sales force and brought the effort in-house.
What prompted the move was the surprise departure of Apple's top education sales executive, Mike Lorion. He left in the summer just as computers were being bought for the coming academic year. With his departure, Apple decided to dump its longtime network of outside educational sales reps and hire its own sales force. The switch in strategy created chaos, according to the schools. Many administrators said the only way they could reach Apple was through the Internet, while Dell's salespeople were showing up in person.
Jobs conceded at Apple's recent briefing on disappointing third-quarter results that switching sales teams during the summer was an error. Revenues slipped in part because of lower education sales.
147. Jobs has stated he is "not proud" of all this and has admitted: http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 50 of 70
[L]et me focus on the Apple-specific issues. First, the megahertz gap. Even though our power PC processors are actually faster than Intel's fastest processors for many of the tasks our customers commonly perform, their megahertz is slower. We are very aware of this .... Two, K-12 education sales. We have slipped to No. 2 in education sales behind Dell. We don't like this. But the tragedy is that Dell didn't win it, we lost it. We are still recovering from shooting ourselves in the foot with the sales force transition in July .... Three, Power Mac G4 Cube. The sales of our Power Mac G4 Cube have stabilized at a ... level ... far below what we had planned for initially.... Four, CD read/write. Apple completely missed the boat on CD read/write drives. Both HP and Compaq ship approximately half of their computers with CD read/write drives. Apple ships none. We just blew this one.
148. Based on Apple's shocking 9/28/00 revelations and subsequent disclosures, analysts slashed the FY 2000 - FY 2001 revenue and EPS forecasts for Apple, such that Apple's FY 2001 revenues were projected to decline (not the 20% growth forecast during the Class Period), to just $7+ billion, $3 billion less than the $9.7-$9.8 billion forecast during the Class Period. Apple also suffered a huge $250 million 1Q 2001 loss and analysts projected Apple's FY 2001 EPS, if any, would be small, a far cry from the 15% increase and $2.10-$2.15 forecast during the Class Period. Based on discussions with Apple insiders and industry sources, analysts have now figured out much of what was actually going on inside Apple during Apple's 4Q 2000 - as the following excerpts from analysts' reports below explain:
Lehman Brothers:
Gross margin of 25% was 160 bp below our expectation of 26.6% and 200 bp below prior guidance of 27%. The reason for the lower than expected gross margin was related to a mix shift to lower margin Power Mac SKUs and accrual charges related to not taking components in Q4 and promotions that will not occur in Q4....
... [T]he $180 million shortfall in revenue was related to three factors. The largest contributor was lower than expected Power Mac G4 Cube sales which accounted for $90 million of the shortfall .... [T]hey were only able to sell 107,000 units.... [T]here were three factors related to the shortfall in Cube sales.
First, the Power Mac G4, while an innovative product from a design standpoint, was priced too high for consumers to purchase....
Second, there was a production problem with some of the Cubes that were shipped to consumers. A shift in the casing which could be caused during shipment would cause the touch switch to be misaligned and cause the G4 Cube to power down at inconvenient times.... In addition, consumers mistook some of the flow lines from the outer casing as cracks. Apple has replaced Cubes that have more pronounced flow lines. Going forward, as Apple ramps up the learning curve on Cube production, these flow lines should not be an issue. We believe that the latter two device specific problems did not help spread good word of mouth amongst PC consumers.
Third, consumers appear to be confused about the MHz gap between Intel processors and G4 PowerPC processors.... Apple is working closely with Motorola to obtain faster http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 51 of 70
PowerPC G4 chips so that they can close the Megahertz gap.
* * *
The second largest culprit for the lower than expected earnings was the poor performance of the education market which accounted for $60 million of the revenue shortfall. Education sales typically account for 20-25% of total sales in the September quarter but accounted for less than this in this particular quarter. Management blames the shortfall [on] an execution problem. Before July, Apple typically sold through the education market via its own sales reps and third party sales reps. Beginning in July, Apple added 150 additional internal sales reps and switched to selling to [the] education market using only its representatives and terminating third party reps. As a result, 40% of Apple's sales reps were new to the company and 50% of Apple's education customers had new sales account managers. Further exacerbating this problem was the fact that the transition could not have occurred at a worse time (peak season for education sales) for Apple's education business.
S.G. Cowen:
[U]nfortunately, the picture is not pretty. The short term prescription is a sharp curtailment in sales into the channel to reduce the channel overhang ....
... Basically, revenues fell some $180MM short ... because of three factors. First, the G4 Cube ... got off to a slow start, due to pricing and perception issues ($90MM delta). Second, it took a hit in the crucial education season [by] going to a direct rep model ... causing a $60MM hit in this sector. Third, in the Power Mac G4 market, mix was poor as sales of high-end dual processor versions failed to catch. In view of the soft sell through apparent by mid-September, management recognized it would be necessary to take reserve accruals against COGS for pricing action to promote sell through in the December quarter and cancellation charges it would incur with suppliers; gross margins therefore took a hit of another 180 ....
Prudential Securities:
Apple was left with a significant channel inventory overhang at quarter end, estimated at 8 weeks vs. more normalized levels of approx. 5 weeks. Management plans to dramatically reduce sales into the channel in FQ1 .... Management has also significantly lowered the FY01 revenue growth outlook ... to 0% ....
* * *
[T]he Apple miss was much more company-specific than Apple initially indicated....
First, weaker September sales were attributed to poor sales of the Cube .... [T]he 450 MHz labeling suggests a materially slower clock speed. Management noted that the http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 52 of 70
company is working with Motorola to offer significantly higher clock speeds over the next 6 months.
Second, management acknowledged a very ill-timed transition in its education sales force during the July timeframe which accounted for a sizeable portion of the miss in sales into the education market (est. at $60MM)....
Third, poor Cube sales ($90MM impact) were attributed to customers' perception that the product was overpriced and that there were quality problems. A miss-aligned [sic] power switch caused some products to shut down unexpectedly. In addition, thin plastic lines in the casing were perceived as cracks.
UBS Warburg:
Apple experienced a $180 million revenue shortfall in September .... Apple ended the quarter with three weeks of excess inventory in the dealer channel ....
* * *
Apple must first bite the bullet of excess channel inventory.... As a result, the December quarter will be a real downer ....
J.P. Morgan:
Remember inventories are this company's sworn enemy. So, the company ... very simply will be shipping very little in order to reset channel inventories.
Gerard Klauer Mattison:
• Product issues depress high-end product sales, contributing to excess channel inventory. Pricing which was too high as well as technical glitches ... have limited sales of the newly introduced G4 Cube ... reducing revenues by about $90 million.... [F]iscal 4Q00 revenues were $30 million lower-than-expected because the company announced dual-processor models of the G4 Power Mac with limited software products that could take advantage of multiple processors, skewing sales to the low- end single processor model with its lower ASP (average selling price) and margins.
... Apple's new product line-up has not significantly increased demand with consumer or graphics/design professionals and ... the restructuring of Apple's education salesforce dampened sales in that segment.... [I]t is difficult to have a high level of confidence that Apple will be able to generate sufficient and consistent demand going forward ....
PaineWebber:
Q400 RESULTS
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The biggest disappointment for the company was slower than expected Power Mac G4 Cube sales, followed by poor execution in education sales, and a mix shift to lower priced Power Mac G4 Dual Processor machines. Management attributed slower Cube sales to the relatively higher price of the product at $1,799 .... And cited the transition of its education sales force in July to all Apple sales reps .... While the Power Mac miss was due to slower G4 clock speeds holding back purchases.... [C]ube sales accounted for $90 million, education sales for $60 million, and Power Mac sales for $30 million of the $180 million shortfall.
... [T]hese factors caused Apple to exit September with a significantly higher than expected eight weeks of channel inventory .... Management will attempt to reduce this level ... punishing results, by the need to liquidate three weeks of channel inventory ....
Credit Suisse First Boston:
Apple's quarter showed a fundamental and fairly comprehensive dropoff in demand. The slowing in demand showed up in two ways: first, channel inventory levels ballooned from 5 weeks at the start of the quarter to 8 weeks exiting the quarter, indicating weak end consumer sell through ....
The demand shortfall was broad-based but impacted different product lines unevenly. The education shortfall, accounting for $60 million of the total $180 revenue miss, was caused by a poorly timed transition from a third-party educational reseller model to a direct Apple representative-based model. The transition came in July, at the height of the K-12 selling season, and many educational institutions were disaffected by the change from familiar, local resellers to new, often inexperienced, and distant Apple representatives.
* * *
The third problem was an unexpected mix skew toward the low end of the G4 Power Mac professional desktop line. This was a new development - typically, on all of Apple's product lines, mix skew to the high end. However, the high end of the Power Mac lineup is the dual-processor model, which adds little in performance over single processor models because the current incarnation of the Macintosh OS, 9.0, cannot fully take advantage of two chips. Only with O/SX early next year comes such functionality as SMP (symmetric multiprocessing, or the ability to assign and spread computing tasks over multiple chips), which is necessary to fully enjoy the advantages of multiple chips.
149. Reports of imperfections in the supposedly perfectly clear pristine crystal G4 Cube case were widespread. On 9/28/00, Reuters news service reported:
As its earnings outlook eroded on Thursday and investor confidence shattered, Apple Computer was also having to answer to loyal customers who complained that its computers were cracked. Several Apple enthusiasts who have plunked down $1,799 for http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 54 of 70
the shimmering new Power Mac G4 Cube computer said that cracks were appearing in the machine's clear plastic casing, ruining the sleek design that they had paid for.
* * *
Apple consumers are famously style-minded and will often make a purchase decision based on a computer's color rather than its storage capacity.
"I bought my Cube thinking it would be as pristine as the ad photos," one unhappy customer wrote on an Internet message board. "It is my genuine belief that the lines are minor stress cracks caused in the assembly process." "These are really cracks and not mould lines," read another comment. "They weren't here when the machine arrived and they are getting bigger."
150. Customers of Apple who purchased the defective G4 Cubes were incensed. They posted messages on Apple's Internet support site, examples of which stated, "These cracks that I am referring to are not mold lines - they are cracks.... You can see them, feel them, watch them grow"; "[L]et's be real here Apple, these are not 'cosmetic markings.' These are pure and simple cracks. I can fit a piece of paper through three 'cosmetic markings.' What really steams my PC butt, is that Apple still refuses to acknowledge these defects and indeed they are major defects. I've disputed the charge for mine and have gone back to a windows machine"; "We who have the Cube also have the intelligence to know the difference between an assembly defect and a knit or flow line. I can see the knit and flow lines in my 15" Studio Display. I don't complain about them because they are not cracks. We can tell the difference between 'appear' and 'feel' - - the cracks can be felt. They are more than the 'appearance of a line.'"
151. Analysts subsequently realized the negative impact that such defects were having and would continue to have on Apple's sales of its most highly touted product. Chris LaTocq of Gartner Securities was quoted on the C-Net News website as stating, "[i]n a stylish design like this, people are paying for style. And apparent cracks aren't style." Tim Deal, a Technology Business Research analyst, was also quoted in the C-Net report as stating, "[t]he Cube relies almost entirely on its appearance, and it is designed for its appeal.... That's the name of the game with Apple. They're all about design and appearance. You can't promote a product off its design and appearance and have flaws with it, then sweep it under the rug as being normal."
152. Apple's 4Q 2000 revenues were only $1.87 billion with EPS of only $0.30 - far below the levels previously forecast. Apple's FY 2001 results have also been abnormal as set forth below:
FY 2000 01/01/00 04/01/00 07/01/00 09/30/00 Year Net Sales $2,343 $1,945 $1,825 $1,870 $7,983 Operating Income $ 100 $ 170 $ 168 $ 84 $ 522 Investment Gains $ 134 $ 100 $ 50 $ 83 $ 367 Net Income $ 183 $ 233 $ 200 $ 170 $ 786 Net Income Excluding Investment Gains $ 173 $ 160 $ 163 $ 108 $ 609 http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 55 of 70
Earnings Per Share Excluding Investment Gains $ 0.50* $ 0.44 $ 0.45 $ 0.30 $ 1.69
* 1Q 2000 net income excludes special charge of $90 million for executive bonuses. Inclusive of this charge but excluding investment gains, net income would have been approximately $82 million or $0.46 per share.
FY 2001 12/30/00 03/31/01 06/30/01 09/29/01 Year Net Sales $ 1,007 $ 1,431 $1,475 $1,450 $5,363 Operating Income (Loss) ($420) ($8) $31 $53 ($344) Investment Gains $71 $5 $11 $1 $88 Net Income (Loss) ($247)* $43 $61 $66 ($37)* Earnings (Loss) Per Share ($0.73)* $0.12 $0.17 $0.19 ($0.11)*
* Excluding investment gains and effects of new accounting pronouncement.
153. The truth about Apple's debacle in the education market was subsequently confirmed by BusinessWeek Online on 12/4/00:
Apple was not simply outmuscled by Michael Dell. The truth is that Steve Jobs is at least partly to blame. He made a big mistake earlier this year when he canned the company's longtime freelance educational sales force and brought the effort in-house.
What prompted the move was the surprise departure of Apple's top education sales executive, Mike Lorion. He left in the summer just as computers were being bought for the coming academic year. With his departure, Apple decided to dump its longtime network of outside educational sales reps and hire its own sales force. The switch in strategy created chaos, according to the schools. Many administrators said the only way they could reach Apple was through the Internet, while Dell's salespeople were showing up in person.
Jobs conceded at Apple's recent briefing on disappointing third-quarter results that switching sales teams during the summer was an error. Revenues slipped in part because of lower education sales.
154. Apple's catastrophe was sneeringly reviewed by Fortune Magazine in a 5/14/01 article:
It seemed like deja vu all over again. Reverting to its Perils of Pauline mode, Apple Computer late last September fessed up that sales of its glossy, curvaceous personal computers were running off a cliff. CFO Fred Anderson, in a prepared statement, opaquely explained what had gone wrong: Apple had grossly overestimated demand for CEO Steve Jobs' pet product of that quarter - the pricey Power Macintosh G4 Cube; Apple, the erstwhile leading supplier of computers to schools, had also shot itself in the foot with a messy overhaul of its education sales operations right in the middle of the peak summer buying season; and, oh yes, the global economy seemed to be weakening. In http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 56 of 70
the same press release Jobs, the master of "insanely great" hyperbole, characterized the sudden reversal as a "speed bump." The next day Apple's market capitalization collapsed by half.
The December quarter showed how abruptly business had slumped. By the time the dust settled, revenues had plummeted 57% from the year-earlier period to a flat $1 billion, and the company was inhaling red ink. Worse, Apple, which Jobs & Co. in the previous three years had rehabilitated into a growing $8-billion-a-year concern, cautioned that revenues would probably dip to around $6 billion for all of fiscal 2001, ending next September. Some speed bump. That's about $1 billion shy of where revenues stood when Jobs marched back into the CEO's suite in 1997 and little better than half the $11.1 billion Apple rang up at its high-water mark in 1995. Moreover, Apple's solid revenue growth in 1999 and 2000 masked the fact that the company's share of the PC market had continued to erode - down to less than 4% in the U.S. and 3% worldwide. The truth about Jobs' speed bump: Apple, once a genuine power of PCdom, is shrinking again, threatening to become as inconsequential as Liechtenstein.
The article chronicled Apple's misstatements in the education market:
Apple's education distribution needed attention; 2000 was the second consecutive year that Dell Computer outsold Apple in a segment Apple had dominated for two decades, a crucial market that accounts for nearly 40% of its sales. For years the company had relied on a loose affiliation of third-party resellers to move the hardware. Apple's then head of sales, Mitch Mandich, wanted to address the problem by bringing the sales force in-house. He had told Jobs back in January 2000 that he wanted to retire sometime during the year, but he hoped to see through the sales-force transition before he left. Despite protests from CFO Anderson and a couple of directors that the timing was all wrong, Jobs told Mandich to go ahead.
Recalls Jobs: "The problem was, we were very straightforward and told these third- party salespeople ahead of time that, 'Hey, in four months we're going to switch and you're going to be out of a job.' Obviously these folks did everything they could to sell as much as they could by June 30, when we let them go, and did absolutely nothing to build for sales in the July quarter. So when our new sales folks got there, they found there was no pipeline work at all; they had to start from scratch. And, duh, this was during the peak buying time for schools. It was just stupid on our part to do this then, and that was my decision. It was a train wreck, and it was totally my fault."
The article also confirmed that Apple had to pay huge penalties for cancellation of computers it had over-ordered:
But it had to pay huge penalty fees for cancellation of key components that it had preordered when it forecast much higher production levels. Also, Apple had to pay rebates and otherwise help its distributors and retailers clear out what had become an 11-week inventory glut to make way for the new products. All that cost big bucks.
A look at the numbers shows what happened. Says Tim Cook: "We cut production by about a third, shipping only 650,000 units in the December quarter, which took down http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 57 of 70
sales-channel inventory to 300,000, or about five weeks' worth. That means Apple itself only registered about $1 billion in sales when the actual retail sell-through was $1.6 billion." And Apple absorbed $260 million in one-time charges, about half in rebates and pricing actions to clear inventory and the other half in cancellation charges for unique parts, such as shells for the Cube and slot-load DVD drives.
155. On 7/3/01, Apple completely abandoned the G4 Cube product line, due to weak demand and product problems. On 7/4/01, the San Jose Mercury News reported:
Apple Computer said Tuesday that it would stop making its Power Mac G4 Cube, a machine heavy on design innovation but short on buyers, less than a year after the product line was first sold.
Sales of the cube-shaped computer have fallen sharply since its introduction in late July last year, causing Apple to miss earnings projections and contributing to the company's first quarterly loss since Steve Jobs returned as chief executive in 1997.
VIII. INSIDER STOCK SALES
A. Apple's Senior Officers' Stock Sales Were Unusual and Suspicious
156. During the Class Period, while Apple was continuing to issue false and misleading statements about Apple, four of Apple's Senior Officers sold 370,000 shares of their personally held Apple stock during 8/25/00-8/31/00 for proceeds of $21.9 million. These four Apple Senior Officers took the opportunity to sell significant amounts of their Apple stock while in possession of materially adverse non-public information. The sales of Apple stock by Senior Officers during the one quarter which makes up the Class Period and just 20-25 trading days before the devastating revelations of 9/28/00, include:
% of Shares Actually Name Position Dates Shares Owned/ Sold Proceeds Rubinstein Senior VP-Hardware 8/31/00 100,000 100% $5,944,000 Engineering Tamaddon Senior VP-Service and 8/31/00 70,000 100% $4,214,000 Support Tevanian Senior VP-Software 8/30/00 150,000 100% $8,887,500 Engineering Heinen Senior VP-General 8/25/00 50,000 100% $2,856,500 Counsel TOTAL N/A 370,000 100% $21,902,000 SALES
157. Factoring in these individuals' vested stock options yields the following:
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Shares Options Exercise Total Class Period % of Holdings Name Held Held Price Holdings Sales Sold Heinen 0 50,000 $6.844 25,000 $17.313 50,000 $47.438 125,000 50,000 40.00% Rubinstein 2,353 133,336 $6.625 150,000 $6.844 16,668 $17.313 302,357 100,000 33.07% Tamaddon 0 73,400 $6.844 25,000 $17.313 50,000 $47.438 148,400 70,000 47.17% Tevanian 2,506 66,666 $6.625 275,838 $6.844 95,416 $17.313 440,426 150,000 34.06%
* Total options held plus total shares held as of 7/19/00.
158. The amounts of these stock sales are evidence that the sellers knew of the serious undisclosed conditions inside Apple's business, which were adversely impacting Apple's business at that time and took advantage of that insider information. For instance:
Rubinstein:
• had sold no Apple stock at all during 00;
• his sale of 100,000 shares on 8/31/00 for $5.9 million was his largest single sale of Apple stock ever; and
• this sale constituted 100% of the Apple stock Rubinstein actually owned and 33% of his vested stock options plus stock actually owned.
Tevanian:
• had sold no Apple stock at all during 00;
• his sale of 150,000 shares on 8/30/00 for $8.8 million was his largest single sale of Apple stock ever; and
• this sale constituted 100% of the Apple stock Tevanian actually owned and 34% of his vested stock options plus stock actually owned.
Tamaddon:
• sold almost 3 times as many shares on 8/31/00 than he had sold in all of 00 to that date;
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• his sale of 70,000 shares on 8/31/00 for $4.2 million was his largest single sale of Apple stock ever; and
• this sale constituted 100% of the Apple stock Tamaddon actually owned and 47% of his vested stock options plus stock actually owned.
159. The highly unusual nature and timing of these Senior Officers' stock sales is also evidence that they acted with scienter and capitalized on defendants' failure to disclose the adverse non-public information. The unusual nature and timing of the Senior Officers' stock sales is evidenced by the following:
(a) Four of the Company's Senior Vice Presidents, including the Senior Vice Presidents in charge of Hardware Engineering, Software Engineering, Service & Support and Legal Affairs - including insider selling compliance - all sold substantial amounts of their Apple stock just 20-25 trading days before the Company revealed its disastrous 4Q 2000 financial results - it is impossible that problems as pervasive and serious as those that destroyed Apple's 4Q 2000 results and FY 2001 prospects could have suddenly developed in that 20-25-day period;
(b) Moreover, it is also unusual that the Senior Officers who suddenly decided to sell their Apple stock did so two-thirds of the way through the back-to-school and holiday buying seasons - the strongest seasonal period of Apple's business, which Apple said was going well and was going to produce strong revenue and EPS growth;
(c) The unusual timing and suspicious nature of the Senior Officers' insider stock sales is also evidenced by the fact that all of the sales of Apple stock by these Senior Officers occurred immediately prior to the time when Apple stock began to decline, during the time when shares of Apple stock were artificially inflated by the false statements made by Apple; and
(d) These stock sales occurred just as Apple was supposedly successfully introducing three new and greatly enhanced personal computer products which caused Apple to increase its 4Q 2000 and FY 2001 revenue and EPS forecasts, which logically would have caused Apple's stock to continue to surge upward, generating greater profits for Apple insiders who held their stock or vested options while this good news came forth, and Apple's stock went higher. Yet, instead of holding onto their Apple stock or vested options - the logical course of action - these key insiders - who knew the truth about what was going on inside Apple (and that it was far different than what Apple was saying publicly or the investing public knew) - bailed out, selling 33%-47% of their Apple stock and vested stock options.
160. The stock sales by Apple's top insiders are dramatic evidence that they already knew what Apple would not reveal for another 20-25 trading days - that Apple's rearrangement of its distribution system to the K-12 education market was a disaster and that its three most important new personal computer products were flawed in design, manufacture and operation and doing very poorly with consumers and, as a result, Apple could not possibly meet its 4Q 2000 forecast.
161. Apple has an insider stock sale protocol that monitors the stock sales by its top executives and requires that any significant sale of stock by a top corporate officer be cleared in advance with the general counsel of Apple, Nancy Heinen. As a result of this protocol, Heinen as the general counsel is in a unique position - she and she alone knows the overall insider selling activities of Apple's top http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 60 of 70
executives before anyone else knows it - in fact, before the sales even occurred. Thus, even though she is not as involved in Apple's daily operations as the other Senior Officers, she is in a position to determine when top insiders who are intimately involved in Apple's daily operations are selling off their Apple stock due to their knowledge of serious undisclosed business problems inconsistent with what Apple is saying to the investment community. She knew, therefore, that three Apple Senior Vice Presidents who were intimately involved in Apple's day-to-day operations, including the launching of its critical new products, were going to bail out of their Apple stock right at the very moment when Apple was supposedly poised to have one of its strongest 4thQs in history, due to the tremendous success it was achieving with strong sales of its revolutionary new personal computer products - a situation which, if true, would cause executives to want to buy Apple stock, not sell it or, at least, hold on to their vested stock options and exercise those options only later after Apple's stock price had advanced further, reflecting these business successes. Thus, Heinen knew that top executives were going to bail out of their Apple stock - conduct completely inconsistent with the claims that were being made publicly by Apple. Seeing this warning sign before anyone else saw it, Heinen bailed out too, selling 50,000 shares of her Apple stock.
162. As demonstrated above, the stock sales of Apple officers Rubinstein, Tamaddon, Tevanian and Heinen constituted 100% of the Apple stock they actually owned and 100% of the Apple stock each of them acquired by exercise of stock options during the Class Period and 33%, 47%, 34% and 40% of their total holdings (stock owned plus vested options) of Apple stock, respectively. These sales were unusual in amount. None of these officers acquired any Apple stock during the Class Period by option exercise or otherwise and continued to own that stock. They sold 100% of the stock they already owned or acquired via option exercise because they knew the stock was artificially inflated and would decline sharply in price when the true facts, which they were concealing, became public.
163. The fact that some Apple officers did not exercise all of their options does not exculpate defendants. First of all, none of these officers wanted to acquire any Apple stock during this period and continue to hold it because they knew the stock was artificially inflated and would collapse when the true facts became known. Thus, none of them exercised any of their vested stock options for the purpose of acquiring and continuing to hold and own Apple stock. In addition, none of these officers were willing to exercise more vested stock options to acquire Apple stock and immediately sell that stock for several reasons. First of all, each of the officers realized that their stock sales would become known to the public, through public reporting of either their Form 144's or Form 4's which they had to file with the SEC to disclose their sales. This public reporting and disclosure acted as a significant market force restraint on the amount of stock these officers could actually sell. Many sophisticated investors and several insider stock selling or short-selling stock newsletter services closely track insider selling by corporate executives at major corporations and then quickly publicize that information as a sign that something is likely seriously wrong at a corporation that has not yet been disclosed - negative publicity which can result in analyst inquiries and often a decline in the stock price. Therefore, while these Apple officers wanted to unload significant amounts of the stock they actually owned or could acquire by stock option exercise, they realized that they had to exercise some restraint and not exercise all their vested stock options and sell the stock acquired thereby because of the negative consequences outlined above. Thus, the Apple officers who sold stock sold only as much of their Apple stock and vested stock as they thought they could without generating trouble and negative publicity.
164. These Apple officers also each had an economic motive for behaving in this way, i.e., not exercising all of their vested stock options and selling off the stock, even though they knew that Apple stock was selling at artificially inflated prices and would likely shortly decline sharply in price. First of http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 61 of 70
all, their vested options would remain vested for several years and thus even a sharp decline in Apple stock in the near term would not completely eliminate the value of these options. These officers had the option of holding onto these options hoping the stock would later recover and they could then exercise these options and sell the stock. Also, these officers knew that they always had the option after the negative information they were concealing became public and Apple's stock price declined sharply, to take their unexercised vested stock options and get Apple's Board of Directors to re-price them downward with much, much lower exercise prices and longer exercise lives and thus restore the value in those unexercised vested stock options. Thus, these officers did not have the same type of economic motive to sell off all of their vested stock options as they did to sell off any stock they actually owned outright, because, while the impending price decline in the Apple stock they owned outright and did not sell could be a permanent economic loss for them, the negative economic impact of a later stock price decline on vested but unexercised stock options could be easily avoided by them by the expedient of having their options re-priced at much lower exercise prices. As a result of the foregoing, these officers actually sold during the Class Period all of the shares of stock of Apple which they actually owned by way of existing actual ownership or exercise of vested stock options and all or nearly all they rationally could sell via the exercise of vested stock options without generating adverse publicity and inquiry, which might result in the premature disclosure of their fraudulent scheme and a decline in and negative impact on the stock price of Apple. By selling off their large amounts of Apple stock when they did, the Apple officers not only personally profited from the artificial inflation in the price of Apple stock that their false and misleading statements and manipulations had created, they also avoided losing millions, which they would have lost had they waited until the true facts they were concealing were known to the market before they sold their stock at much lower levels.
165. While the Apple officers that sold stock also owned vested stock options which were not exercised, their stock sales were still significant in amount and unusual in timing. Ownership of stock options is considerably different from ownership in stock.
166. A stock option is a right to purchase a security for a pre-determined price (the exercise price) on or before a specified expiration date. It is common for publicly traded companies to compensate their management, in part, by granting them long-term stock options which vest over time. No money changes hands at the time these options are granted. Since stock options are a "free ride," there is no fundamental economic incentive to exercise options before they expire unless a holder expects to see poor stock performance.
167. Apple used stock options as part of its compensation package for the Company's management. These stock options were typically several years in length and became vested slowly in monthly increments over the succeeding three years and lapsed after several years, thus providing a multi-year "free ride" to Apple management.
168. Ownership of stock options is considerably different from ownership of common stock. First, stock options have no capital at risk. The exercise price is not paid until the option is exercised. Thus, an option has substantial upside potential without the downside risk. Second, owners of stock options do not have voting rights. Consequently, stock option holders cannot vote in matters of corporate governance. Third, stock options do not receive dividends. Fourth, stock options are not "marginable" the way stock is. Fifth, stock options issued by a company are not freely tradeable. Because of this, they have to be held to maturity to realize their full economic value. As a result of these significant differences, one cannot and should not lump an insider's stock ownership together with an insider's vested options to determine the insider's "total holdings" of stock in the company. In http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 62 of 70
fact, none of the insider trading services that collect and disseminate information about securities by corporate insiders include vested stock options in their calculation of the insider's "total holdings" of stock.
169. Vested stock options do not carry the same economic risk as actual stock ownership. If a stock's price declines, the owner of the stock suffers a real economic loss of the money paid for the stock. The holder of a vested stock option does not lose any invested money; at worst, the option holder suffers a reduced expectancy of profit in the future. Thus, vested options are not the equivalent of common stock owned because stock actually owned carries all of the indicia of ownership - no further action or expenditure is required. The owner's invested cash is actually at risk to any market price decline. The holder of a vested stock option has no invested cash and no money at risk until that person actually purchases the stock, i.e., pays the exercise price. To actually own the stock, the option holder must put capital at risk. Thus, the failure of some Apple officers to exercise any more of their vested options, i.e., their failure to purchase more Apple stock, is consistent with plaintiffs' theory of the case - these insiders were getting out of their Apple stock, not buying more. Exercising more options would be investing in Apple, while these Apple officers were divesting themselves of their Apple stock.
170. Executives do not face the same risk of loss in stock options as they do with common stock - because they did not pay for the options, and because a company can always lower the exercise price of the options if the price of the stock falls:
Directors simply lower the options' exercise prices to the stock's current price level. Presto! The options can soon be back in the money again. It doesn't matter if the stock ever returns to the levels where the options were originally issued.
E. S. Browning & Laura Jereski, In the Money: Firms With Sagging Stocks Set New "Repricings" of Executive Options, Wall St. J., 6/1/97, at C1; see Adam Levy, The New Math of CEO Pay, Bloomberg, 7/99, at 24:
CEOs, already richly compensated, now get stock options that reward them even when they don't deliver for their shareholders. The practice is called repricing.
* * *
Options - grants that let executives buy stock at a certain price during a set period of time - were supposed to tie CEO pay to company performance. If the stock went up, the options were worth a bundle. Now, companies are repricing options to give executives a shot at cashing in even though their stocks have sunk. In short, options have become an entitlement rather than an incentive.
171. Because stock options are not freely tradeable, they cannot simply be sold on the open market at a price approximating their value. For the holder to make a disposition, the stock option first has to be exercised, i.e., the holder pays the exercise price in return for the underlying stock. Then the stock can be sold at the market price. Absent transaction costs, the proceeds to the stock option holder thus equal the price received for the sale of the stock, less the exercise price paid. This is also known as an option's intrinsic value. However, the economic value of a stock option equals the http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 63 of 70
intrinsic value, plus a premium reflecting the substantial upside potential of the option. This is similar to the option premium that an investor pays when he buys options in the open market.
172. As a stock option approaches its expiration date, the economic value and intrinsic value converge. Therefore, a stock option has to be held until expiration to realize its full economic value. Ownership of stock has no such considerations.
B. Options Valuation Provides Additional Evidence of Scienter
173. An analysis of the timing of an insider's exercise of stock options and sale of the underlying shares can provide clear and convincing evidence that these transactions were based on non-public information. The analysis is based on the common sense notion that executives will not irrationally, and needlessly, waste large amounts of their wealth absent information that the asset they hold is about to radically decline in value. If the finder of fact is unwilling to believe that financially sophisticated executives, privy to all of a company's non-public information, would engage in dramatically irrational personal financial decisions, then a strong inference can be drawn that transactions were based on non- public information, and therefore were illegal.
174. Options are valuable rights because an option allows its owner to preserve the opportunity for upside gain without any capital commitment and without any risk of loss. One analytical tool used to value options is the universally accepted method for calculating the value of stock options, named for its authors, Black and Scholes, who earned the Nobel Prize for this now well-established methodology.(3) The Black Scholes formula calculates the expected market value of any option based on several factors: stock price; exercise price of the option; expiration date of the option; volatility of the stock; and the risk-free rate of return. At any time prior to its expiration date, the market value of an option has two components: (1) "intrinsic value," the amount of money that one could obtain by exercising the option as of today (stock price less the strike or exercise price of the option); and (2) "time value," the value from any potential increase in the stock price during the term of the option. The formula demonstrates that a rational investor in an environment of efficient markets, relying solely upon public information, will be hesitant to exercise an option prior to the expiration date of the option, since an early option exercise forfeits the time value of the option.
175. Holding the option to maturity maximizes the holder's wealth, assuming that the holder makes transactions based only on public information. At a practical level, most early option exercises sacrifice very little value in this manner (i.e., less than 5%) and therefore do not sufficiently raise an inference of insider trading. However, some early option exercises would result in the loss of substantial wealth. Such exercises are avoided by executives for this exact reason. Indeed the rational executive will never forfeit more than a small amount of the value of an option because it is unnecessary to do so. Any desire for asset liquidity or diversification can be achieved by any number of financial instruments readily available and commonly used by executives. For example, executives commonly protect themselves from risk by the use of put options, call options, zero cost collars, and equity swaps. All these instruments are readily available, are commonly used, and can be obtained by a simple phone call to a broker. Similarly, information regarding these options is readily available to these executives through financial advisors and is part of the course work involved in obtaining business degrees. Further, such instruments are commonly used by executives in performing their duties.
176. Should the holder of an executive option exercise these options early, the Black Scholes formula quantifies the resulting market loss to the executive. The premature exercise of vested http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 64 of 70
options where such an exercise substantially reduces the apparent wealth of the executive can be explained as rational, i.e., to maximize the returns on their asset, only if the Apple officers were in possession of material adverse undisclosed inside information. Those Apple officers would be willing to forego the time value of the option because they know that the current value is based upon an artificially inflated stock price - a price that does not yet reflect the non-public adverse information on which the executive is basing his or her decision to exercise and sell his or her stock.
177. The Black Scholes formula often is used by corporations to value their executive stock options in conformance with FAS 123. For example, Gateway Inc., Adaptec Inc., and 3Com Corp. have reported in their proxy statements that they all recently used the Black Scholes formula for valuing executive options.
178. Using Black Scholes in this case reveals that Rubinstein exercised 16,668 options in a way which demonstrates his use and possession of inside, non-public information. In particular, on 8/31/00, Rubinstein prematurely exercised options for 16,668 shares - options that would not have expired for over eight years. The total value of these options on that day was $876,974. That is, were one to attempt to purchase such options at an options exchange or in an over-the-counter transaction, one would have paid approximately $876,974 to obtain options with rights similar to those held by Rubinstein. Nevertheless, Rubinstein prematurely exercised his options and obtained only $702,206. Absent Rubinstein's possession and use of inside information, Rubinstein's transaction makes no rational sense as he forfeited $174,768 of expected value by this early exercise.(4)
179. By contrast, Rubinstein's otherwise irrational act is clearly rational when viewed as a decision based on inside information. The options that were valued at $876,974 using public information on the day he exercised the options declined precipitously to $337,533 after the bad news was revealed. Hence, Rubinstein's otherwise irrational exercise of these options, was, in fact, rational if based upon inside information of Apple's pending stock crash. Indeed, Rubinstein's use of inside information led him to realize a $364,673 profit over what he would have obtained had he held onto his options. Such trading is clearly suspicious and is designed to "'maximize the personal benefit from undisclosed inside information.'" In re Silicon Graphics Sec. Litig., 183 F.3d 970, 986-87 (9th Cir.1999) (quoting In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989)).
180. More importantly, using the Black Scholes equation we can also analyze those options which Apple insiders did not exercise. For example, during the Class Period, Jobs chose not to exercise options for 15,000,000 shares with an exercise price of $43.59. However, the fact that he chose not to exercise these options in no way defeats scienter in this case. In particular, the Black Scholes valuation of these options on 9/28/00 was $640,067,766. Had Jobs exercised and sold these options he would have obtained only $148,590,000, a loss of almost one-half billion dollars, or 76.79%, in the value of these options. No rational investor would have sold these options in this case. Jobs' decision not to exercise these options makes sense even if he had based his decision on insider information as the value of these options after the bad news was revealed was still $264,675,848, or almost $116,685,848 more than he would have obtained by early exercise during the Class Period. Because no executive would ever exercise such an option under these circumstances, this option is not in any way informative of Jobs' holdings available for sale and should not be considered as such by this Court.
181. Similarly, it is reasonable to expect, and plaintiffs allege and will prove at trial, that a lawful rational executive would never exercise an option in which he or she would incur greater than a 20% loss by its premature exercise. Removing such irrational option exercises from Apple officers' http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 65 of 70
"available holdings" demonstrates that the following options should not be considered as "available holdings" for purposes of analyzing Apple officers' stock sales:
Pre-Crash Proceeds by Penny Per Option Class Period Wealth Dollar Number Value Exercise Lost if Obtained Name of Options (9/28/00) (9/28/00) Exercised if Exercised Heinen 25,000 $1,173,537 $904,675 $268,862 77¢ 50,000 $2,100,575 $303,100 $1,797,475 14¢ Tevanian 95,416 $4,478,968 $3,452,819 $1,026,149 77¢ Tamaddon 25,000 $1,173,537 $904,675 $268,862 77¢ 50,000 $2,100,575 $303,100 $1,797,475 14¢ Jobs 15,000,000 $640,067,766 $148,590,000 $491,477,766 14¢
As such, failure to sell these options does not defeat scienter, for no lawful executive would ever have sold these options.
182. Plaintiffs have also submitted the attached Declaration of Scott Hakala which confirms these same results using an alternative option valuation technique. Dr. Hakala comes to the same conclusion regarding Mr. Job's options namely that it would have made sense for Jobs to have exercised the 15,000,000 options he held.
183. Removing these options from available holdings produces the following results for Heinen, Tevanian and Tamaddon:
Excludable Original % Corrected % Name Options of Sales of Sales Heinen 75,000 40% 100% Tevanian 95,416 34.06% 43.47% Tamaddon 75,000 47.17% 95.37%
In addition, removing such options makes clear that Jobs had only 60,000 options rationally available for exercise.
C. Statistical Analysis Provides Additional Evidence of Scienter
184. Plaintiffs hereby incorporate the contents of the Declaration of Scott D. Hakala ("Hakala Decl."), an expert in security market econometrics, attached as Exhibit B.
185. It has been shown through scientific method that the Apple officers' sales were based on the possession and use of inside information. According to Dr. Hakala, the stock sales are statistically associated with the bad news ("subsequent adverse disclosures") revealed to investors. Dr. Hakala is an expert in the field of financial economics. According to Dr. Hakala, there is less than 1 chance in 100 that Apple officers traded in the manner they did independent of the possession and use of material, adverse non-public information. Hakala Decl., ¶¶5, 17. In other words, Dr. Hakala's study concluded that the probability that the Apple officers traded on inside information is greater than 99%. This level of certainty far exceeds the scientific acceptance standard (95%), plaintiffs' civil standard of http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 66 of 70
proof, and plaintiffs' pleading burden. These results are summarized in the following chart:
Meets Standard for Confidence Level Inferring Association Associated with Threshold for of Insider Sales Test of Statistical With Subsequent Name Independence Significance Adverse Disclosure Tamaddon >.99 .95 Yes Rubinstein >.99 .95 Yes Tevanian >.99 .95 Yes Heinen >.99 .95 Yes As a Group >.99 .95 Yes
As such, plaintiffs have met their pleading burden for scienter because plaintiffs have proven with 99% certitude that defendants traded on inside information, a level that far exceeds their pleading and proof standards.
IX. CLASS ACTION ALLEGATIONS
186. Plaintiffs bring this action as a class action pursuant to Rule 23(a) and (b)(3), on behalf of a class consisting of all persons who purchased Apple stock during the Class Period and who were damaged thereby (the "Class").
187. The members of the Class are so numerous that joinder of all members is impracticable. There were over 324 million shares of Apple common stock issued and outstanding. There are hundreds of thousands of members in the proposed Class. Record owners and other members of the Class may be identified from records maintained by Apple or its transfer agent and may be notified of the pendency of this action by mail, using a form of notice similar to that customarily used in securities class actions.
188. Plaintiffs' claims are typical of the claims of the members of the Class as all members of the Class are similarly affected by defendants' wrongful conduct in violation of federal law that is complained of herein.
189. Plaintiffs will fairly and adequately protect the interests of the members of the Class and has retained counsel competent and experienced in class and securities litigation.
190. Common questions of law and fact exist as to all members of the Class and predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are:
(a) Whether the federal securities laws were violated by defendants' acts as alleged herein;
(b) Whether statements made by defendants to the investing public during the Class Period misrepresented material facts about the business, operations, and financial statements of Apple; and
(c) To what extent the members of the Class have sustained damages and the proper http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 67 of 70
measure of damages.
191. A class action is superior to all other available methods for the fair and efficient adjudication of this controversy since joinder of all members is impracticable. The damages suffered by individual Class members may be relatively small, thus the expense and burden of individual litigation make it impossible for members of the Class to individually redress the wrongs done to them. There will be no difficulty in the management of this action as a class action.
X. NO SAFE HARBOR
192. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to any of the allegedly false statements pleaded in this complaint. The specific statements pleaded herein were not specifically identified as "forward-looking statements" when made. To the extent there were any forward-looking statements, there were no meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe harbor does apply to any forward-looking statements pleaded herein, Apple is liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker knew that the particular forward-looking statement was false, and/or the forward-looking statement was authorized and/or approved by a Senior Officer of Apple who knew that those statements were false when made.
XI. CLAIM FOR RELIEF
FIRST CLAIM FOR RELIEF
For Violation of Section 10(b) of the 1934 Act and Rule 10b-5 Against Apple Computer, Inc.
193. Plaintiffs incorporate ¶¶ 1-192 by reference.
194. During the Class Period, defendant Apple through its Senior Officers disseminated or approved the false statements specified above, which they knew or recklessly disregarded were misleading in that they contained misrepresentations and failed to disclose material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
195. Defendant Apple violated §10(b) of the 1934 Act and Rule 10b-5 by:
(a) Employing devices, schemes and artifices to defraud;
(b) Making untrue statements of material facts or omitting 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) Engaging 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 Apple publicly traded securities during the Class Period.
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196. Plaintiffs and the Class have suffered damages by paying artificially inflated prices for Apple publicly traded securities in reliance on the integrity of the market. Plaintiffs and the Class would not have purchased Apple publicly traded securities 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.
197. As a direct and proximate result of defendants' wrongful conduct, plaintiffs and the other members of the Class suffered damages in connection with their purchases of Apple publicly traded securities during the Class Period.
198. In ignorance of the fact that the market price of Apple common stock was artificially inflated, and relying directly or indirectly on the false and misleading statements made by defendant, or upon the integrity of the market, plaintiffs and the other members of the Class acquired Apple stock during the Class Period at artificially high prices and were damaged thereby.
199. As a direct and proximate result of defendant's wrongful conduct, plaintiffs and the other members of the Class suffered damages in connection with their respective purchases of Apple stock during the Class Period.
SECOND CLAIM FOR RELIEF
For Violation of Section 20(a) of the 1934 Act Against Steven Jobs
200. Plaintiffs incorporate ¶¶1-199 by reference.
201. Defendant Jobs acted as a controlling person of Apple within the meaning of §20(a) of the 1934 Act. By reason of Jobs position as Chief Executive Officer of Apple, Jobs controlled and directed all of Apple's officers and employees and had the power and authority to cause Apple to engage in the wrongful conduct complained of herein. By virtue of Jobs' high-level position, substantial stock holdings, participation in and/or awareness of Apple's operations and/or intimate knowledge of its internal financial condition, business practices, products and the actual progress of development and marketing efforts, these defendants had the power to influence and control and did influence and control, directly or indirectly, Apple's decision making, including the content and dissemination of the various statements which plaintiffs contend are false and misleading.
XII. PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for relief and judgment as follows:
A. Determining that this action is a proper class action pursuant to Rule 23;
B. Awarding damages in favor of plaintiffs and the other Class members in an amount to be proven at trial, including interest thereon;
C. Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity and the federal statutory provisions sued hereunder, pursuant to Rules 64, 65 and any other appropriate state law remedies; http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 69 of 70
D. Awarding plaintiffs and the Class their reasonable costs and expenses incurred in this action, including counsel fees and expert fees; and
E. Such other and further relief as the Court may deem just and proper.
XIII. JURY DEMAND
Plaintiffs hereby demand a trial by jury.
DATED: April 10, 2002 MILBERG WEISS BERSHAD HYNES & LERACH LLP PATRICK J. COUGHLIN RANDI D. BANDMAN SYLVIA WAHBA ELI R. GREENSTEIN
______PATRICK J. COUGHLIN
100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax)
MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH THOMAS E. EGLER 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)
Lead Counsel for Plaintiffs
EXHIBITS A THROUGH C NOT AVAILABLE
DECLARATION OF SERVICE BY FACSIMILE PURSUANT TO NORTHERN DISTRICT LOCAL RULE 23-2(c)(2)
I, the undersigned, declare:
1. That declarant is and was, at all times herein mentioned, a citizen of the United States and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interest in the within action; that declarant's business address is 100 Pine Street, 26th Floor, San Francisco, California 94111. http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../1 8/7/02 Page 70 of 70
2. That on April 10, 2002, declarant served by facsimile the CONSOLIDATED COMPLAINT FOR VIOLATION OF THE SECURITIES EXCHANGE ACT OF 1934 to the parties listed on the attached Service List and this document was forwarded to the following designated Internet site at:
http://securities.milberg.com
3. That there is a regular communication by facsimile between the place of origin and the places so addressed.
I declare under penalty of perjury that the foregoing is true and correct. Executed this 10th day of April, 2002, at San Francisco, California.
______SUSAN MILLER
1. Each of the Confidential Witnesses referred to in this Complaint ("CW ___") was an employee of either Apple or one of Apple's customers or business partners during the Class Period. Confidential Witnesses have been identified with as much particularity as possible without disclosing their identities. Plaintiffs are informed and believe that disclosing the witnesses' identities publicly, and/or to Apple could result in serious injury to the witnesses' careers.
2. The Wall Street Journal article states that "[i]n July 2000, the company transitioned from using a contracted sales force to working with a bigger in-house sales team." As demonstrated by the evidence pled below, this "transition" took place prior to that time.
3. See generally F. Black and M. Scholes, The Pricing of Options and Corporate Liabilities, J. Pol. Econ. (May/June 1973); S. Natenberg, Options Volatility & Pricing: Advanced Trading Strategies and Techniques (1994); V. Bhensali, Pricing and Managing Exotic and Hybrid Options (1998).
4. The source of information for all of the calculations in this section are Apple's Proxy Statements, the officers' Forms 3, 4, 5 and 144 filed with the SEC, publicly available risk-free interest rate data, publicly available volatility calculations for Apple stock, and publicly available Apple price data. •
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