In Re: Sara Lee Corporation Securities Litigation 03-CV-3202
, n IN THE UNITED STATES DISTRIC - OUR1 FOR THE NORTHERN DISTRICT OF I". OI '.
IN RE SARA LEE CORPORATION ) MASTER FILE NO.' 0`3 CV 3202 SECURITIES LITIGATION ) JURY TRIAL DEMANDED FILED NOTICE OF FLING 64 U %;a ~ JAN 2 0 200 4 JAN 2 6 2004 TO: SEE ATTACHED SERVICE LIST JUDGE CHARLES R. NORGL.E U.S. district court Judge
PLEASE TAKE NOTICE that on January 20, 2004 we filed Lead Plaintiffs', Boca Raton
General Employees Retirement Fund and the Central Laborers' Pension Fund, Consolidated
Amended Class Action Complaint with the Clerk of the United States District Court for the Northern
District of Illinois, Eastern Division. A copy of this document accompanies this Notice .
Dated: January 20, 2004 Respectfully submitted,
V MUCH SHELIST FREED DENENBERG AMENT& RUBENSTEIN, P.C. . Carol V. Gilden Louis A. Kessler 191 North Wacker Dr., Suite 1800 Chicago, Illinois 60606 312-521-2000 Telephone 312-521-2100 Facsimil e
Member of Plaintiffs' Counsel' s Executive Committee MAGER WHITE & GOLDSTEIN, LLP Jayne Arnold Goldstein Abraham Rappaport 2825 University Drive Suite 350 Coral Springs, Florida 33065 954-341-0844 Telephone 954-341-0855 Facsimil e
Chair of Plaintiffs' Counsel's Executive Committee
MILBERG WEISS BERSHAD HYNES & LERACH,LLP Lee Weiss Jeffery Spinazzol a One Pennsylvania Plaza New York, New York 10119-0165 Telephone : (212) 594-5300 Facsimile: (212) 868-1229
Member of Plaintiffs' Counsel's Executive Committee CERTIFICATE OF SERVIC E
I, Louis A. Kessler, hereby certify that on January 20, 2004, I caused true and correc t copies of the Lead Plaintiffs', Boca Raton General Employees Retirement Fund and the Central
Laborers' Pension Fund, Consolidated Amended Class Action Complaint to be served on th e parties listed on the attached service list in the manner indicated.
Louis A. Kessler SERVICE LIST
VIA HAND DELIVERY
Howard S. Suskin JENNER & BLOCK One IBM Plaza Chicago, IL 6061 1 Counsel for Defendant Sara Lee
VIA FEDERAL EXPRESS
Jayne Arnold Goldstein Abraham Rappaport MAGER WHITE & GOLDSTEIN, LLP 2825 University Drive Suite 350 Coral Springs, Florida 33065
Lee A. Weiss MILBERG WEISS BERSHAD HYNES & LERACH, LLP One Pennsylvania Plaza New York, NY 10119-0165 Counsel for Plaintiff Sitorsky
VIA FIRST CLASS MAIL
Marvin A. Miller Jennifer Winter Sprengel Christopher B . Sanchez MILLER FAUCHER & CAFFERTY, LLP 30 North LaSalle Street, Suite 3200 Chicago, IL 60602 Counsel for Plaintiffs Sitorsky and Gallo
Patrick V. Dahlstrom Leigh R. Randleman POMERANTZ HAUDEK BLOCK GROSSMAN & GROSS, LLP One North LaSalle Street, Suite 2225 Chicago, IL 60602 Counsel for Plaintiff Anderson
Kenneth A . Wexler Elizabeth Fegan Hartweg THE WEXLER FIRM One North LaSalle Street, Suite 2000 Chicago, IL 60602 Counsel for Plaintiff Katz Peter D. Bull Josh Lifshitz BULL & LIFSHITZ, LLP 18 East 41st Street New York, NY 10017 Counsel for Plaintiff Sitorsky
Mel E. Lifshitz Gregory M. Egleston BERNSEIN LIEBHARD & LIFSHITZ, LLP 10 East 40th Street 22nd Floor New York, NY 10016 Counsel for Plaintiff Pankratz
Samuel H. Rudman Russell J. Gunyan CAUELY GELLER BOWMAN COATES & RUDMAN, LLP 200 Broadhollow Road , Suite 406 Melville, NY 11747 Counsel for Plaintiff Gallo
Marc A. Topaz SCHIFFRIN & BARROWAY, LLP 3 Bala Plaza East, Suite 40 0 Bala Cynwyd, PA 19004 Counsel for Plaintiff Gallo
Guri Aderni Shpetim Adem i ADEMI & O'REILLY, LLP 3620 East Layton Avenue Cudahy, WI 53110 Counsel for Plaintiff Gallo
Lionel Z. Glancy Michael Goldberg GLANCY & BINKOW, LLP 1801 Avenue of the Stars , Suite 311 Los Angeles, CA 90067 Counsel for Plaintiff Anderson
Robert 1. Harwood Jeffrey M. Norton WECHSLER HARWOOD, LLP 488 Madison Avenue, 8a' Floor New York, NY 10022 Counsel for Plaintiff Levi e
Charles J. Piven LAW OFFICE OF CHARLES J . PIVEN, P.A. 401 East Pratt Street, Suite 252 5 Baltimore, MD 21202 Counsel for Plaintiff Levi e
Mark Gardy ABBEY GARDY, LLP 212 East 39th Street New York, NY 10016 Counsel for Plaintiff Kat z
Nadeem Faruqi FARUQI & FARUQI, LLP 320 East 39th Street New York, NY 10016 Counsel for Plaintiff Katz PILE IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS 'a" 2 0 2004 EASTERN DIVISION `BUDGE C1-~gR. LES U.S Districtrt~ ORCLE udge IN RE SARA LEE CORPORATION } Master File No . 03 CV 3202 SECURITIES LITIGATION Hon . Charles R. Norgle EE } JURY TRIAL DEMANDED TEO JAN 2 6 2004 CONSOLIDATED AMENDED CLASS ACTION COMPLAINT FO R VIOLATIONS OF FEDERAL SECURITIES LAWS
Lead Plaintiffs, the Boca Raton General Employees Retirement Fund and the Central
Laborers' Pension Fund (collectively, "Plaintiffs"), by their undersigned attorneys, on behalf of
themselves and on behalf of all other persons similarly situated allege, upon personal knowledge
as to themselves and their own acts, and upon information and belief as to all other matters,
based upon, inter alia, the investigation conducted by and through their attorneys, which
investigation included an extensive review of press releases and other public statements made by
defendant Sara Lee Corporation ("Sara Lee" or the "Company") and its officers and agents;
filings by Sara Lee with the United .States Securities and Exchange Commission ("SEC");
reports by securities analysts about Sara Lee ; publicly available articles and information abou t
Sara Lee and its management in the financial and general press and on the internet; extensive review and analysis of Sara Lee's public financial statements in consultations with forer~sR accountants ; C~l and interviews of former Sara Lee employees with knowledge of the C!*~pany's
Ractivities during the Class Period (as defined below ). Plaintiffs believe that addi t. al fact Sd ~ . evidence available only from internal Sara Lee documents and the testimony o Irv
-officers, employees and agents will further support the claims alleged herein. 4> }
NATURE OF THE ACTION
1 . This is a federal securities fraud class action brought on behalf of purchasers o f
Sara Lee common stock (the "Class") between August 1, 2002 and April 24, 2003, inclusive (the
"Class Period"), arising from defendants' violations of the antifraud provisions of the Securitie s
Exchange Act of 1934 (the "Exchange Act"), and SEC Rules and Regulations promulgate d thereunder.
2. During the Class Period, Sara Lee and its top managers , defendants C. Steven
McMillan (Chairman of the Board of Directors, President and Chief Executive Officer) and
Lambertus M. de Kool (Executive Vice President and Chief Financial Officer)' engaged in a fraudulent scheme to mislead the investing public into believing that the Company's
"Reshaping" program was being successfully implemented and had improved, and was continuing to improve, Sara Lee's overall business and financial condition . The Reshaping program was an ambitious business strategy designed to streamline Sara Lee's organization an d focus the Company on its most profitable businesses . Defendant McMillan was principally responsible for conceiving and implementing the Reshaping program prior to his elevation to
CEO in 2000. During the Class Period, defendants McMillan and de Kool had ultimate responsibility for and actively managed the Reshaping program.
3. The Reshaping program, however, was plagued with grave problems that were well known not only to Sara Lee's top management, but to Company employees at all levels .
These problems included attempts to integrate businesses that could not be combined efficiently, failure to integrate other acquisitions, poor planning in attempts to streamline divisions, an d hasty, overpriced acquisitions completed without the requisite due diligence necessary t o
I Defendants Sara Lee, McMillan and de Kool are referred to collectively as "Defendants," while defendants McMillan and de Kool are referred to collectively as the "Individual Defendants."
2 properly evaluate the acquired companies and their ability to-achieve and/or further the state d goals of the Reshaping program . These undisclosed problems had a material negative financia l impact on Sara Lee's business throughout the Class Period and extended into, among other areas , the Company's manufacturing operations, delivery systems, accounting controls, billing systems, cost controls, marketing and sales operations .
4. A major component of the Reshaping program involved selling off or closin g certain operations and businesses and acquiring others . The largest of these transactions was the acquisition of The Earthgrains Company ("Earthgrains") - then the second largest bakery company in the United States - in July 2001, which proved to be a recklessly conceived and implemented project spearheaded by defendant McMillan . The Earthgrains acquisition, which
Investors Business Journal Daily described the same day it was announced as being part of
McMillan's efforts "to boost sales of a handful of more profitable food, underwear and househol d goods to revive Sara Lee's stock, which has fallen 40 percent from a high of $31 .81 in April
1998," was completed hastily and with virtually no meaningful due diligence, resulting in th e
Company recklessly investing over $2. 8 billion in an enterprise that Defendants claimed would
"yield significant competitive advantages, high returns and superior growth ." In fact, by the time the Class Period had begun, Sara Lee's poor management of the Earthgrains brand ha d eliminated such competitive advantages. Moreover, Sara Lee's lack of due diligence caused the
Company to fail to account for conspicuous costs in operating Earthgrains that precluded hig h returns or superior growth .
5. By failing to conduct meaningful due diligence, the Company grossly overpaid t o acquire Earthgrains . By the time the Class Period began, the continuing costs of the Defendants ' reckless stewardship of the Earthgrains acquisition and business were apparent to any Compan y
3 insider. Further, in acquiring Earthgrains, the Company also acquired a major environmenta l
liability, the costs and consequences of which Defendants failed to adequately disclose to th e
investing public .
6. The fraudulent scheme and course of deceptive conduct alleged in this Complaint
was intended to, and did throughout the Class Period, cover up the failure of the Reshapin g program, including the Earthgrains acquisition, and the true business and financial condition o f
Sara Lee. Defendants' unlawful deceptions included the public dissemination of misleadin g statements of material fact about Sara Lee' s business in the Company's SEC filings, in presentations to market analysts and in statements made to the financial press . The scheme also involved a laundry list of deceptive and improper accounting devices and business practices that were intended to, and did, cause Sara Lee's public financial statements to present an inaccurat e account of the Company's actual financial and business condition, a violation of the mos t fundamental provisions of Generally Accepted Accounting Principles ("GAAP"). In fact, as
Plaintiffs uncovered through their investigation, the use of fraudulent and deceptive devices t o manipulate and conceal the truth about the Company's operations and results was pervasiv e throughout Sara Lee's various business segments during the Class Period . These deceptive practices also allowed Defendants to repeatedly and knowingly disseminate earnings forecasts, with no reasonable basis in fact, to securities analysts and the investing public, which had th e intended effect of artificially inflating the Company's stock price .
7. Throughout the Class Period, Defendants' fraud artificially inflated the price o f
Sara Lee common stock to as high as $23 .84 per share on November 26, 2002. On April 24,
2003, after Sara Lee could no longer hide the Reshaping program's failure from the public, the
Company issued a press release over Business Wire announcing that earnings per share would be
4 in the range of $1 .50 to $1 .52, well below the consensus estimate of $1 .59 per share, a figure which was based on the Company's own projection disseminated to the public .
8. Securities analysts immediately recognized that the previously undisclosed failur e of the Reshaping program and Earthgrains acquisition were the catalysts for the Company' s troubles. For example, on that day, a Morgan Stanley analyst noted that "ft]here is little evidence that restructuring or reinvestment efforts are benefiting overall performance," and that
"[b]akery results were extremely weak," attributing part of the problem to the "ill-timed" an d
"costly acquisition" of Earthgrains . The following day, a Bear Steams analyst indicated that Sara
Lee's announcement caused him to be "worried about the overall health of certain Sara Lee's businesses, especially bakery . "
9. By Monday, April 28, 2003, the second trading day after Sara Lee's April 24 ,
2003 disclosures of financial problems at the Company, the market had fully absorbed the impor t of the disclosure driving Sara Lee common stock to trade as low as $16.25 per share. This represents a loss of nearly $6 billion of market capitalization and shareholder value from th e artificially inflated highs for the Company's stock price during the Class Period .
JURISDICTION AND VENU E
10. The claims asserted herein arise under Sections 10(b) and 20(a) of the Exchang e
Act, 15 U.S.C. §§ 78j(b) and 78t(a), and SEC Rule lob-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
11 . This Court has jurisdiction over the subject matter of this action pursuant to 28
U.S.C. §§ 1331 and 1337, and Section 27 of the Exchange Act, 15 U.S.C. § 78aa.
12. Venue is proper in this District pursuant to Section 27 of the Exchange Act and 28
U.S.C. § 1391(b). Many of the acts charged herein , including the preparation and dissemination
5 of materially false and misleading information to the investing public, occurred in substantial
part in this District, and Sara Lee maintains its principal executive offices in this District .
13. In connection with the acts and conduct alleged in this Complaint, Defendants ,
directly or indirectly, used the means and instrumentalities of interstate commerce, including, bu t
not limited to, the U.S . mails, interstate telephone communications, and the facilities of the national securities exchanges .
PARTIES
14. Plaintiff Boca Raton General Employees Retirement Fund purchased the common
stock of Sara Lee at artificially inflated prices during the Class Period as set forth in the certification filed with the Court previously and has been damaged thereby .
15. Plaintiff Central Laborers' Pension Fund purchased the common stock of Sara
Lee at artificially inflated prices during the Class Period as set forth in the certification filed with the Court previously and has been damaged thereby .
16. Defendant Sara Lee is a Maryland corporation with its principal executive office s in Chicago, Illinois. Sara Lee describes itself as "one of the world's leading branded consumer packaged goods companies, selling its products in nearly 200 countries ." As a result of the
Reshaping program, the Company currently has three global lines of business, Food and
Beverage, Intimates and Underwear, and Household Products, through which it manufacture s
and markets products.
17. Defendant McMillan, the Company's Chairman, President and Chief Executiv e
Officer during the Class Period, began his career at Sara Lee in 1976, and for the next ten years
was a top executive in a number of Sara Lee divisions and groups . In 1986 he was appointed
Senior Vice President of Strategy Development, and in 1990, he assumed responsibility for Sar a
6 OAS
Lee's Packaged Meats, Bakery and Foodservice businesses . In 1993, McMillan was also give n responsibility for Sara Lee's Netherlands based Coffee and Grocery, and Household and Bod y
Care businesses. In that same year, McMillan was named an Executive Vice President and a
Director of the Company . In March, 1997, he was named President, and, in December, 1997, he was appointed Chief Operating Officer. In July, 2000, as part of the Reshaping program,
McMillan was appointed Sara Lee's Chief Executive Officer, and on August 30, 2001, on th e heels of his orchestration of the Company's acquisition of Earthgrains, McMillan was elected
Chairman of the Board of Directors, effective October 5, 2001 . McMillan rose to the pinnacle of
Sara Lee based largely on his initiation and leadership of the Reshaping program, including his central role in the Earthgrains acquisition and his promise that his new management and busines s strategies would revitalize the Company's stagnant financial performance .
18. Defendant de Kool, Sara Lee's Chief Financial Officer during the Class Period, began his career with Sara Lee in 1990 as Vice president of Finance for the Household an d
Personal Care diVision of Sara Lee/DE. In 1993, de Kool left Sara Lee/DE to serve as CEO of the Blokker retail chain. He returned to the Company in 1995, again at Sara Lee/DE, as tha t division's CFO and a member of its board of management. In 1996, de Kool was named a Vic e
President of Sara Lee, and was promoted to Senior Vice President in 2001 . In January 2002, de
Kool became the Company's Chief Financial Officer and an Executive Vice President, positions he held throughout the Class Period .
19. Because of their positions and long history at Sara Lee, both of the Individua l
Defendants had access to non-public information about its business, finances, products, markets, and present and future business prospects via access to internal corporate documents , conversations and communications with other corporate officers and employees, attendance a t
7 management and Board of Directors meetings and committees thereof, and via reports and other information provided to them in connection therewith . Because of their possession of such information, the Individual Defendants knew or recklessly disregarded that the adverse material facts about Sara Lee's business, financial condition and business prospects specified herein had not been disclosed to, and were being concealed from, the investing public .
20. The Individual Defendants are liable as direct participants in the wrong s complained of herein . In addition, the Individual Defendants, by reason of their status as the
Company's top executive officers and, for McMillan, as Chairman of the Board of Directors, were "control persons" within the meaning of Section 20 of the Exchange Act, with the power and influence to cause the Company to engage in the unlawful conduct alleged herein. During the Class Period, the Individual Defendants, as Sara Lee's most senior executive officers and as
Board members, were privy to confidential and proprietary information concerning Sara Lee, its operations, finances, financial condition, and present and future business prospects, particularized herein, and acted to misrepresent, misstate or conceal such information from
Plaintiffs and the investing public .
21. By virtue of their positions with the Company, the Individual Defendants als o controlled, and/or possessed the authority to control, the contents of Sara Lee's reports, press releases and presentations to securities analysts . The Individual Defendants were provided with copies of the Company's reports and press releases alleged herein to be misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or cause them to be corrected . Thus, the Individual Defendants had the opportunity to commit the fraudulent acts alleged herein.
8 22. As the Company's most senior executive officers, and, for McMillan, as
Chairman of the Board of Directors, and as controlling persons of a publicly-traded compan y whose common stock was, and is, registered with the SEC pursuant to the Exchange Act, an d was, and is, traded on the NYSE and governed by the federal securities laws, the Individual
Defendants had a duty to disseminate promptly accurate and truthful information about Sara
Lee's financial condition and performance, growth, operations, financial statements , business, products, markets, management, earnings, and present and future business prospects, and t o correct any previously issued statements that had become materially misleading or untrue, so that the market price of Sara Lee's common stock would be based upon truthful and accurate information. The Individual Defendants' misrepresentations and omissions during the Clas s
Period violated these specific requirements and obligations .
23 . The Individual Defendants are each liable as participants in a fraudulent scheme and course of conduct that operated as a fraud and deceit on purchasers of Sara Lee's common stock by disseminating materially false and misleading statements and/or concealing material adverse facts. The scheme : (i) deceived the investing public about the condition of Sara Lee' s business, operations, finances and management and thus the intrinsic value of Sara Lee common stock; (ii) enabled the Individual Defendants, particularly defendant McMillan, to collec t enormous bonuses and other remuneration based on the Company's executive compensation plan; (iii) was used by the Individual Defendants to buy time, as they were desperately hopin g that Sara Lee's business would dramatically improve, by serendipity or otherwise, before th e investing public learned the truth about the dismal failure of the Reshaping program and th e
Company's deteriorating business and financial condition which they feared would result in th e loss of their status and positions at Sara Lee, and their reputations in the corporate busines s
9 world as elite and accomplished corporate executives and managers -- a status each had worke d
so long to attain; (iv) enabled Sara Lee to complete a debt offering raising more than $70 0
million during the Class Period; and (v) caused Plaintiffs and the other members of the Class t o
purchase Sara Lee' s common stock at artificially inflated prices .
Background Facts
24. With great fanfare, on May 30, 2000, a Sara Lee press release announced "a new
vision for Sara Lee." to be realized by its initiation of a "Reshaping program." The Reshaping
program was presented as a means to improve Sara Lee's global business by concentrating its
resources in three business segments: Food and Beverage, Intimate and Underwear, an d
Household. The Company further announced that defendant McMillan, then the Company's
Chief Operating Officer, would assume the role of Chief Executive Officer in July 2000, and
lead the ambitious Reshaping program. Defendant McMillan explained the goals of the
Reshaping program as follows:
This reshaping will increase Sara Lee's opportunities to leverage our global presence, marketing expertise, manufacturing scale and proprietary production processes to yield significant competitive advantages, high returns and superior growth.
25. The Reshaping program was going to include the spin off of Coach, a leading
leather goods business, followed by the sale of a number of the Company's businesses . The
sales would include PYA/Monarch, then the country' s fourth-largest full service food service
distributor, and Champion, a manufacturer of high-quality athletic apparel. These businesses s were chosen for divestiture because they purportedly did "not fit with Sara Lee's renewed focus
on branded consumer packaged goods segments in which the company can enjoy leadin g
category positions around the world." At the same time, Sara Lee announced that it planned t o
10 make acquisitions to strengthen the Company's global position in its Food and Beverage an d
Intimates and Underwear segments, including Uniao Coffee, the largest coffee company i n
Brazil, and Sol y Oro, the largest branded intimate apparel and men's underwear company i n
Argentina, and a minority interest in Johnsonville Sausage Company, the leading manufacture r of premium fresh sausage products in the United States .
26. A December 4, 2000 Sara Lee press release announced the completion of the sale of PYA/Monarch to US Foodservice, a wholly owned subsidiary of Royal Ahold, the $50 billio n
Dutch supermarket giant . The sale was for $1 .57 billion in cash and also led to the formation o f a multi-year supply contract between Sara Lee's U .S. Food and Beverage division and Royal
Ahold.
27. A January 24, 2001 Sara Lee press release announced the Company' s intention to divest an additional eight companies as part of the Reshaping program . The release stated that since the announcement of the Reshaping program in May 2000, the Company divested 1 4 companies, representing more than $4 .5 billion in revenue. In the release, defendant McMillan said:
Disposing of these non-core companies allows us to supply our financial and management resources toward the future growth of a smaller number of more focused business positions .
28. On April 11, 2001, in connection with the completion of Sara Lee ' s divestiture of its investment of Coach, McMillan boasted:
Less than a year ago, Sara Lee announced a significant reshaping of its business portfolio to strengthen its leadership position as a global branded consumer packaged goods company. With the completion of the Coach disposition, Sara Lee achieves an important milestone in its Reshaping program.
11 29. A former manager of an Earthgrains plant, and later Sara Lee, reported senior
Sara Lee management responded to an inquiry about why they were selling Coach - one of thei r fastest growing and most profitable divisions - by saying only that "Coach didn't fit thei r profile." When asked what Sara Lee planned to do with the proceeds of the sales, managemen t admitted they "didn't know yet."
Sara Lee Acquires Earthgrains Without Conducting Any Meaningful Due Diligenc e
30. A July 2, 2001 Sara Lee press release announced that as part of the Reshaping program it intended to purchase Earthgrains for $2 .8 billion ($1 .7 billion in cash and the assumption of $1 .1 billion in debt), its largest acquisition to date . The acquisition was structured to include a Sara Lee tender offer to buy all of Earthgrains' shares for $40 .25 per share in cash, representing a $14.25 per share, or close to 50%, premium over the market price of Earthgrain s shares immediately before the announcement of the deal . Acquiring Earthgrains instantly mad e
Sara Lee the nation's second-largest fresh bread company . Defendant McMillan stressed the importance of the Earthgrains acquisition to the Reshaping program :
As a leading player in the fresh bread and refrigerated dough categories, Earthgrains is a highly strategic acquisition for our company. Earthgrains is a key element in the investment phase of Sara Lee's Reshaping program as it creates a strong growth platform for one of our core businesses. ..[Emphasis added.]
Defendant McMillan also claimed that the acquisition would also result in significant cos t savings through supposed operational synergies :
Consolidation within the U.S . baking industry is accelerating, and this acquisition will transform the size and scale of Sara Lee's current bakery operations. The new business will be more competitive and certainly more profitable than our separate, existing operations . Adding Earthgrains will allow us to improve our supply chain management in several key areas including purchasing, plant utilization and distribution, and we anticipate achieving cost synergies of more than $45 million annually by fiscal year 2003.
12 * * *
In the first year, Sara Lee anticipates the acquisition to add approximately $.04 to cash earnings per share (EPS), and to dilute accounting EPS by approximately $ .03 . These forecasts reflect the new accounting rules relating to goodwill amortization that Sara Lee anticipates will become effective for its full fiscal 2002 year . After the first twelve months, the acquisition is expected to add to both cash and accounting EPS . Separately, the new accounting rules will add approximately $ .08 to Sara Lee EPS in fiscal 2002, bringing our current forecasted range to $1 .30 to $1 .40, including the impact of the Earthgrains acquisition .
31 . In an August 14, 2001 press release, the Company announced the completion of
the Earthgrains acquisition and that the combined bakery operations of Sara Lee and Earthgrains ,
which would be called the "Sara Lee Bakery Group," was expected to generate approximatel y
$3.4 billion in annual sales.
32. Defendant McMillan had been determined to make a big splash with a major acquisition of a bakery business. A former Earthgrains Vice President of Manufacturing Support who then worked for Sara Lee reported that McMillan had attempted to buy several other baking companies before turning to Earthgrains . This former executive said that Sara Lee had attempted to buy Best Foods, which owns, among other brands, Entenmann's . However, Sara Lee was outbid for Best Foods by George Weston Bakery, Inc . Only after being outbid for Best Foods did McMillan focus attention on Earthgrains. Defendants McMillan met directly with Barry
Beracha, the CEO of Earthgrains, and the acquisition was finalized within four months .
33 . According to a number of former employees, as more fully described below, the
Earthgrains acquisition , despite being the largest transaction by far that Sara Lee ' had ever undertaken, was hastily conceived, negotiated and completed . The idea was hatched in April or
May of 2001, an agreement was signed by the end of June and the transaction closed in August.
Only defendant McMillan and a small group of his top executives were privy to the Company' s
13 negotiations with Earthgrains and the determination of Earthgrains' supposed value to Sara Lee, which was purportedly based on McMillan's projections and plans for integrating Sara Lee's existing bakery operations with Earthgrains' operations, which included integrating the respective businesses' plants, distribution channels, operating systems and accounting controls .
34. On August 30, 2001, apparently in recognition of his work on the Reshaping program, and particularly the Earthgrains acquisition, Defendant McMillan was named Chairman of the Company's Board of Directors .
35. At the time defendant McMillan was trumpeting his multi-billion dolla r acquisition of Earthgrains and assuring the market that the deal would make Sara Lee a more efficient and profitable company, numerous people at Sara Lee's corporate headquarters were alarmed by the manner in which the acquisition was accomplished and concerned about the negative impact acquiring Earthgrains would have on Sara Lee . For example, a former Sara Lee facilities manager at corporate headquarters reported that Earthgrains "vas bought real fast and I don't know if due diligence was done through the whole process or if there was time to do due diligence at all ." This former Sara Lee manager said that when Sara Lee acquired Earthgrains,
"it was very quick . . . . What I heard was that Steve McMillan did it himself - like made the decision that we were oin to buy it and then it was bought and then the due diligence started afterwards." [Emphasis added.]
36. This former Sara Lee manager also further recalled the effect of the lack of due diligence and planning . After the Earthgrains acquisition, Sara Lee management decided to close Sara Lee's Chicago bakery division offices and research and development facility and combine them with Earthgrains' facilities . Sara Lee's Chicago offices, however, had recently signed a fifteen year lease, and paid a heavy price to exit the lease : Sara Lee "put tons of money
14 into this place and only stayed two years . . . I know we did pay a big penalty to get out of [the
lease] -- it was several million dollars, maybe $15 million."
37. A former operations finance manager of the Sara Lee bakery division confirmed
the lack of due diligence in the Earthgrains acquisition . This former bakery division financ e
manager stated, "When [Sara Lee] acquired Earthgrains, they were sold on a song and dance.
They were told Earthgrains has this incredible sales growth , incredible margins. After we
acquired them, they never hit their numbers ."
38. Likewise, employees working at Earthgrains at the time of the acquisition wer e
shocked that Sara Lee would want to acquire Earthgrains. A former Director of Field Marketing
who had worked at Earthgrains since 1994, and then Sara Lee, recounted, "We didn't know wh y
Sara Lee would want to [acquire Earthgrains] . . .It's a tough business, a low margin business ,
and our bakeries were averaging around 70 years old . Only a handful were modernized."
39. A former Senior Manufacturing Engineer stated that Sara Lee greatly overvalue d
Earthgrains' assets because of its failure to perform inspections . He "thought it was unusual that
Sara Lee would buy Earthgrains without any due diligence, none whatsoever ." This knowledgeable former Earthgrains engineer believed that Sara Lee could not reconcile the high price Sara Lee paid with the fact that, among other things, the Earthgrains' plants were very ol d and had been forced to shut down due to equipment failure on more than one occasion becaus e of neglect. He reported that the malfunctioning plants frequently remained closed for as long a s four days. These plant disruptions interrupted shipments to customers, eroding market share .
Earthgrains also had labor problems which closed twenty facilities for almost a month, resultin g in a significant loss of business.
15 40. A former manager of an Earthgrains plant who stayed on with Sara Lee after it
acquired Earthgrains, was also surprised by the announcement of Sara Lee's acquisition of
Earthgrains, because not one person from Sara Lee ever visited his plant, which was located minutes from Sara Lee's corporate headquarters in Chicago. This former manager was particularly troubled because he knew that when Earthgrains made acquisitions, it would never close a deal without field visits to see the bakeries they were buying, obviously a critical aspect of due diligence in the bakery industry . But Sara Lee, as far as he knew, did "no due diligence whatsoever."
41 . A former Director of Finance at Earthgrains, and later Sara Lee, further confirme d
Sara Lee's failure to conduct due diligence before closing its deal to buy Earthgrains . He also described Sara Lee management's lofty and unrealistic expectations from the acquisition of
Earthgrains, expectations that had no reasonable basis . "The bar was always set very high, and the resources were limited, and the competition - it's a low margin business. It is hard to cut costs when you don't have investment into better equipment." The former executive continued,
"McMillan [had] been under pressure for several years and most of the reshaping plans that he
[had] have not given the results that people were expecting ." This former highly placed
Earthgrains and Sara Lee finance executive said, "I don't think the analysis was well done, because the thinking is they overpaid . The whole thing was very very confidential - just key people involved in it - if at all, I would say between the CEO and a few of the people in the planning group."
42. After the acquisition closed, the former finance executive recalled how
"McMillan was painting rosy expectations to the investors - he kept giving expectations that things were changing [when] things were not improving ." He also described how McMillan' s
16 004
Reshaping program involved closing plants and consolidating divisions in the new "Sara Lee
Bakery Group," which lowered expenses but hurt customer service resulting in some account s being completely ignored. He said that by the time he left Sara Lee in mid-2002, near or shortl y before the beginning of the Class Period, sales were down significantly .
43. A former Vice President of Manufacturing Support at Earthgrains and later, Sar a
Lee, whose job it was to oversee sixty-five bakery facilities also corroborated Sara Lee's failure to conduct due diligence . As someone very familiar with Earthgrains' business at the time Sara
Lee acquired Earthgrains, this former employee believed that if the Company had done its du e diligence, it certainly would not have paid over forty dollars per share for Eartbgrains - more than a 50% premium over the pre-acquisition price of Earthgrains stock-- and may not have even gone through with the transaction at all .
44. The lack of due diligence was symptomatic of the recklessness with whic h defendant McMillan and de Kool implemented the Reshaping program, and led to a multitude o f problems which the Defendants chose to conceal while continuing to tout the success of th e
Reshaping program.
45. After the Earthgrains acquisition many highly experienced personnel were terminated. Another former Sara Lee employee, who had been a manager of an Earthgrains plant, reported surprise to find out after the acquisition that the Earthgrains management team ,
"one of the strongest in the food business," was being replaced by Sara Lee managers who ha d the reputation of being the weakest in the food industry . This former employee said that one of the first signs of this weakness was the appointment of Ann Zeigler as CFO of Earthgrains after the acquisition . Ms. Zeigler was an attorney prior to joining Sara Lee, where she was first a n assistant counsel, then Executive Director of corporate development, and finally Vice Presiden t
17 of the corporation . The former manager expressed dismay that Sara Lee would appoint someone who had so little financial experience as the CFO . When the former manager asked Ms . Zeigler about her vision of the future of Earthgrains, her reply, was "Well you know what, we have so many businesses and it's so complicated that we really don't get involved at that level ."
46. This sentiment was also echoed by another former Earthgrains employee who became Sara Lee's Director of Field Marketing. This former manager observed that Sara Lee removed many Earthgrains senior managers, in direct contrast to the Company's statement during the acquisition that acquiring Earthgrains' skilled managers was one of the importan t motivations for the acquisition .
47. This same former Director of Field Marketing reported that after the acquisition ,
Sara Lee attempted to implement a cost cutting plan at older Earthgrains plants . However, because of their age, the plants could not be run effectively on less money. The employee said that the cost-cutting was so severe it got so bad after the acquisition that by the third week of every month the plant manager was not allowed to spend what was needed to run the plant to it s full capacity.
48. Further, numerous problems were created when Sara Lee made uninforme d decisions to either combine or close plants . Earthgrains changed from having eight regions to three regions and then down to two. According to a former Director of Finance in the Bakery
Group, this lowered expenses, but ultimately hurt results as it had an adverse effect on customer service, lessening the company's ability to react to the needs of the individual customers.
49. A former long-term Earthgrains employee who then worked for Sara Lee in th e
Springfield, Missouri plant until June 2003, stated that the Missouri plant was closed on the recommendation of a consulting company hired by Sara Lee. The stated reason was that the
18 Oklahoma and Kansas facilities could supply the Missouri region . However, this former
employee stated that the Oklahoma and Kansas plants are not able to fill the void and meet the
supply demands of the Missouri region . The former employee also added that product qualit y
had also deteriorated due to the closing of the facility .
50. Another former Earthgrains administrator in the Missouri plant was surprised
when the Missouri plant was closed because, although it was small, it was profitable an d
provided products for many customers in the region it served .
51 . After Sara Lee's acquisition of Earthgrains, Sara Lee changed the Earthgrain s
label to Sara Lee. A former Earthgrains employee who was not employed by Earthgrains at th e
time of the acquisition, but was re-hired two months later, saw that the label change became a
drag on sales.
52. Another former Earthgrains employee who had worked for the company for twenty-three years and then worked for Sara Lee until June 2003 in the Financial Shared
Services Group also saw a noticeable drop in accounts receivables after the label change . This
former employee stated, "the product may not change but the label change did affect sales. They are going to have to do some fancy footwork in marketing to keep these products viable ."
53. A former Finance Operations Manager who worked in Sara Lee's Fresh Bakery division in California reported that since the acquisition there had been a decline in marketing.
As an example in the Texas area, he said that Sara Lee had not been marketing their bagel line , resulting in lost market share . This former Finance Operations Manager also saw a n overemphasis on pushing the Sara Lee brand name at the cost of maintaining the existin g
Earthgrains brand which was familiar to consumers .
The Reshaping Is Unsuccessful And Plagued With Operational Difficulties
19 54. The problems with the Reshaping program were not, moreover, limited to the
Earthgrains acquisition . The reckless haste of McMillan's acquisition of Earthgrains had it s
counterpart in the implementation of the Reshaping program throughout Sara Lee's othe r
divisions, creating unnecessary costs and hamstringing formerly profitable divisions through
poor management of brands.
55. A former member of the Enterprise Resource Planning group responsible for
overseeing operations planning, discussed problems with the Reshaping program prior to the
Class Period . She said upper level management "had no clue what they were doing . They just
threw money at this [Enterprise Resource Planning] project [part of the Reshaping program].
They were biting off more than they could chew at once ." She said that Sara Lee hired Andersen
Consulting, who sent at least 100 people to work on the restructuring, and it was all "a mess."
Long time customer service employees were let go in favor of recent college grads that had littl e
customer service experience, and Sara Lee lost sales and customers as a result . She also
described how the computer system tracking operations at the various divisions was in disarray ,
and that Sara Lee lost millions of dollars because of implementation problems .
56. The failure of the Reshaping program was evident throughout Sara Lee' s operations. Another former employee in Florida noted that after the restructuring , Sara Lee rented the largest building in Broward County to house its Latin America division . However, the building consistently remained at least three quarters empty and the Latin America division wa s suddenly disbanded shortly after the lease was signed .
57. A former Vice President of Sales in the Coffee division stated that "they were
slow in doing the things they needed to do to make Sara Lee a top tier organization in terms of
Reshaping, in terms of consolidation, in terms of one voice." This former V.P. noted that after
20 the Reshaping, each company in the Coffee division was still a separate entity with its own
policies and procedures . "There wasn't a lot of communication between operating companies ,
the ability to use the strength of Sara Lee corporate - selling all the brands instead of just on e
piece -- they didn't have that ." As a result, this former V .P. said, the Coffee division continued
consistently to lose market share. A former Credit Analyst in the Coffee division confirmed thi s
and reported that while the Coffee division was purportedly "Reshaping," it lost over 25% of it s
market share.
58. A former senior revenue officer at Best Kosher, one of the businesses in the Meat
division, reported that when the Reshaping program resulted in declining sales, the costs were buried within "restructuring" charges. The former senior officer also said this approach - burying costs from ill-conceived Reshaping plans in the restructuring charge - was used "in many of th e businesses in Sara Lee." A byproduct of this poor execution was the loss of key Meat divisio n personnel. The former revenue officer said the Best Kosher division was left "directionless ."
59. A former Director of Inventory in the Jimmy Dean Foods division reported tha t the Reshaping program called for the closings of various regional plants and the consolidation o f shipping and other support features with other brands in the Meat division, including Hillshir e
Farms. This former director disclosed that Sara Lee corporate's reshaping plan for the Mea t division was to close plants and consolidate shipping from central warehouses . However, this plan was ill-conceived as Jimmy Dean was a top performer and profit maker for Sara Lee, yet
Sara Lee's plan involved closing its plants and consolidating warehousing with other brands in the division. She explained that having both products in the same distribution system would not , and did not work, given that the Jimmy Dean product is "date-sensitive because it is a rolled sausage product, a pork product that is highly perishable with a close shelf-life- very short-dated
21 versus, say a Hillshire smoked sausage which is a longer dated product ." The former directo r further said that this was apparent to everyone in the Meat division, including upper management .
Internal Sara Lee Sources Confirm The Pervasive Use Of Improper Accounting And Business Practices Both Before And During The Class Period
60. The acquisition of Earthgrains and the numerous other failures that resulted fro m the ill-conceived and poorly executed Reshaping program soon proved detrimental to Sara Lee' s financial performance, contrary to the representations senior management proffered to the public .
Thus, Defendants resorted to various business and accounting artifices used to manipulate Sar a
Lee's financial statements to conceal from the public the actual state of the Company's business operations and finances. These artifices were critical to Defendants' success in misleading th e public with untrue statements about the supposedly ongoing operational and financial succes s defendant McMillan's new "Reshaping" strategies had achieved and about the Company's futur e prospects. These particular devices include the following :
a. Revenue Recognition Manipulation Through "Channel Stuffing " Inventory
61 . Prior to and during the Call Period, the Company manipulated its periodi c publicly reported financial results by overloading major customers with goods prior to the end o f a reporting period. This practice, known as "channel stuffing," had two principal effects .
62. First, by accelerating shipments prior to the end of a reporting period, Defendants inflated the results for that period, making it appear to the market and the investing public that the Company's business, as measured by the principal indicia of its sales, was robust and healthier overall than it actually was . This deception also allowed Defendants to "make their numbers," in other words, to meet the earnings per share ("EPS") targets disseminated to the
22 market by Defendants and by market analysts whose consensus EPS targets were based o n
Defendants' statements (to the public and to analysts directly) about the Company's business an d financial condition . This channel stuffing permitted Defendants to delay disclosing slowin g growth, deteriorating sales and other serious problems with business operations that existed at
Sara Lee as a result of the failure of the Reshaping program, including its ill-conceived
Earthgrains acquisition.
63. Second, the Company' s channel stuffing virtually guaranteed that sales would deteriorate in the following quarters because customer demand would naturally decrease give n their bloated on-hand inventory the Company had shipped prematurely to manipulate publicl y reported financial statements. Here, the Company's undisclosed channel stuffing during fiscal
2002 and the beginning of fiscal 2003 ultimately doomed the third and fourth quarters of fisca l
2003.
64. A former Director of Business Planning at Sara Lee's Apparel division, who left the Company in 2003, described many instances of channel stuffing in the Hosiery division.
This former Director of Business Planning said that salespeople were constantly under a lot o f pressure to generate end of quarter numbers and that forcing inventory on existing customer s was the only way to accomplish that . "What we would do is - I know when I worked in sale s myself - we would try to go cut deals with people like Target, and say hey look, we want to ge t our inventory -- ship it before the end of this month ." This former Director of Business Plannin g claimed the sales people would offer discounts and free shipping to induce extra end of th e quarter sales, and that it would have a significant negative effect on the beginning of th e following quarter. This person continued :
. . . if year end came and they needed $5 million, they'd say, took we're going to take the shipments out of the first two weeks of Jury, stick them at the end o f
23 June, so it looks like we made our year, but then we start off the beginning of the next quarter in the [toilet] because you just robbed Peter to pay Paul . They did that with anybody they could- Walmart, K-mart. Walmart- you're talking millions of dollars there that they would move from July into June to help [Sara Lee] make the financial year end. . . .1 can't imagine they've stopped the practice anytime soon. I wasn't there in June 2003, but in June the year before [2002], they were always looking to do that, in just about every business . [Emphasis added.]
65 . This former Director of Business Planning further described how customers wer e not enthusiastic initially about taking in extra inventory at the end of the quarters or the year, bu t soon learned to take advantage of the situation by extracting severe concessions from Sara Lee.
Many times, this person said, it looked as if Sara Lee would not make their year end numbers ,
"and then, to and behold, they'd make the year ." This former Director of Business Planning believed that knowledge of this activity went all the way up the line, certainly to the "A players" and likely all the way to McMillan .
66. A former high level sales executive, who worked in Sara Lee' s Intimate Apparel division in Winston-Salem, North Carolina prior to, during and after the Class Period, reporte d that fiscal 2003 (ended June 30, 2003 -- just two months after the end of the Class Period) : "was tough, especially in Intimate Apparel ." This former sales executive ran the Company' s
"Walmart business [handling Sara Lee's Hanes, Playtex, Hanes Her Way, Just My Size, Lovable and Hanes Sport products, among others] and that was 65% of their mass business, and busines s was tough, no doubt about it. We had slowed down on new product creativity and we had grown t so quickly over the 3 years prior that we just didn't have anything in the pipeline to keep growing at the rate we were growing."
67. The same former Intimate Apparel sales executive reported that Walmart - like some other major customers - had what he called a "vendor [Sara Lee] managed" inventor y arrangement for supplying intimate apparel products . Sara Lee's management, in essence,
24 controlled Walmart's inventory on a short-term basis at their discretion. He explained that this
arrangement allowed Sara Lee to "spike [shipments to Walmart's inventory] at the end of a
month to hit your month, and then you'll have to calm down your shipments for two weeks o f
the following month, and then spike them again - it's like a big hockey stick . Then in June -
May or June, you're always looking at what can you do to hit your year end projections that you
made in March, making sure you don't fall short of that ." He described it as a "constant game"
and stated that, "you'd hurt your next month's shipments - any time you spike shipments you
hurt your next month's shipments . . . .One of the beauties about why Sara Lee never wanted to
lose vendor management in Intimates is because we controlled kinda our own destiny. Walmart
was not privy to everything. We thought we could cover it by backing off the next couple of
weeks (no shipments) but if it was the end of a month or end of a quarter, you'd make sure yo u
hit that quarter or end of year ." This former knowledgeable sales executive also did not believe
that Sara Lee restricted these deceptive practices to Walmart, and probably did it with man y customers, particularly those that were "vendor managed" : "I don't think it was Walmart
specific. "
68. The same former highly placed Intimate Apparel sales executive said that, "over
the last 2 years I would tell you that the business, for me certainly being that I was a very larg e piece of the Intimate Apparel business, the business wasn't healthy and they certainly weren' t reporting that intimates wasn't healthy. They were saying the business was just in a little bit of a turnaround mode because we had grown so fast - they used the growing so fast excuse for 1 8 months." This same former employee also said that Sara Lee was losing market share from
March 2002 until he left in September 2003. "Hanes Her Way got as high at Walmart as 36 % market share, now it's probably [less than] 28% . "
25 69. He also said that these activities were well known to top management includin g the Individual Defendants. Cary McMillan, who was the "CO of the Apparel group, reported directly" to defendant McMillan, and, according to this informant, "Cary knew. Cary is very hands-on, so Cary knew everything that was going on -- he was in Winston-Salem constantly. I mean, the guy even bought a house in Winston -Salem. So he knew what was going on in the business." Cary McMillan had to know, "because he'd see the numbers at the end of the month on a sloppy quarter where you couldn 't make April or May but you'd certainly make your June.
I don't know if somebody would come out and say to him we loaded Walmart up in the month of
June, but he would certainly have to question why we would have two tough months and all of a sudden we'd hit a number at the end of the year."
70. Another executive, a Vice President of Supply Chain Planning for the Appare l
Division, who was with the Company from 1991 until the summer of 2003 and was also knowledgeable about Sara Lee's control over Walmart's Intimate Apparel inventory reported facts consistent with the facts alleged above. This former V.P. said that the Intimate Apparel
"business has been flat and growth has been minimal over the past 2 or 3 years . " It was also reported that "they [management] were pushing us to grow at 10% per year -- we were less than that, growing at maybe 5 to 7%, and then last year (2002) they may have barely squeaked out
1%, if any at all, and I think the target was 7%. So they were underperforming what their goal s were."
71 . This long time V.P. of Supply Chain Planning for Sara Lee further confirmed accounts of channel stuffing when he stated that Sara Lee "managed[d] [Walmart's] inventory, " and that in "2003 Walmart said we've got too much inventory and you [Sara Lee] need to take i t down. We had to reduce it and, I think the number was somewhere between $8 and $12 million ,
26 that they were pushing us to bring the inventory down ." There was no question that Sara Lee could do this, he explained, because they had "control over" Walmart's inventory . It was also indicated that as a general matter, channel stuffing was more likely to occur with mass merchandiser customers like Walmart, where Sara Lee had more control over inventory levels than with department stores.
b. Defendants Improperly Deferred Expenses For SelfInsurance
72. Defendants also changed the Company's accounting for insurance expenses during the Class Period which provided a vehicle to defer those expenses to future accountin g periods. As disclosed in a Form 8-K/A which was filed with the SEC on September 4, 2001 : "As of March 27, 2001, $26.6 million in letters of credit were outstanding under the [Earthgrains ] revolving credit facility, principally related to self-insurance requirements." In addition,
Earthgrains' financial statements disclosed the following :
SUPPLEMENTAL BALANCE SHEET INFORMATION (IN MILLIONS)
MARCH 27, 2001 MARCH 28, 2000
Other current $ 21 .5 $24.9 liabilities: Current portion of self-insurance reserves Other noncurren t liabilities: 30.5 32.6 Self-insurance Reserves $ 52.0 $ 57.5
Thus, Earthgrains historically provided a significant level of reserves for self-insurance claims.
27 73 . Upon acquiring Earthgrains, Sara Lee adopted Earthgrains' policy of self-insuring for the entire Company . Accordingly, a note to Sara Lee's financial statements for th e
Company's fiscal year ended June 29, 2002 (as contained in the Company's fiscal 2002 Form
10-K) contained the following disclosure :
Self-insurance Reserves - The corporation purchases third-party insurance for workers' compensation, automobile, product and general liability claims that exceed a certain level . However, the corporation is responsible for the payment of claims under these insured limits . In estimating the obligation associated with incurred losses, the corporation utilizes loss development factors prepared by consulting insurance carriers . These development factors utilize historical data to project the future development of incurred losses . Loss estimates are adjusted based upon actual claims settlements and reported claims.
74. A substantially identical disclosure was contained in a note to Sara Lee 's financial statements for the Company's fiscal year ended June 28, 2003 in the Company's fiscal 2003 SE C
Form 10-K. Although the Company' s adoption of self-insurance was disclosed during the Class
Period, Sara Lee's financial statements (unlike those of Earthgrains) concealed the magnitude of the Company's self-insurance reserves .
75. After the Class Period, the Company issued its financial statements for the quarterly period ended September 27, 2003. These financial statements, which ultimately reflected a catch-up for the prior under-accrual of company's self-insurance losses, stated : "the corporate office recognized higher expenses for insurance and litigation costs ." Although th e amount of the "higher expenses" were not disclosed, the fact of the disclosure alone indicates that the amount was material .
Defendants Artificially Inflated Reported Income By Failing To Take An Appropriate Charge To Income For The Environmental Liability Sara Lee Incurred When It Acquired Earthgrains
28 0ON
76. During the Class Period, the Company's SEC filings disclosed the fact that, in
June 2000, well prior to its acquisition by Sara Lee, Earthgrains had been investigated by the
EPA for non-compliance with the requirements of 40 C.F.R. Part 82 governing ozone-depleting substances and that the EPA had referred the results of its investigation to the United States
Department of Justice (the "DOJ ).
77. For example, according to the Company's June 29, 2002 Form 10-K :
. . .Sara Lee, the EPA and the DOJ currently are engaged in settlement discussions regarding this matter. Although it remains unclear whether a settlement will be reached, Sara Lee has offered to pay a stipulated penalty under certain conditions. The amount of any such penalty would depend upon a number of variables, and the terms and conditions of settlement, and cannot be reasonably estimated at this time . The Company's management, however, believes that, whether or not the Company agrees to settle, the ultimate liability, if any, arising from this matter will not have a material adverse effect on Sara Lee's consolidated results of operations, financial position or cash flows .
78. As later disclosed in the Company's June 28, 2003 Form 10-K, in July 2003 , certain wholly-owned subsidiaries of Sara Lee Bakery Group entered into a consent decree with the EPA and the DOJ whereby Sara Lee Bakery Group agreed to pay a penalty of $5 .25 million and to retrofit, retire or replace 264 pieces of refrigerant-using equipment by April 2006, in continuing an effort that Earthgrains began in 1994. This was the largest EPA fine ever for a bakery company.
79. A former manager of an Earthgrains plant who was employed by Sara Lee for a period of time after the acquisition stated that Sara Lee's lack of due diligence came as a shock to him because he knew of major EPA compliance issues at various Earthgrains plants around the country. He stated he was aware of the ongoing possibility that certain smokestacks fro m bakery ovens might be subject to EPA regulation, which would require the implementation o f
"scrubbers" or "thermal oxidizers" on the ovens to comply with EPA regulations on smokestac k
29 emissions. He stated that the fixed costs of installing such thermal oxidizers was "around $ 1 million per oven" and that running these thermal oxidizers cost "around $80,000 per year." Yet, while this ongoing issue was known to Earthgrains plant managers, Sara Lee made no inquiry into these possible expenses . He further stated that there were also significant costs involved i n the clean up of any plants that were shut down, yet to his knowledge, Sara Lee management made no inquiry into these potential costs before shutting down select plants .
80. Another former Earthgrains employee also confirmed the extent of certain cost s that Sara Lee failed to account for in its acquisition of Earthgrains by performing no du e diligence. This employee confirmed that it was widely known that Earthgrains was subject to ongoing "hefty" EPA fines associated with the use of Freon in "their antiquated bakin g facilities." Freon purchases , he said, are closely monitored by the EPA because if a factory is going through large quantities of Freon, "it usually raises a flag ." He said that the state of
Earthgrains' baking facilities would have been apparent to anyone who actually visited th e
Earthgrains plants, and that after the acquisition, Sara Lee implemented cost cutting that slashe d the funds for necessary capital improvements to run the plants effectively. He stated that the engineers that were hired to maintain the equipment were "extremely weak and lacked th e knowledge of refrigeration necessary to operate the plants ."
81 . As evidenced by the above, there is no question that 264 pieces of the Company's refrigerant-using equipment were significantly impaired during the Class Period and that a liability had been incurred during the Class Period .
Booking Sales Revenues Without Disclosing Unusual and Unduly High Risks of Uncollectability
30 82. Another device Defendants used to improperly inflate reported sales revenue was
filling orders for customers knowing, or recklessly disregarding, that the "sales" were unlikely to
ever generate any real revenue, or, if they did, realized revenue would be nowhere near the
amount of the reported sales. Plaintiffs uncovered two specific examples of this deception . In
one, the chief executive and finance officers of a critical Food and Beverage division intervene d
to override Sara Lee's internal credit guidelines to authorize extending six to ten times th e
amount of credit approved by a Sara Lee credit analyst to a particular customer . In the other, the
Company allowed a grocery distributor notorious in the industry for refusing to pay for good s
shipped, to amass an uncollectible $6 million debt to the Company which was only revealed at
the end of the Class Period.
83. A former Sara Lee credit analyst at the Company's Coffee and Tea section fro m
late 1999 through January of 2003 identified a situation where sales personnel went directly to
the Division's CEO and CFO, who in turn reported to the Individual Defendants, for the go-
ahead to extend materially the credit of a customer whose credit had been sharply limited b y
Sara Lee's credit analysts . The credit analyst reported as a general matter, that "[i]f the y
[management] wanted the business they didn't care what the credit analysis was . If the sales gu y
got the deal and they needed it to keep the roasters going, they were going to take it . "
84. As an example, this former Sara Lee credit analyst described "a request that came in from a customer for $300,000 based on their estimated purchasing needs,. . . and we... said no, $50,000 maybe. " The Credit Analysis department based its conclusion on internal
Company guidelines. " The [customer] was leveraged to the hilt and had all this debt and al l their revenue streams are from franchise fees . Here we are heading into a slowdown, in the economy and I said unemployment is going up -- where are they putting all these places to sell
31 this stuff, where are they putting their stores, they were putting them next to major offic e complexes who are firing people 5000 at a time." Nevertheless, the "sales people went to the
CEO who basically gave the customer an open line of credit." By the time the former credit analyst left the Company, this particular customer, Quiznos, had been extended credit that grew to a balance owing of between $300,000 and $500,000, or between six and ten times the limi t set by the Company's credit analysts as appropriate.
85. A similar situation involving a major Sara Lee grocery distributor customer,
Fleming Companies, Inc . ("Fleming"), resulted in the accumulation of a $6 million uncollectibl e receivable that was disclosed only at the end of the Class Period . Until then, however, the
Company's financial statements were reporting this material amount as legitimate sales revenue.
However, analysis of the Defendants' disclosures on April 24, 2003, the end of the Class Period, and press accounts about Fleming's notoriety in the wholesale grocery industry during the Clas s
Period for improperly re fusing to pay its bills in full , or at all demonstrates otherwise. In fact,
Defendants certainly knew about Fleming's reputation given that Fleming was one of its majo r customers, yet continued to make "sales" to Fleming and booking those sales as revenue in the
Company's public financial statements .
86. In the grocery industry, purchasers, including wholesalers and retailers , sometimes inform vendors that they are making "deductions" from invoices, usually to accoun t for some special circumstance warranting a price reduction . It is standard industry practice for wholesalers and retailers to provide vendors with written notification - referred to as "debi t memos"--- of a proposed deduction to the vendors ' invoices. Valid debit memos arise primarily as a consequence of the return of merchandise, allowance for damaged merchandise not returned , adjustments for incorrect quantities invoiced (e .g., for short shipments), adjustments for incorrec t
32 pricing (e.g., prices that differed from the prices set forth in purchase orders), and adjustment s pursuant to written contractual arrangements (e.g., co-operative advertising agreements and volume discount agreements).
87. Fleming, however, did not follow standard industry practice. Fleming did not propose deductions at all, instead Fleming unilaterally took unjustified deductions from vendo r invoices which were not authorized by the affected vendors. Fleming became notorious for this practice; its vendors refused to accept Fleming's baseless deductions, often threatening to cut off the product supply to Fleming if Fleming did not remit the amounts that Fleming had improperl y deducted.
88. On September 5, 2002, The Wall Street Journal published an expose about
Fleming's practice :
Early this year, Oil-Dri Corp . of America drew the line with its longtime grocery distributor: It refused to ship any more cat litter.
Oil-Dri complained that when the distributor, Fleming Cos., paid its bills, it arbitrarily deducted large sums for things such as product placement or early bill payment, even if it was actually paying late . "There are hundreds of thousands of dollars of erroneous deductions that need to be cleared off our account," the company wrote to Fleming .
89. The Wall Street Journal article reported that Fleming's practices were so egregious that it had become notorious among vendors :
Some suppliers temporarily stopped shipping to the distributor this year until a deduction dispute was resolved. In other cases, when they complained, Fleming threatened to halt or reduce its purchases from them . Fleming's "relationship, with vendors is ugly," say Richard Kochersperger, a food-industry consultant who has worked for Fleming and for a competitor. "They deduct and deduct until a vendor cuts them off, then they pay . Then they start deducting again."
90. Sara Lee, unlike the other vendors discussed in the Wall Street Journal article , apparently did not object to Fleming's practices and continued to make shipments to Fleming ,
33 booking them as legitimate sales revenue. Again, the Defendants were more than willing to pu t off the day of reckoning by treating the problem of their inability to collect from Fleming as a problem they could defer reporting until some future time - a time when, they hoped, th e
Company's legitimate sales revenue would have increased enough that the recognition of "losses " from Flemings payment practices would escape notice. In the meantime, however, Defendants knew or recklessly ignored that the "sales" to Fleming that Defendants were reporting to the SE C and the public, when booked, were likely not going to result in actual revenue .
91. The future arrived at the end of the Class Period on April 24, 2003, when Sar a
Lee disclosed, among other previously undisclosed adverse information, that the Company' s
"results were negatively affected by a $6 million pre-tax charge to increase reserves for amount s due from Fleming Companies Inc., a grocery products distributor that recently filed for bankruptcy. "
92. Recording "sales revenue" from sales to customers who they knew presented an undisclosed unusually high risk of uncollectability is further corroboration of the pervasivenes s of Defendants use of accounting manipulations to conceal the extent and magnitude of th e
Company's ongoing business and financial problems . The investing public was reassured by
Sara Lee making its projected numbers, ignorant of the truth that those reported number s included "sales revenue" that, as Defendants knew, or recklessly disregarded, had not and likel y would not, bring real money to Sara Lee's coffers .
Inadequate Reporting Systems And/Or Deficient Internal Controls
93 . Unbeknownst to the investing public, Sara Lee's reporting systems and/or interna l controls were so inadequate during and immediately prior to the Class Period that it wa s
34 impossible for the Company to make projections with respect to the Company 's sales and/or earnings per share without doing so in a knowingly reckless and unreasonable manner .
94. Specifically, numerous former Sara Lee employees have testified to significant and pervasive deficiencies in the Company's reporting systems and/or internal controls . These problems included, but were not limited to, failures to timely process accounts payable, regula r instances of channel stuffing, failures to properly process credit analysis for potential customers , and failures to timely close and distribute the Company's month end financial reports .
95. For example, a former Sara Lee Purchasing Agent in the Underwear division, wh o was with the Company for over 22 years until leaving on July 23, 2003, commented on variou s control problems with the Company's accounts payable and related end of quarter financia l manipulations. Specifically, although Sara Lee suppliers are supposed to be paid within forty- five days of the receipt of goods, the Company routinely failed to make timely payments . The former Sara Lee Purchasing Agent commented with respect to plant managements manipulation s as follows:
"They don't want to go into some big meeting and be [asked] how come you've got a negative variance. So, what would happen is, goods would come in and they know that if they don't receive them they won't have to be paid for. So they may wait 10 or 15 days before they receive them so that when the meeting comes up they don't show a negative variance. They receive them (goods) from the carrier but they wouldn't go into the system and say we've got them . I'm talking about the online computer mainframe . They signed the bill of lading with the carrier, so technically we've received it, but our system, as far as paying, we're not paying until it's been received online in the system . Now the goods may be already received or . . . may already be being used, but until it's on the system, accounts payable says we haven't received them ."
96. Reporting problems were not limited to situations with Sara Lee suppliers, bu t extended to customers as well. For example, a former Sara Lee employee in the Company's
Information Technology department from October 2001 until September 2002, responsible fo r
35 implementations of software, commented on customer service catastrophes caused by inadequate internal reporting systems. Specifically, the Reshaping program and other implementations spearheaded by a team of consultants from Arthur Andersen caused customer relations problems with Kroger and Walmart . The former Information Technology employee commented that there were "chargebacks involved, there's money that doesn't get paid on time which then of course costs you money at the bank. You've got your financial hit because you're not getting your orders processed on time and you're losing orders and all that - - there's also all these Andersen people, they're paying them boatloads of money to not get anything in return ."
97. A former purchasing agent for Sara Lee's apparel division stated that he was aware of accounting improprieties and financial manipulations at the end of certain quarters .
The employee stated that suppliers were supposed to be paid on terms of net 45 days from receipt of goods . However, the employee stated that Sara Lee often didn't pay within the 45 days. He stated "I was told that plant managers have been told to do this because they're trying to cover themselves - they don't want to go into some big meeting and be asked why they've go t a negative variance." He continued to describe how goods would come into the plant but management would wait up to two weeks before recording their receipt of the goods in "the computer system." This was, he stated, designed to delay the time in which accounts payable had record of the receipt of goods . This practice stretched out payments to vendors, he said, and if a vendor ever complained, Sara Lee would demand proof of delivery as a further delaying tactic. All of this he said, was a strategic ploy to allow management to take certain costs off the books for certain months .
98. Another example is Sara Lee's deficient internal controls relate to its relationship with the Dutch supermarket giant Koninklijke Ahold N .V. ("Ahold"). On December 19, 2000 ,
36 Sara Lee filed a Form 8-K with the SEC which reported that, on December 4, 2000, Sara Le e completed the sale of all of the outstanding common stock of PYA/Monarch, Inc ., a Maryland corporation ("PYA"), to JP Foodservice Distributors, Inc ., a Delaware corporation ("JP") and a wholly-owned subsidiary of Ahold. Significantly, the document stated:
In connection with the transaction, the Company entered into a multi-year supply agreement between the Company's U.S. food and beverage manufacturing operations and Ahold's U .S, foodservice operations . Ahold is a major customer of the Company's U .S. food and beverage manufacturing operations . [Emphasis added.]
99. Because Ahold's U.S. foodservice was a "major customer," Sara Lee's Corporate executives took a special interest in this customer and made this special interest known to Sara
Lee's Food Group employees . As stated by a former member of Sara Lee's Human Resource s department in Sara Lee's Food Group, Sara Lee employees were "interested in pleasing corporate
. . . many times I did hear this is what corporate said we were going to do which was not necessarily what the businesses said they could do -- so it was `find a way to do it' ." This special interest was understandable, given a multi-year supply agreement which afforded Sara Lee an opportunity to accelerate shipments (stuff the food service channel) in quarters where a revenue injection was required to meet Wall Street's earnings estimates .
100. Indeed, on April 8, 2003, The Wall Street Journal reported that, "Sara Lee Corp. said three of its sales people signed inaccurate documents that could have been used to hel p inflate earnings at U.S. Foodservice, now being investigated for accounting irregularities ."
According to the article :
U.S . Foodservice executives asked the Sara Lee salespeople to sign and forward to Deloitte & Touche, U.S. Foodservice's outside auditor, documents that showed Sara Lee owed more to the food-service company than it actually did, Sara Lee spokeswoman Julie Ketay said . The salespeople signed and forwarded the inaccurate documents withou t
37 alerting managers or the Chicago food maker's accounting department, she said, adding that the company is still investi atin 'ust wh the did so. [Emphasis added.]
101 . As a consequence of the public disclosure of Sara Lee's participation in collusive securities fraud, in June 2003 Sara Lee established a "Qualified Legal Compliance Committee " in order to "facilitate the confidential receipt, retention and consideration of reports, made b y attorneys retained or employed by Sara Lee, of evidence of a material violation of U .S. federal or state securities law, a material breach of fiduciary duty arising under federal or state law, or a similar material violation of any U.S. federal or state law by Sara Lee or any of its officers, directors, employees or agents ." (September 22, 2003 Form DEF 14A.)
102. Nine months has elapsed since the date of this article and seven months has elapsed since the "Qualified Legal Compliance Committee " (a Committee which reported to the highest level of the Company's management) commenced its investigation, yet Sara Lee ha s neither fired the sales people nor explained why the employees did what they did. A former Sara
Lee employee when inquiring about these issues was told "they're really holding this close to the vest."
103. A Sara Lee Staff Accountant in the Company's Accounting Department for the
Coffee & Tea division in Harrison, New York, described consistent problems within the
Accounting Department. Specifically, he found that it was "unusual" how long it took the
Company to close its books. Moreover, not only did it take three business days following th e end of the month to close the Company's books, but the financial reports would then b e overnight mailed to Holland prior to being sent anywhere in the United States. More striking , the former Staff Accountant described certain improper adjustments in accounting that occurred
38 on a monthly basis . For instance, the former Staff Accountant stated that on a month end closing, if the numbers did not look right, they were finessed as follows :
"We would adjust it. Certain accounts were too high for their liking, for example if the transportation account for the month was like $70,000 . . . they would analyze it and they would say there is no way it could be that and they'll say we have to move a certain amount to the other account because there is no way transportation should be $70,000."
104. Indeed, the reporting problems and control systems inadequacies were s o widespread that even Sara Lee employees who attempted to properly report financial result s were improperly trained to do so . Thus, a Sara Lee employee with the Company from June 1999 until February 2003 as a Plant Manager in the Company's Coffee & Tea division in Harahan,
Louisiana, commented on the Company's reporting problems within the Coffee division.
Specifically, with respect to the Plant Manager's financial reports, he attributed "poor processes " to the fact that it could take him a month to unravel a financial problem because of th e
Company's failure to clearly explain the financial system.
105 . Likewise, a former Cost Accountant in a Weston, Florida subsidiary for Sara Lee ,
Hardwood Companies, commented on the gross incompetence of one of the Company' s controllers. The former Cost Accountant commented as follows with respect to certain unchecked practices within the Company: "sometimes you do things to make it match, because when they acquired Host Apparel, not all the documents came over, so I know that some of it , they had to like guesstimate, you know, when they were doing reconciliations as far as Host was concerned. "
106. Rather than addressing the inadequacies in its reporting system and internal controls, the Company continued to stress the already inadequate system by constantly changing the reporting structure . A former Sara Lee employee in the Company's Meat division, workin g
39 in the division's Accounting and Finance Department, until September 2002, and responsible for compiling end of month closing and other financial reports, commented that there were constant changes in the Company's reporting structure .
107. The Company's pervasive inadequacies in reporting and internal controls were only exacerbated by the Earthgrains acquisition . For instance, a former Sara Lee Accounts
Receivable Manager, working in St. Louis, Missouri, who was a long time employee of
Earthgrains and employed by Sara Lee after the acquisition and until the summer of June, 2003, commented with respect to integrations issues following the acquisition of Earthgrains .
Specifically, the former Accounts Receivable Manager stated that Sara Lee was not inclined to integrate its software system with the Earthgrains' system after the acquisition . Moreover, the former Accounts Receivable Manger was "certain" that this implementation failure caused confusion in the reporting system.
108. A former manager of Earthgrains, and later Sara Lee, who was on one of the
Bakery division's management committees, explained why the division missed its projections so badly after the acquisition of Earthgrains : "These budgets were always driven from the top down," he stated. He further explained that an executive committee, comprised of the former
Earthgrains CEO, Barry Beracha, who was appointed to the Board of Directors of Sara Lee after the acquisition, and other Sara Lee bakery executives, was responsible for creating the financial projections . This committee, he said, created the projection, or as he put it, "the big number," through a combination of unrealistically high sales and revenue numbers and cost projections that were "very understated ." Because the numbers were driven from the top, each management
section of the bakery division was asked "what they could contribute" in order to make "the big number." Each management committee for each bakery division was required to project futur e
40 costs, and these numbers, he said, were always being revised and reduced by the executiv e committee. Finance sheets, he said, often even included two columns for "actual" numbers and
"projected" numbers, and after the Earthgrains acquisition, the actual numbers were always much lower than the projected numbers . Projections, he said, were never revised to bring them in line with reality. Instead the executive committee would cut budgets in an attempt to cut costs and meet projected numbers . Ultimately, he said these cost cutting measures ended up hurtin g sales and distribution significantly.
109. A former manager of a Coffee division plant employee reported that inventor y controls were in disarray. He gave as a common example situations where "finished goods
[came] out of the packaging department, [went] into the shipping department and then [were] distribut[ed] . . . to the customer. Improper inventory taken at the warehouse, the offsite warehouse, improper inventory or not correct inventory taken at my warehouse and doubl e recording of transactions ." He also reported that after inquiring about discrepancies in inventor y numbers "nobody could really pinpoint what happened, and all they said is `that's the way it is' ."
110. This former manager reported as a specific example where an inventory audit revealed that further stated that over $100,000 of receipts for shipped product were unaccounted for, and no internal investigation was conducted by accounting because "the accounting structur e was sort of ambiguous" and was controlled by an accountant that did not report to the employe e at the plant. Instead, the accountant reported to the corporate office accounting group, and as far as he knew, no accountants reported to plant managers - rather they all reported to the corporat e offices. The accounting and auditing process, he recalled was "very susceptible to manual error." In the specific example involving the lost receipts of $100,000 of shipped goods, thi s
41 manager stated that when he asked how the discrepancy was resolved, he was told "they wrote it off as a one-time charge at the end of the year ."
111 . The Company's internal controls and reporting systems were so deficient that such inadequacies even extended into the Company's human resources department, increasin g certain litigation risks associated with potential accusations of discrimination . A former Sara
Lee employee, in the Food Group's Human Resources department, employed by the Company until February 2003, commented on ongoing prol?lef'ls in the Company's hiring process caused by inadequate internal audits . Specifically, she commented that internal applicant tracking and other control measures commonly ensure that a company is not discriminating in the hiring process and that such measures allow a company to provide evidence in the event they ar e audited from claims of discrimination ; but, because Sara Lee lacked the appropriate internal controls, such as internal audits and/or self assessment process , the Company would not have been able to provide the necessary documentation to external audits .
112. Finally, the accounting manipulations described above, including the pervasiv e channel stuffing and failure to conduct proper credit analysis demonstrates the Company' s utterly deficient accounting and internal control systems .
FALSE AND MISLEADING STATE MENTS DURING THE CLASS PERIOD
113. The Class Period begins on August 1, 2002 . On that date, the Company issued a press release over Business Wire in which it announced its financial results for its fourth quarter and fiscal year ended June 29, 2002. The Company reported an increase in sales and revenues and projected a double-digit operating income increase in fiscal 2003 . In this regard, the pres s release stated, in pertinent part:
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Sara Lee Corporation (NYSE:SLE) today announced that sales for the fourth quarter of fiscal 2002, ending June 29, 2002, were $4 .5 billion, up 14% over the fourth quarter in 2001 . Excluding unusual items, diluted earnings per share (EPS) were $.42, an increase of 14% compared to $ .37 for last year's fourth quarter. For the fiscal year, sales were $17 .6 billion, up 6% over the same period a year ago. Diluted EPS for the full year, excluding unusual items, were $1 .36 in fiscal 2002, equal to last year's results .
Including unusual items, diluted EPS for the fourth quarter of 2002 were $ .43 compared to diluted EPS of $1 .19 in the year ago period. Diluted EPS for fiscal 2002, including unusual items, were $1 .23 compared to EPS for fiscal 2001 of $2.65. Fiscal 2001 results include a significant gain from business dispositions and a charge related to the corporation's. Reshaping program.
Corporate unit volumes, excluding acquisitions and divestitures, increased 1% in the fourth quarter, and were flat for the fiscal year. Operating income increased 7% in the fourth quarter but declined 5% for the fiscal year. Results in the most recent quarter reflect the acquisition of The Earthgrains Company as well as increased base business income from the Sara Lee Meats and Intimates and Underwear lines of business.
114. In the press release, defendant McMillan focused on the alleged success of th e
Reshaping program :
We ended fiscal 2002 with a strong fourth quarter for many of our key businesses. We began to see the benefits of the Reshaping efforts carried out over the last two years, and I expect the company's improved sales and profit performance to strengthen throughout fiscal 2003 .
I strongly believe that Sara Lee has the right mix of businesses today to meet consumers' needs for high quality, convenience food, apparel and household products around the world. We significantly increased our focus on product and process innovation in fiscal 2002 , and we supported our exciting new product initiatives with increased marketing spending that will continue into fiscal 2003. These initiatives, which were funded through our strong cash flow, are creating a new momentum for top -line and operating income growth throughout our company. [Emphasis added.]
115. Additionally, defendant McMillan stressed the importance he and defendant de
Kool purportedly place on full and accurate disclosure:
CFO Theo de Kool and I fully endorse the new federal law that requires CEOs and CFOs to sign sworn statements certifying their company's annual and quarterly filings, which we will be doing when we file our fiscal 2002 Form 10-K
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around Sept. 27. We strongly believe that it is incumbent upon today 's business leaders to work vigorously to resto re investor confidence in this volatile marketplace.
The press release further discussed the impact of the Reshaping program on the Company's results:
The company's results for the fourth quarters and fiscal years ended June 2002 and 2001 were affected by actions related to the Reshaping program initiated in May 2000. This program includes a number of business dispositions and the closure or sale of certain high-cost manufacturing and distribution activities . Income from continuing operations, net income and diluted EPS including and excluding these unusual items are quantified in the notes to the financial statements that accompany this press release .
Including the impact of unusual items in each period, net income decreased from $973 million in the fourth quarter of fiscal 2001 to $351 million in the comparable period of fiscal 2002, while diluted EPS in the same periods decreased from $1 .19 to $.43. For the full fiscal year, net income decreased from $2 .3 billion in 2001 to $1 .0 billion in fiscal 2002, and diluted EPS declined from $2.65 to $1 .23 over the same period as a result of unusual items recorded in each period . Fiscal 2001 results include significant gains from the disposition of the PYA/Monarch foodservice and Coach accessories businesses .
116. In the press release, the Company represented that the business disposition portion
of the Reshaping program was essentially complete :
No new Reshaping projects were initiated in the fourth quarter of fiscal 2002, and the company completed certain projects initiated and recognized in prior quarters . Reshaping actions completed during the 2002 fourth quarter were executed for amounts that were more favorable than previously estimated, and the impact of these actions increased pretax income and net income by $13 million and $10 million, respectively. The impact of the unusual items in the fourth quarter increased diluted EPS by $.01 to $.43.
For fiscal 2002, Reshaping actions reduced pretax income and net income by $170 million and $101 million, respectively, or $ .12 per diluted share . The pretax charge consists of $165 million related to the exit of certain high-cost manufacturing, distribution and administrative activities and $5 million associated with expected losses on business dispositions previously announced. An income tax benefit of $40 million was recognized on the charges associated with exit activities, and a $29 million tax benefit was recognized on the business disposition activities executed during the year. Since the inception of the Reshaping program, the company has completed the disposition of 17 of the 1 8
44 opt
business units targeted for disposal . The company is in the final stages of closing a small bakery operation in China to complete the business disposition portion of the Reshaping program .
117. In a discussion of the Company' s bakery business, the press release focused o n the importance of the Earthgrains acquisition and its purported success to date :
The significant growth in sales and operating income reflects the acquisition of The Earthgrains Company in August 2001 . This acquisition more than tripled the size of Sara Lee Bakery's operations and substantially increased its profitability . As a result, sales grew to $803 million in the fourth quarter, and for the fiscal year, sales increased from $832 million in fiscal 2001 to nearly $3 billion .
In the fourth quarter, unit volumes for the U .S. frozen operations rose 4%, driven by increased pie sales and strong demand for in-store bakery products . In the U.S . fresh bakery business, unit volumes fell slightly, down 2% compared to The Earthgrains Company's performance in the year ago period prior to its acquisition by Sara Lee. Lower unit volumes in the popular segment of the fresh bread market offset strong sales of superpremium Sara Lee and Earth Grains branded products. European fresh bread unit sales increased 2% during the quarter, while refrigerated dough unit sales fell 2% in the United States and 4% in Europe .
118. The press release also contained the Company's projections for the first quarter and full year fiscal 2003 :
Sara Lee's management currently expects diluted EPS for the first quarter of fiscal 2003 to fall within a range of $ .27 to $.29 compared to $ .26 in the year-ago period. Full-year fiscal 2003 diluted EPS are expected to fall in a range of $1 .44 to $1 .50, compared to $1 .36 in fiscal 2002.
By line of business, in the first quarter, management expects modestly higher sales and a high-single-digit to low double-digit increase in operating income for Sara Lee Meats, driven by increased unit sales, lower commodity costs and an improved product mix . Sara Lee Bakery results in the first quarter should show strong double-digit gains, benefiting from base business increases as well as approximately five additional weeks of Earthgrains' revenues and profits, based on the August 7, 2001 closing date . Given their significant exposure to foreign currency, reported results for Sara Lee's Beverage and Household Products lines of business, the company's two most global operations, will depend on changes in year-over-year foreign currency relationships . In local currency terms, the Beverage group is likely to report flat revenues and lower operating income in the first quarter, as the company continues to support its Senseo product in Europe and deals with difficult U.S. coffee markets. Household Products revenues and profits should be flat to modestly up. Revenues for Intimates and Underwear will
45 continue to be affected by discontinued product lines in the first quarter, but operating income is expected to increase at a strong double-digit rate .
For the full year, the company expects total corporate revenue growth in the low- to mid-single digit range, with a double-digit operating income increase as all five lines of business are expected to contribute to higher profits.
119. The statements referenced above were materially false and misleading when made because the sales and earnings per share reported in the press release for the fourth quarter 200 2 and fiscal year 2002, both ending June 29, 2002, were materially misstated and inflated, and the true data was omitted, because Defendants failed to disclose that the Company's reporte d revenue figures were inflated by Sara Lee's pervasive practice of channel stuffing as set fort h above . Specifically, Defendants failed to disclose and/or misrepresented the following adverse facts, among others, as set forth above:
a. Sara Lee's reported sales and earnings per share were overstated during the Class Period due to the Company's improper recognition of revenue through channel stuffing ;
b. Sara Lee overstated the demand for its product as a result of the Company's systematic and continuous channel stuffing;
c. Sara Lee was shipping products to major customers, including Walmart, prior to customer order and/or demand, notwithstanding the likelihood that the client would balk and refuse to pay for the unwanted products ;
d. Sara L.ee's market share was overstated as a result of the Company's continuous improper recognition of revenue through channel stuffing;
e. Sara Lee's reported earnings per share were inflated by the Company's improper recognition of revenue ;
f. Sara Lee's revenue growth was achieved, in part, at the expense of future results because Sara Lee's channel stuffing had the effect of pulling sales forward into an earlier period ;
g. Sara Lee's reported earnings per share were overstated during the Class Period because of the failure to disclose litigation and other
46 costs incurred as a result of having adopted a Company-wide policy of self-insurance;
h. Sara Lee had failed to disclose contingent liabilities and significant risks and uncertainties related to the EPA investigation into The Earthgrains Company, as set forth in above ;
i. Sara Lee's reported financial results were inherently unreliable because of the Company's inadequate reporting systems and deficient internal controls; and
j. Sara Lee was, therefore, not making full and accurate disclosures, the importance of which had espoused by defendants McMillan and de Kool .
120. The statements referenced above were additionally false and misleading whe n made because the sales and earnings per share reported in the press release for the fourth quarte r
2002 and fiscal year 2002, both ending June 29, 2002, were materially misstated and inflated, and the true data was omitted, because Defendants failed to disclose that the Company's reported revenue figures were inflated by Sara Lee's pervasive practice of granting credit to certai n customers far in excess of what Sara Lee knew was justified and by failing to timely expens e uncollectible receivable, specifically those related to Fleming Companies, Inc ., as set forth above. Thus, Sara Lee failed to disclose and/or misrepresented that the Company's sales an d earnings per share were overstated during the Class Period due to the Company's policy o f failing to timely expense uncollectible receivables, or to carry an adequate reserve against the receivables due from customers - including Fleming Companies, Inc . - that lacked creditworthiness.
121 . The statements referenced above, specifically relating to Earthgrains' contribution to the financial reports, were also materially false and misleading when made because th e earnings per share reported in the press release for the fourth quarter 2002 and fiscal year 2002, both ending June 29, 2002, were materially misstated and inflated, and the true data was omitted ,
47 because Defendants failed to disclose that the Company's reported revenue figures were inflate d by Sara Lee's failure to disclose contingent liabilities and significant risks and uncertainties related to the EPA investigation into The Earthgrains Company, as set forth above .
122. The foregoing statements referenced above, specifically relating to th e contribution of the Company's Reshaping program to the fourth quarter financial results and it s expected contributions going forward, were also materially false and misleading when mad e because the Company failed to disclose and/or misrepresented the following adverse facts , among others:
a. Sara Lee had already learned, as set forth above, that the Company's reckless failure to perform adequate due diligence prior to acquiring Earthgrains, the centerpiece of the Reshaping program, had already proven to be a regrettable and unprofitable decision, having an adverse effect on the bakery division as a whole;
b. Sara Lee had already learned, contrary to expectations held by the Company prior to the acquisition, as set forth above, that only a handful of Earthgrains' bakeries were modernized ;
c. Sara Lee had already learned, as set forth above, that the Company was already losing sales and customers as a result of problems associated with the acquisition of Earthgrains ;
d. Sara Lee had already learned, as set forth above, that the Company was already incurring substantial costs as a result of technology implementation problems related to the acquisition ; and
e. Sara Lee had already learned, as set forth above, of additional failures with the Reshaping program outside of the bakery division;
123. The projections, including the EPS projection, made in the August 1, 2002 press release were each materially false and misleading when made because Defendants knew they were false, did not believe them or had no reasonable basis for them, because of the Company' s
48 004
pervasive channel stuffing and because of the Company's inadequate reporting systems and
deficient internal controls, as discussed above .
124. Subsequent to issuing the August 1, 2002 press release, Sara Lee conducted a
conference call with analysts. During the conference call, the Company reiterated the results se t
forth in the August 1, 2002 press release, including the emphasis on Earthgrains:
We enjoyed our strongest operating performance of the year in the fourth quarter, with a reported operating profits of 7% led by gains in meat and apparel, as well as the Earthgrains acquisition.
125. The Company then explained its strategy of focusing its marketing spending on it s most important brands :
As we indicated at the beginning of the year, part of our marketing strategy for fiscal '02 was to make sure that the biggest spending increases would go to support our most important brands . For example, while corporate media spending was 12% in fiscal '02 media spending behind our largest key brands increased almost 20% .
126. The Company also discussed the purported positive impact of the Reshapin g program on its operating results :
We have also begun to enjoy some savings from the Reshaping efforts throughout the Corporation over the last two years . Operating income benefited by about $25 million in the fourth quarter, primarily in Intimates and Underwear, at about $90 million for the full year from earlier projects designed to improve our efficiency and lower our costs . For fiscal '03, we expect additional technology and reorganization spending of about $30 million in the meat group, and an additional $25 million in corporate unallocated for additional technology projects throughout the Corporation. Savings from our Reshaping efforts, including more than $50 million in the meat group alone, should total about $135 million next year . Below the operating line profit line going back to this year, interest expense increased about $15 million during the fourth quarter relating to higher debt levels to finance Earthgrains .
127 . The Company also emphasized the strength of its Wal-Mart business : "We continue to enjoy very strong sales to Wal-Mart. Revenues to this account increased more than
60% in the fourth quarter." Moreover, the Company emphasized that its strong sales to Wal-
49 Mart were not the result of "investor build." Further, the Company acknowledged that Wal-Mar t was "an important customer and an important indicator of how business for Sara Lee is doing."
128. Finally, during the August 1, 2002 analyst conference call, the Company reaffirmed the earnings projections set forth in the August 1, 2002 press release, focusing on th e
Reshaping program:
In short, as we move from fiscal '02 to '03, we continue to reinvest in our key brands. We continue to make operations and process improvements . And we expect to produce results in '03 where earnings per share growth is more directly driven by top-line and operating profit gains .
129. The statements referenced above, made during the August 1, 2002 conferenc e call, were materially false and misleading when made for the reasons set forth in 11119 - 123
above. Additionally, the statements referenced above with respect to the Company's success at
Walmart were materially false and misleading because Sara Lee was, as set forth above, shippin g products to major customers, including Walmart, prior to customer order and/or demand, notwithstanding the likelihood that the client would balk and refuse to pay for the unwanted products. Thus, given that this practice of channel stuffing would cause Sara Lee's relationship with Walmart to deteriorate, Sara Lee was reckless and/or unreasonable to tout its improving business with Walmart.
130. On August 14, 2002, the Company issued a press release over Business Wire in which it announced that "its chief executive officer and its chief financial officer will certify without exceptions its fiscal 2002 annual report on Form 10-K with the Securities and Exchange
Commission (SEC)." At that time, defendant McMillan assured the investing public that "CFO
Theo de Kool and I will sign oaths swearing to the accuracy and truthfulness of Sara Lee' s financial statements ."
50 004
131 . On September 25, 2002, the Company filed its annual report on Form 10-K fo r
the fiscal year ended June 29, 2002, which repeated the financial results set forth in the August 1 ,
2002 press release. The Form 10-K described the Reshaping program, and its impact on
operations as follows :
Business Reshaping-In May 2000, a program to reshape the business activities of the corporation (Reshaping) was announced . The primary objectives of this program were to: 1) divest PYA/Monarch, a domestic foodservice business, and focus on the global operations of the Sara Lee Foods, Beverage, Intimates and Underwear and Household Products segments ; 2) divest the Coach accessories business and focus the Intimates and Underwear segment around operations that market basic, nonfashion, repeat purchase branded apparel items ; 3) divest certain other businesses that have limited growth opportunities and low returns ; and 4) improve the competitive structure of the corporation by exiting certain high-cost manufacturing, distribution and administrative activities .
The exit activities associated with the Reshaping program to date are intended to improve the competitive structure of the corporation and are expected to result in savings of $230 million in 2004 . Operating income was favorably impacted during 2002 by $89 million of cost savings associated with completed exit activities.
Excluding PYA/Monarch, the businesses disposed of as part of the Reshaping program had sales of $15 million in 2002, $1,046 million in 2001 and $1,363 million in 2000. The operating results of these businesses were a loss of $3 million in 2002, operating . income of $81 million in 2001 and operating income of $40 million in 2000 . A complete description of the Reshaping activities from the initiation of the program is presented in the unusual items note to the consolidated financial statements. No additional exit activities or business dispositions are currently anticipated under the Reshaping program .
132. The foregoing statements in the Form 10-K were materially false and misleadin g when made for the reasons set forth in 11 119 - 123 above.
133 . Similarly, for the reasons set forth in 11 119 - 123 above, the following certifications in the Form 10-K were materially false and misleading:
I, C. Steven McMillan, Chairman of the Board, President and Chief Executive Officer of Sara Lee Corporation, certify that :
51 1 . I have reviewed this annual report on Form 10-K of Sara Lee Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
Date: September 25, 2002 By: Is/ C. STEVEN MCNIILLAN
C. Steven McMillan Chairman of the Board, President and Chief Executive Officer
I, L.M. de Kool, Executive Vice President and Chief Financial Officer of Sara Lee Corporation, certify that : 1. 1 have reviewed this annual report on Form 10-K of Sara Lee Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report ; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report .
Date: September 25, 2002 By: ISI L.M. (THEO) DE KOOL
L.M. (Theo) de Kool Executive Vice President and Chief Financial Officer
52 134. Additionally, in the Company' s Form 10-K for the fiscal year ended June 29,
2002, defendants McMillan and de Kool, by their signatures, specifically reported as to the
purported adequacy of Sara Lee's internal controls as follows :
The corporation maintains a system of internal accounting controls designed to be cost-effective while providing reasonable assurance that assets are safeguarded and transactions are executed in accordance with management's authorization while being properly recorded in the financial records. The system of internal controls is characterized by a control- oriented environment within the corporation, which includes written policies and procedures, careful selection and training of personnel, and audits by a professional staff of internal auditors. The corporation's control environment is further enhanced through a set of Global Business Standards that are communicated throughout the organization which establish ethical and legal responsibilities for employees worldwide .
135. These statements were materially false and misleading due to the Company's inadequate reporting systems and deficient internal controls .
136. On September 26, 2002, the Chicago Sun-Times published an article with respect to contradictory steps towards corporate accountability . The article commented that "three Sara
Lee board members who have been caught up in controversies have retired or will retire soo n from the board, including former longtime Sara Lee CEO John H. Bryan," but despite these forward advances "Bryan will retain his controversial role as a $500,000-a-year consultant to
Chicago-based Sara Lee ." Moreover the article reported that, "though Sara Lee is languishing amid weak earnings and falling market share, the company granted its top executives hefty raises," including a "86 percent increase in [McMillan's] bonus for fiscal 2002, to $2 .4 million on top of a 5 percent increase in base salary, to a $1 .05 million."
137. In a press release dated October 8, 2002, the Company raised its projections fo r the first quarter of fiscal 2003 and the entire fiscal year, based primarily on the purported benefits of the Reshaping program:
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Sara Lee Corporation (NYSE :SLE) announced today that it expects its first quarter earnings per share (EPS) to be more than 30% higher than last year's first quarter EPS of $0.26 per diluted share. The higher projections are a result of benefits from the company's Reshaping program, including increased sales of higher margin products and reduced operating costs . Favorable foreign currency exchange rates, lower interest expense and fewer shares outstanding also contributed to the above-expectation results . Sara Lee's management currently expects diluted EPS for the first quarter of fiscal 2003 to be at least $ .35. For the first quarter, the analysts' consensus estimate, as measured by First Call, is currently $.28 per diluted share.
For fiscal 2003, Sara Lee currently projects that its diluted EPS will be in a range of $1.54 to $1 .60 compared to $1 .36 in fiscal 2002, a gain of 13% to 18%. The analysts' current consensus estimate, as measured by First Call, is $1 .47 for fiscal 2003.
In its fiscal 2002 year-end earnings press release issued August 1, 2002, Sara Lee's outlook for the first quarter of fiscal 2003 was an EPS range of $ .27 to $.29 per diluted share. For the full year, the company at that time projected a range of $1 .44 to $1 .50 per diluted share.
Reported sales are expected to increase 7% . Excluding acquisitions and divestitures, dollar sales are expected to be flat in the quarter as strength in Meats, Household Products, Intimate Apparel and Socks was offset by lower revenues from Beverage, Bakery, Hosiery and Direct Selling operations .
138. In the press release, defendant McMillan touted the supposed positive effect o f the Reshaping program :
We began 2003 with a pipeline full of innovative products, a strengthened investment program and a healthy balance sheet supported by superb cash flow . The strategy we began two years ago to invest in our key brands and take costs out of our manufacturing, distribution and administrative operations is working as demonstrated by our above-expectation first quarter results .
As a result of our Reshaping program, for the first time in several years we are seeing growth in operating income . In this first quarter, we project that operating income will grow more than 20% over the year ago period, and for the full fiscal year we anticipate that it will grow more than 15% with increased operating income from all lines of business .
139. Analysts reacted positively towards the Company' s positive statements :
• On October 8, 2002, Salomon Smith Barney commented on the positive press release, noting that Sara Lee management "attributes the upside for the
54 quarter . . . including the realization of restructuring benefits from its 2001 `reshaping' program. In response to Sara Lee's upwardly revised projections, Salomon Smith Barney raised its "estimate for the quarter by $ .08 to $.35 from $.27."
• On October 8, 2002, in response to Sara Lee's "pre-released earnings for its F1Q03 (ended Sep) at $ .35 versus our and consensus estimates, which the Company had attributed to "better product mix, lower operating costs" and other factors, Merrill Lynch raised its full year EPS estimate to $1 .55-1 .60 from $1 .45-1 .55 in light of strength in the quarter ."
• On October 9, 2002, Bear Steams commented on Sara Lee's significantly raised earnings projections, which had been attributed, in part, to CEO Steve McMillan's Reshaping program ." Bear Steams also commented on Sara Lee's estimate that full year 2003 results would be "in a range of $1 .54 to $1 .60," a range whose "midpoint . . . . represents a 7% increase over the consensus $1.47 ." In response to these projections, Bear Steams admitted "to being pleasantly shocked by the numbers ."
• On October 9, 2002, in response to Sara Lee's full year estimates, Banc of America Securities raised its own estimates from "$1 .50 to $1 .60, an increase of 19% versus last year's EPS of $1 .35." Banc of America Securities stressed that Sara Lee had "indicated that reduced costs from the company's restructuring program, favorable commodity costs" and other factors were "favorable factors to the higher than expected first quarter and full year results."
140. The statements referenced above were materially false and misleading when made because the Company had failed to disclose that the Reshaping program had been an abjec t failure, for the reasons set forth in 1 122 above.
141 . Further, the revised projections, including the EPS projection, made in th e
October 8, 2002 press release were each materially false and misleading when made because
Defendants knew they were false, did not believe them or had no reasonable basis for them, because of the Company's pervasive channel stuffing and because of the Company's inadequate reporting systems and deficient internal controls, as discussed above.
55 142, By press released dated October 24, 2002, the Company announced that its firs t
quarter fiscal 2003 earnings had increased 42% over the same period in the fiscal 2002 . The
press release focused on the Earthgrains acquisition and the Reshaping program :
Sara Lee Corporation today reported diluted earnings per share (EPS), excluding unusual items, of $ .37, an increase of 42% compared to $.26 one year ago.
Sales were $4.5 billion compared to $4.2 billion a year ago, an inc rease of 7%, driven largely by the acquisition of The Earthgrains Company. Unit volumes, excluding acquisitions and divestitures , were flat during the quarter, with gains in the company's Meats, Intimates and Underwear, and Household and Body Care operations offset by declines in the Beverage and Bakery businesses.
Operating income rose 25% due to benefits from the company's Reshaping program, including increased sales of higher margin products and reduced operating costs. The additional' five weeks of Earthgrains' earnings in fiscal 2003, lower commodity costs and favorable foreign currency exchange rates also contributed to the increased results . The company's strongest base business operating income gains occurred in the Meats and Intimates and Underwear businesses.
Including unusual items related to the Reshaping program, the company reported earnings of $.38 per diluted share for the first quarter of fiscal 2003, ending September 28, 2002, compared to $.30 one year ago.
In its fiscal 2002 year-end news release issued in August 2002, Sara Lee's outlook for the first quarter of fiscal 2003 was an EPS range of $ .27 to $.29 per diluted share, excluding unusual items . Today's EPS of $ .37 is 28% above the top end of that range reflecting the positive operating performance discussed in this release, including benefits from the company's Reshaping program, as well as favorable foreign currency exchange rates, lower interest expense and fewer shares outstanding.
143 . In the earnings announcement, defendant McMillan highlighted the purporte d success of the Reshaping program :
Our strategy is working . We are beginning to realize benefits from the Reshaping program that Sara Lee began two years ago. I strongly believe that Sara Lee Corporation today has the right mix of food, apparel and household products to satisfy the growing appetite of consumers around the world for high-quality, convenient products that meet their everyday needs .
56 My current priority is to make certain that Sara Lee invests in new product development, marketing support for our brands and enhanced organizational structures to deliver sustainable top-line growth . . .
144. The press release also discussed the effect of the Reshaping program on EPS :
The company's results for the first quarters of fiscal 2003 and 2002 were affected by actions related to the Reshaping program initiated in May 2000 . Reshaping actions completed during the first quarter of fiscal 2003 were executed for amounts that were more favorable than previously estimated, resulting in an increase in pretax income, net income and diluted EPS of $9 million, $7 million and $.01, respectively. During the first quarter of fiscal 2002, the company's management approved plans to close certain high cost manufacturing and distribution activities and completed the disposition of certain non-core businesses. Also, during the first quarter of 2002, the company concluded that it could not complete a previously announced business disposition in a timely manner, resulting in the reversal of the charge previously recognized for this planned action . The net impact of these fiscal 2002 activities was a$1 million reduction in pretax income, a $29 million increase in net income and an increase in diluted EPS of $ .04 per share.
145. The press release emphasized the importance of Earthgrains to the Company' s
bakery business:
The significant growth in sales and operating income reflects an additional five weeks of Earthgrains' results based on the acquisition's completion in August 2001 . This acquisition more than tripled the size of Sara Lee Bakery's operations and substantially increased its profitability . Sara Lee Bakery's first quarter sales grew to $822 million compared to $545 million for the same period last year . Operating income grew to $44 million, up 25% from $35 million a year ago . Excluding the impact of the Earthgrains acquisition and foreign exchange, sales were down 3% and operating income was down 26% due to volume declines in the U.S. fresh bread category and increased employee costs .
146. The statements referenced above were materially false and misleading when made
for the reasons set forth in 11119 - 123 above.
147. Subsequent to issuing the October 24, 2002 press release , the Company conducted its conference call with analysts. During the conference, defendant de Kool attempted to assur e analysts that Earthgrains was not going to be a problem for the Company :
57 We are on track by launching our new products . . . I think we suffer from some heavier competition different than when we had forecasted when we made the acquisition. But we do not look at it as a kind of drama . It is a short-term, medium-term thing we have to overcome and we have the management in place . We think that they understand the issues and know what to do about it . So we are confident that we will see improvement going forward .
148. On October 24, 2002, based upon information from the Company, Banc of
America Securities reported projections estimates for the Company's fiscal year 2003 as follows :
Operating Sales Income (in millions ) Meat $ 3,743 $ 392
Beverage 2,615 43 1
Household 2,081 369
Bakery 3,328 162
Apparel 6,491 821
Total $ 18,258 $ 2,175
149. The statements referenced above were mate rially false and misleading when made because defendant de Kool was already aware of the significant problems the Earthgrain s acquisition discussed in 1 122 above.
150. Moreover, the projections given by the Company to analysts were materially fals e and misleading because Defendants knew they were false, did not believe them or had n o reasonable basis for them, because of the Company's pervasive channel stuffing and because of the Company's inadequate reporting systems and deficient internal controls, as discussed above.
151 . On October 28, 2002, Sara Lee issued a press release announcing a $500 million
30-year senior unsecured notes offering . That same day, Sara Lee filed with the SEC a Rule
424(b)(5) Prospectus Supplement registering the $500 million offering.
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152. On November 7, 2002, the Company filed with the SEC its quarterly report on
Form 10-Q for the first quarter of fiscal 2003, ending September 30, 2002. The 10-Q repeate d the earnings report in the October 24, 2002 press release detailed above .
153 . The November 7, 2002 Form 10-Q was materially false and misleading for the reasons set forth in 11119 - 123 above .
154. On November 11, 2002, Sara Lee issued a press release announcing a proposed two-year Euro 250 million guaranteed floating rate note offering . The release stated that the notes would issued by Sara Lee/DE Antilles N .V. and unconditionally and irrevocably guaranteed by Sara Lee, and that proceeds from the offering would be used to refinance current maturities and repay commercial paper.
155. By press release dated January 23, 2003, the Company announced that its secon d quarter fiscal 2003 earnings had increased 110% over the same period in fiscal 2002 :
Sara Lee Corporation today reported diluted earnings per share (EPS) of $ .42 for the second quarter of fiscal 2003, ending December 28, 2002, as compared to $ .20 one year ago. The second quarter of fiscal 2003 included restructuring costs and income that had no net impact on reported results . In the second quarter of fiscal 2002, costs associated with restructuring and business dispositions reduced diluted EPS by $ .17 per share. For the first six months of fiscal 2003, diluted EPS were $ .80 compared to $ .49 for the first half of fiscal 2002. Amounts recognized in the first half of fiscal 2003 for restructuring and business dispositions increased diluted EPS by $ .01, while restructuring and business disposition activities recognized in the first half of the prior year reduced diluted EPS by $ .14.
Sales for the second quarter of fiscal 2003 increased 2% to $ 4 .8 billion compared to $ 4.7 billion in the prior year's quarter. For the fiscal six months, sales increased 4% to $ 9 .3 billion compared to $ 8.9 billion for the year ago period During the quarter and six-month periods, sales benefited from favorable foreign currency exchange rates . The year-to-date period also benefited from the inclusion of an additional five weeks of Earthgrains' results in the first quarter of fiscal 2003 . Unit volumes, excluding acquisitions and divestitures, were up 1% during the second quarter, with gains in the company's Meats and Household Products operations partially offset by declines in the Beverage and Bakery businesses. Intimates and Underwear volumes were flat versus the prior year .
59 Through the first six months of fiscal 2003, corporate unit volumes, excluding acquisitions and divestitures, were flat .
Operating income increased 66% to $ 556 million for the quarter and 45% to $ 1 .1 billion for the first six months . The second quarter of fiscal 2003 included restructuring costs and income that increased operating income by $ 3 million, while restructuring and business disposition costs decreased operating income by $ 187 million in the second quarter of fiscal 2002 . For the first half of fiscal 2003, restructuring costs and income increased operating income by $ 12 million, while restructuring and business disposition costs decreased operating income by $ 188 million in the year ago period . Beyond these restructuring and business disposition items, operating income growth for the second quarter and six months of fiscal 2003 reflected incremental benefits and savings resulting from the company's restructuring activities, favorable foreign currency exchange rates, lower commodity costs and increased sales of higher margin products in response to strengthened marketing initiatives. Operating income growth was strongest in the company's Meats, Household Products and Intimates and Underwear operations. Results for the six months were also impacted by the inclusion of an additional five weeks of Earthgrains' results in the first quarter of fiscal 2003 .
156. In the January 23, 2003 press release, defendant McMillan focused on the success of the Reshaping program and the Company's purported emphasis on its "key brands" :
"I am very pleased that the second quarter continued the momentum begun late last year," said C . Steven McMillan, chairman, president and chief executive officer of Sara Lee Corporation . "The strategies outlined in our annual report last September are serving our company well .
"Our increased investment in media advertising and new product development is starting to accelerate the growth of our key brands . We are especially pleased with the strong consumer acceptance of a wide range of new products including the Hanes Tagless T-shirt, Playtex and Bali gel-strap bras, Sara Lee fresh breads, IronKids crustless bread, Hillshire Farm ultra-thin deli meats, the Senseo coffee system, Jimmy Dean Fresh Taste. Fast! sausage and bacon, and Ambi-Pur air care products.
In addition, our restructuring initiatives to reduce costs while consolidating and strengthening our operational capabilities continued to show good progress . Through the first six months of fiscal 2003, we estimate that these efforts generated incremental savings of $ 65 million over the prior year .
"Our cash flow from operations grew 40% through the first six months of this fiscal year and generated funds of more than $ 850 million . Our consistently high level of cash generation gives us financial and operational flexibility to reinvest in our businesses and to pay down debt . Cash flow from operations is one of the ke y
60 metrics of our company, and I am proud to report on our performance so far this year," concluded McMillan.
The press release also discussed the earnings effect of the ongoing restructu ring:
The reported results for the quarter and the first six months of fiscal 2003 and 2002 reflect amounts recognized in connection with ongoing restructuring and business disposition activities . In the second quarter of fiscal 2003, the corporation's management approved actions to sever 311 employees, exit leases and dispose of assets in the Bakery segment. These actions resulted in an after-tax charge of$ 14 million (pretax $ 22 million) or $ .02 per share. In addition, the corporation completed certain restructuring and business disposition activities for amounts that were less than previously reflected in the financial statements, and the recognition of these completed transactions essentially offset the after-tax charge associated with the Bakery restructuring actions. In the second quarter of fiscal 2002, the corporation's management approved actions to sever employees, exit leases and dispose of assets in its various businesses that resulted in an after- tax charge of $ 130 million . In addition, the corporation's management approved actions to dispose of certain businesses that resulted in an additional after-tax charge of $ 13 million. The combined impact of the $ 143 million of charges was a reduction in diluted EPS of $ .17.
In the first half of fiscal 2003, the corporation completed certain restructuring activities for amounts that were less than previously reflected in the financial statements, and the recognition of these completed transactions increased pretax income and net income by $ 30 million and $ 21 million, respectively . The corporation also completed the disposition of certain businesses for amounts in excess of those previously anticipated that increased pretax income and net income by $ 4 million. The favorable outcome of the completed restructuring and business disposition activities increased pretax income, net income and diluted EPS by $ 34 million, $ 25 million and$ .03, respectively. Offsetting this amount was the recognition of a charge associated with management's second quarter decision to restructure the operations of the Bakery segment. These actions reduced pretax income, net income and diluted EPS by $ 22 million, $ 14 million and $ .02, respectively. In the first half of fiscal 2002, the corporation's management approved a series of actions to sever employees, exit leases and dispose of assets . In addition, the corporation completed certain restructuring and business disposition activities that were previously recognized in the financial statements. The net impact of these actions was to reduce pretax income, net income and diluted EPS in the first half of 2002 by $ 188 million, $ 114 million and $ .14 per share, respectively .
As a result of the restructuring actions taken, the corporation's cost structure was reduced and efficiency improved . It is estimated that operating income in the second quarter and first half of fiscal 2003 included $ 33 million and $ 65 million ,
61 Owl
respectively, of incremental benefits over those realized in the prior year, as a result of these factors.
The press release also contained the Company's EPS projections for the third quarter and ful l year fiscal 2003:
Sara Lee's management currently expects diluted EPS for the third quarter of fiscal 2003 to fall within a range of $ .33 to $ .35 compared to $ .31 in the year- ago period.
Full-year fiscal 2003 diluted EPS are expected to be in a range of$ 1 .54 to $ 1 .60, compared to $ 1 .23 in fiscal 2002. Fiscal 2002 included expenses related to the company's restructuring program totaling $ .12 per share after-tax .
By line of business, management expects increased operating income in the third quarter versus the year ago period for each of its lines of business, except Bakery . For Sara Lee Meats, increased retail and deli product sales, lower commodity costs and savings from the company's restructuring program will drive higher profits. Although Bakery operating income is expected to be below the prior year due to continued softness in the U .S. fresh bread sector, operating income will benefit from the cost-reduction actions implemented in the second quarter as well as higher net prices due to more efficient trade spending . The Beverage group is expected to show increased operating income based on continued strong results in Europe combined with improved sales and operating income in the company's Brazilian operations . Household Products' operating income will benefit from continued volume growth in its core categories and improved results from its Direct Selling operations . In the Intimates and Underwear line of business, operating income is expected to continue to grow by more than 10% as a result of its targeted advertising and product introductions.
For the full year, the company is targeting sales growth of approximately 2%, excluding acquisitions, with a double-digit operating income increase as all five lines of business are expected to contribute to higher profits .
157 . The statements in the January 23, 2003 press release referenced above were materially false and misleading when made for the reasons set forth in ¶q 119 -123 above.
158 . Moreover, the projections given by the Company in the press release were materially false and misleading because Defendants knew they were false, did not believe them or had no reasonable basis for them, because of the Company's pervasive channel stuffing an d
62 because of the Company's inadequate reporting systems and deficient internal controls, a s
discussed above.
159. On January 23, 2003, the Company conducted its customary conference call with
analysts wherein it confirmed the results set forth in the January 23, 2003 press release . Once
again, the Company highlighted the purported economic benefits of the Reshaping program :
"We also benefited from $33 million of incremental reshaping savings during the second quarte r from previous efforts to improve productivity and lower costs. The Intimates and Underwear line of business enjoyed the largest piece of these savings ."
160. During the January 23, 2003 conference call, the Company also explained how the Reshaping program would benefit the Bakery business in the following quarter :
We are not projecting a profit increase for Bakery on a year over year basis in the third quarter, but we do expect performance in the third quarter to be better than what we saw in the second quarter, as we begin to realize cost savings implemented in December, as well as higher margins for Sara Lee bread as a result of lower introductory start up costs .
The Company further highlighted improvements in its apparel (Intimates and Underwear ) business :
Business trends continue the improvement we saw in the first quarter, with operating profits benefiting from restructuring savings, lower cotton costs and increased sales of higher margin products . . . Sales for our key brands grew three percent during the second quarter. We enjoyed our strongest results among our Intimate apparel key brands, which have had more consistent marketing support in recent years .
63 During the conference call, the Company once again focused on the purported success of the
Reshaping program:
We are staying the course we remain committed to the Reshaping program launched more than two and half years ago with its goal to jump start top-line growth by restructuring our business portfolio, centralizing our organizational structure and significantly increasing marketing and new product development efforts. The strength of our key brands is particularly evident with sales up seven percent through the first half, supported by marketing increase of more than fifteen percent. These are the products that will allow us to increase our operating margins over time. Our cash flow is strong and growing, up forty percent through the first half of this year driven by higher earnings and improved working capital management . We remain committed to our EPS growth of eight to ten percent growth over time and expect to meet or beat that objecting in fiscal 2003 .
161. In the conference call, defendant de Kool expressed optimism concerning th e
Earthgrains acquisition:
I am still pretty optimistic in that we are doing the right thing. We have high confidence in the management in the Bakery . . . of course, it is a disappointment that it is so short after the acquisition, the returns are not in line with expectations, but I'm really confident that in the medium-term, we will see good improvement over there.
162. During the conference call, the Company also touted its purportedly strong Wal-
Mart business during the quarter: "The reception for our new product activity is very strong and all of our customers, including Wal-Mart.
163. On January 23, 2003, Banc of America Securities, based on information provide d by the Company, reduced, in total, its projected estimates for fiscal year 2003 to the following :
Operating Sales Income (in millions) Meat $ 3,704 $ 378
Beverage 2,642 427
Household 2,078 364
Bakery 3,243 134
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Apparel 6,511 825
Total $ 18,178 $ 2,12 8
164. The statements in the January 23, 2003 conference call referenced above were materially false and misleading when made for the reasons set forth in In 119 - 123 above.
165. Moreover, the projections given by the Company to analysts were materially false and misleading because Defendants knew they were false, did not believe them or had n o reasonable basis for them, because of the Company's pervasive channel stuffing and because of the Company's inadequate reporting systems and deficient internal controls, as discussed above .
166. On February 7, 2003, the Company filed with the SEC its quarterly report o n
Form 10-Q for the first quarter of fiscal 2003, ending December 31, 2003 . The 10-Q repeated the earnings report in the January 23, 2003 press release detailed above .
167 . The February 7, 2003 Form 10-Q was materially false and misleading for the reasons set forth in 1 1119 - 123 above.
168 . In a press release dated March 3, 2003, the Company discussed that day' s
"quarterly update meeting" with the analysts wherein the Company reviewed its Bakery business. In the press release, Richard A. Noll, the COO of Sara Lee Bakery Group and senior vice president of the Company, discussed the supposed success of the Sara Lee bread brand :
"Sara Lee breads were launched throughout our direct-store delivery system in October, and in just a few months this product line has become Sara Lee Bakery Group's number-one selling domestic bread brand. Beyond that, the Sara lee brand is helping us grow by opening the door to new geographies," said Noll . "The success of Sara Lee breads clearly illustrates the power of the brand, and we will leverage that power to generate long-term growth for the company. "
While Noll acknowledged difficulties in the U .S . fresh bread market, both he and the Compan y stated that the Reshaping program would benefit operating income :
65 OPN
As reported in the company's second quarter earnings announcement in January, the U.S . fresh bread business is currently facing increased costs, lower volumes and tough margin pressures . While third quarter results are expected to be below the prior year due to continued softness in the U .S. fresh bread sector, operating income will benefit from cost-reduction actions as well as higher net prices due to more efficient trade spending .
Sara Lee Bakery Group has already taken several steps to improve its performance. In the last 12 months, the business has consolidated U .S . operations and increased cost efficiencies through the closure of six bakeries. In December, Sara Lee Bakery Group reduced its headquarters and regional office staffs by 18% - in addition to cutting a significant number of positions in the U.S. fresh bread field organization - realigning its organization for better efficiency and effectiveness . These actions, combined with other cost-cutting measures, are anticipated to generate $40 million to $45 million in annual savings .
The key to improving Sara Lee Bakery Group's performance is a strong strategic focus. We must focus on leveraging the Sara Lee brand while at the same time we must consider reducing the number of other brands and SKUs that we produce . As we reduce the complexity of our business, we will increase our productivity and generate long-term, sustainable growth .
169. On March 4, 2003, the Company issued a press release to supposedly correct
"inaccurate media coverage" of the March 3, 2003 quarterly analyst meeting:
Sara Lee Corporation today advised its shareholders and potential shareholders to refer to the company's second quarter earnings press release, which was issued Jan. 23, 2003, and its second quarter Form 10-Q, which was filed with the Securities and Exchange Commission on Feb . 7, 2003, for guidance regarding expected third quarter results for the entire corporation .
Sara Lee is responding to an inaccurate newspaper story regarding the company's earnings outlook for the third quarter, which ends March 29, 2003 . At a quarterly analyst meeting held yesterday, the company provided the investment community with an overview of its $ 3 billion bakery business, Sara Lee Bakery Group, which represents approximately 17% of Sara Lee Corporation' s sales. As stated during that meeting, which was broadcast live via the Internet, and in a press release issued yesterday, the company noted that it is expecting third quarter results for the bakery line of business to be below last year . However, the overall outlook for Sara Lee Corporation's third quarter results is expected to be higher as compared to last year's third quarter, as stated in the company's second quarter earnings announcement .
66 170. In the press release, defendant de Kool stated expressly that the Company had not
lowered its earnings guidance:
I want to assure our shareholders that Sara Lee Corporation did not lower our earnings guidance yesterday," said Theo de Kool, chief financial officer of Sara Lee Corporation . "As it is too early in the quarter to provide an update on our third quarter outlook, we referred analysts and shareholders to our second quarter earnings release and 10-Q filing for guidance regarding our third quarter performance.
171 . The statements referenced above were materially false and misleading when mad e
because, Sara Lee failed to disclose other problems outside of its bakery business that would require it to lower its previous projections for the fourth quarter and the full fiscal year 2003 after continuing to stuff the channel in order to meet the third quarter projections . Thus, even if the
Company managed to meet the third quarter projections, it would do so at the expense of future periods because of the following undisclosed adverse facts, among others, set forth in 1119
above.
172. On March 28, 2003, the Company issued a press release concerning a Wall Street
Journal article, quoting an anonymous source, alleging that the Company had acted improperl y in its relationship with Ahold's U.S. Foodservice division . Defendant McMillan represented that the Company had investigated the matter and found no evidence of wrongdoing:
Sara Lee Corporation responded to a story in today's Wall Street Journal in which an anonymous source alleges that the company has acted inappropriately in its customer relationship with Ahold's U.S. Foodservice division .
C. Steven McMillan, chairman, president and chief executive officer of Sara Lee Corporation stated, "Last month, when Ahold announced that it had found accounting irregularities in its U .S. Foodservice business, we immediately reviewed all of our records associated with each of our foodservice distributors and confirmed that our conduct and accounting was appropriate and accurate . Moreover, we have not been contacted by any investigators - either from the U.S. Attorney's office, the Securities and Exchange Commission or Ahold's outside auditor, Deloitte & Touche - regarding our relationship with U .S. Foodservice . We are prepared to cooperate fully should any of these investigative bodie s
67 contact us. To the best of our knowledge, we have always conducted our business with U. S . Foodservice and all of our customers with the highest ethical standards."
173. On April 7, 2003, despite defendant McMillan 's prior representations, the
Company disclosed that an internal company investigation had determined that three Compan y employees had provided false information to U .S. Foodservice's auditors:
Sara Lee Corporation announced today that an internal review of its relationship with Royal Ahold's U .S. Foodservice unit has revealed that three salespeople independently confirmed to U.S. Foodservice's auditor, Deloitte & Touche, inaccurate amounts payable to U.S. Foodservice. These amounts were inconsistent with the formal reporting of rebate balances that Sara Lee provided on a monthly basis to U .S. Foodservice. Documents indicate that these individuals improperly responded to direct requests from senior U.S. Foodservice executives to confirm rebates and balances due from Sara Lee that were inaccurate and higher than what was owed . Sara Lee is providing its findings and related materials to the Securities and Exchange Commission (SEC) in conjunction with the SEC's ongoing investigation into this matter.
Sara Lee emphasized that these three salespeople, who have been relieved of their sales responsibilities, were not authorized to make these confirmations . The company acknowledged that the letters could have been used improperly by certain U.S. Foodservice personnel to indicate higher than actual earnings .
THE TRUTH BEGINS TO EMERGE
174. On April 24, 2003, the Company issued a press release over Business Wire in which it announced that earnings for fiscal year 2003 would be in the range of $1 .50 to $1.52 per share, instead of the previously projected range of $1 .54 to $1 .60 per share, and below the consensus estimate of $1 .59. The press release stated, with respect to Sara Lee's operating performance, in pertinent part, as follows :
Sara Lee Corporation today reported diluted earnings per share (EPS) of $.33 for the third quarter of fiscal 2003, a 6% increase compared to $ .31 one year ago. For the first nine months of fiscal 2003, diluted EPS were $1 .13 compared to $.80 for the first nine months of fiscal 2002, a 41 % increase .
68 For the third quarters of fiscal 2002 and 2003, restructuring and business disposition activities had no net impact on EPS. Results for the nine-month periods include restructuring and business disposition activities that increased EPS by $.01 in fiscal 2003 and reduced EPS by $.14 in fiscal 2002.
Fiscal 2003 third quarter sales increased 4% to $4 .4 billion, and nine-month sales also rose 4% to $13.7 billion. Favorable foreign currency rates increased sales by six percentage points for the quarter and four percentage points for the nine- month period. The year-to-date period also benefited by two percentage points from an additional five weeks of Earthgrains' results in the first quarter of fiscal 2003. Unit volumes, excluding acquisitions and divestitures, fell 2% in the third quarter and declined 1 % through the first nine months versus the prior year .
Total operating segment income rose 3% in the third quarter to $469 million and increased 29% to $1 .5 billion through the first nine months . Significant items affecting operating segment income in the third quarter included income from restructuring and business disposition activities of $5 million in fiscal 2002 and $1 million in fiscal 2003 ; operating losses related to businesses sold of $5 million in fiscal 2002 ; and a foreign currency benefit of $37 million in the most recent period. Through the first nine months, significant items included costs from restructuring and business disposition activities of $183 million in fiscal 2002 and income of $13 million in fiscal 2003 ; and operating losses related to businesses sold of $10 million in fiscal 2002 and income of acquired businesses, primarily The Earthgrains Company, of $21 million in fiscal 2003 . In addition, favorable foreign currency comparisons added $76 million to operating segment income through the first nine months of fiscal 2003 .
Excluding these significant items, total operating segment income fell 5% in the third quarter reflecting significantly higher marketing spending to support key brands and new product introductions, challenging market conditions in the foodservice sector and weakness among some retail customers. [. . .]
Both media advertising and other advertising and promotions increased 23% in the quarter. All five lines of business reported higher marketing spending, with double-digit increases in Meats, Bakery, Beverage, and Intimates and Underwear . Through nine months, media advertising and promotion spending increased 12%.
"We remain committed to our strategic plans for growth in this challenging economic environment, " said C . Steven McMillan, chairman, president and chief executive officer of Sara Lee Corporation . "Sara Lee's businesses continue to benefit from incremental cost savings and increased productivity related to previous restructuring activities. In addition, our heightened investment in new product initiatives and our strategy to increase marketing support for our largest, most important brands are together driving higher growth rates for our key brands."
69 "In recent months, we have seen some of these benefits offset by slower retail sales and a weaker environment for foodservice products, but we continue to focus our resources to provide convenient, everyday items that look, feel or taste terrific." [Emphasis added .)
175. As a result of this news , the Company's shares, which opened at $19 .20 on April
24, 2003, closed the day down 7.8 percent at $17.80 on extremely heavy trading of more than 1 2 million shares .
176. In an April 24, 2003 conference call discussing the 3`d quarter results, defendant
McMillan finally acknowledged that despite three years of a supposedly successful Reshapin g and restructuring, the Company needed to reevaluate all of its businesses, as many were still underperforming:
It is certainly clear to me that we need to take another very hard look at our portfolio of businesses and brands to determine those that should be run radically differently in the future specifically to identify those that should be managed even more aggressively for cash through either reduced investment levels, downsizing or even divestment .
Defendant McMillan went on to explain that the Company would have to devote considerabl e energy and resources to this process in the upcoming fiscal year:
It is too early for me to be more specific on this point but I can tell you that identification of non-core product lines and brands will be a key focus of our FY '04 annual operating plan process which begins this Monday .
Later on in the conference call, defendant McMillan admitted that Sara Lee's portfolio was still plagued by numerous weak businesses:
Our issue clearly is we still have too large a pot of our portfolio in businesses that either aren't growing or in a lot of cases, declining. I think the economic conditions have contributed to that. I would've hoped we would have more than offset the softness of those businesses by the strength in our top brands but I think we need to go back in prioritize even more aggressively where we're going to spend our money, maybe even tighten up the definition of what our key brands and key product lines are . And we clearly have to get much more
70 aggressive in driving more cash out or actually exiting some of the other businesses.
177. On April 24, 2003, in response to "worse than expected" earnings guidance for the fourth quarter 2003, Prudential Financial lowered its 2003 estimates on Sara Lee an d downgraded its recommendation on the Company. Prudential Financial attributed th e downgrade in projections chiefly to problems with "operations, namely apparel, beverages an d other foodservice operations ."
178. On April 24, 2003, Morgan Stanley expressed that it was "surprised by the extent to which retail, foodservice, and operating environment have adversely impacted SLE's overal l performance." On this news, Morgan Stanley downgraded its full-year Sara Lee EPS estimate from $1 .57 to $1.50 and commented that "[t]here is little evidence that restructuring o r reinvestment efforts are benefiting overall performance ." Further Morgan Stanley stated tha t
"[b]akery results were extremely week," attributing part of the problem to the "ill-timed" an d
"costly acquisition" of Earthgrains .
179. On April 25, 2003, the Chicago Tribune and the Chicago Sun Times each published articles that fleshed out the previously undisclosed facts known to Defendants that ha d led to Sara Lee's shockingly poor operating performance and prospects . The Chicago Tribune article headlined, "Sara Lee misses target, reduces profit outlook," noted that Sara Lee' s performance would have been even worse had it not been for currency translation benefits the
Company received as a result of the weakening of the U .S. dollar. In this regard, the article stated, in pertinent part, as follows :
For the quarter ended March 29, the Chicago-based consumer-products giant reported net income of $269 million, or 33 cents a diluted share, up 4 .7 percent from $257 million, or 31 cents a share, a year ago . Sales increased 3 .6 percent, to $4.35 billion.
71 Citing the profit squeeze caused by plant closings and other cost-cutting moves, the company cautioned investors to expect fourth-quarter earnings of 36 cents to 38 cents a share, rather than the 46 cents analysts anticipated.
Without the help of a weakening U.S. dollar, Sara Lee's results would have been even more daunting: With its big presence in Europe and other offshore markets, the company reaped a significant financial benefit from favorable currency translation. Currency gains bolstered sales by 6 percentage points, the company said, and boosted pretax profit by $37 million. On a volume basis, excluding the contribution of acquired or divested businesses, unit sales fell 2 percent, Sara Lee said.
In a conference call with analysts, McMillan suggested that the company is prepared to re-examine some operations . "It's certainly clear to me that we need to take another very hard look at our portfolio and business or brands to determine those that should be run radically differently in the future," he said . [Emphasis added.]
180. The Chicago Sun Times article headlined, Sara Lee's news sends stock down
almost 10%, stated, in pertinent part:
Sara Lee Corp., grasping for a growth strategy, gave investors a triple dose of bad news Thursday, and its shares took their biggest one-day plunge in 15 years .
The Chicago-based company reported worse-than-expected results and slashed its earnings forecast for the current quarter, and its CEO said it needs to sell more of its poorly performing businesses--even after three years of massive restructuring .
Sara Lee's shares plunged 9.8 percent, or $1 .94, to end the day at $17.80, the lowest close in nearly three years . The 9.8 percent drop was the biggest one-day decline since January 1988.
181 . On April 25, 2003, in response to Sara Lee's lower fourth quarter estimates, which the Company had attributed, in part, to "higher levels of apparel inventories at retail following soft demand during the Christmas season and the need for increased spending," UBS
Warburg reduced its "4Q03 estimate to $0.39 and [its] fiscal 2003 estimate to $1 .51 from $1 .57."
182. On April 25, 2003, "worried about the overall health of certain Sara Lee's businesses, especially bakery," and in response se to below expectations third quarter results, as
72 well as disappointing fourth quarter guidance, Bear Stems lowered its "Q4 EPS estimate t o
$0.38, from $0.47, and [its] fiscal '03 forecast to $1 .50 per share, from $1 .60."
The Company's Conference Call Concerning Fiscal 2003 Results Confirms The Failure Of The Reshaping Program And The Effect Of The Company's Class Period Channel Stuffin g
183. During a July 31, 2003 conference call, discussing 4t' quarter and full-year result s for fiscal 2003, the Company released information demonstrating the utter failure of the
Reshaping program. Specifically, the Company disclosed the remarkable fact that in the 4'h quarter, "key brand sales increased in line with corporate s ales during the quarter ." Thus, after years of purportedly focusing the Company , and its marketing, on Sara Lee's supposed core brands (earlier in the call, defendant McMillan had revealed that almost 70 percent of the
Company's marketing spending was on its key brands), by the end of fiscal 2003 , those brand s were not growing any faster than the businesses upon which the Company was not focusing. In response to a question as to how this could happen, the Company's Vice President of Corporat e
Relations could only respond : "I can't give you a real scientific answer." She then provided further support that the Company had been stuffing its Intimates and Underwear channel durin g the .Class Period: "A lot of our key brands are in Intimates and Underwear and with the softnes s and the de-loading by the retail trade, I think that had an impact on our reported sales more tha n anything else."
184. Defendant McMillan' s statements during the July 31, 2003 conference call also confirm the allegations in this Complaint about Sara Lee's channel stuffing in its apparel business earlier in the fiscal year. Specifically, with respect to the Company's Underwear an d
Intimates business, McMillan disclosed:
Business trends were decidedly unfavorable in the fourth quarter, primarily reflecting weak . consumer demand , combined with retaile r
73 OP4
efforts to lower inventory levels. Sales in the quarter fell 5 percent and profits fell 36 percent. [Emphasis added .]
Defendant McMillan also acknowledged similar activity by retailers with respect to the
Company's sock business: "For socks, we believe the below trend unit volume results reflect reduced inventory levels at key retail accounts, rather than long-term market brand o r product weakness."
185 . During the conference call, the Company confirmed McMillan 's statements:
"The major apparel issue in intimate and underwear is the amount of inventor y replenishment." Yet rather than acknowledge the channel stuffing, the Company offered th e following weak explanation for its problems with retailers : "We've seen a move to casual dress. Unless we go to a further move j o no dress of all, I would expect at some point retailers are going to have to start replenishing inventory." However, readily able to quantify the effects of its channel stuffing, the Company was able to "project" an upcoming "recovery" in this area: We're really calling that [the inventory replenishment] for the second half of the year . . . "
186. Later in the conference call, in response to a specific question concerning th e
Company's sales to Wal-Mart, defendant McMillan confirmed that Wal-Mart was overstocke d with inventory: "we have not seen substantial open to buys and inventory replenishment t o date."
187. Fiscal 2003 sales (excluding intersegment sales) and operating income b y segment as reported in Sara Lee's 2003 Form 10-K filed on September 22, 2003 demonstrate th e tremendous problems with the apparel and bakery business that were undisclosed during th e
Class Period. The Company Form 10-K for 2003 reported as follows :
Operating Sales Income (in millions)
74 Meat $ 3,746 $ 375
Beverage 2,756 429
Household 2,118 369
Bakery 3,276 98
Apparel 6,399 763
Total $ 18,295 $ 2,034
THE COMPANY'S CLASS PERIOD FINANCIAL STATEMENTS WERE MATERIALLY FALSE AND MISLEADING AND VIOLATED GAA P
188. During the Class Period, the Defendants represented that Sara Lee's financial statements when issued, were prepared in conformity with Generally Accepted Accounting
Principles (GAAP), which are recognized by the accounting profession and the SEC- as the uniform rules, conventions and procedures necessary to define accepted accounting practice at a particular time. These representations were materially false and misleading when made because
Defendants, in violation of GAAP, the SEC and it own disclosed policies, knowingly and/or recklessly employed improper accounting practices to falsely inflate the Company's reporte d revenues and earnings during the Class Period.
189. Sara Lee's materially false and misleading financial statements resulted from a series of deliberate senior management decisions designed to conceal the truth regarding Sar a
Lee's actual operating results . Specifically, Defendants caused the Company to violate GAAP by:
• Improperly failing to disclose contingent liabilities and significant risks and
uncertainties related to the United States Environmental Protection Agenc y
75 ("EPA") investigation into The Earthgrains Company which was acquired an d
included as part of the Sara Lee Bakery Group in August 2001 ;
• Improperly accelerating and recognizing revenue through channel stuffing ;
• Failing to timely expense uncollectible receivables , specifically those related
to Fleming Companies, Inc.; and
• Failing to accrue a reasonable estimate of the amount of losses expected fro m
its newly adopted self-insurance program .
190. As set forth in Financial Accounting Standards Board ("FASB") Statements of
Financial Accounting Concepts ("Concepts Statement") No . 1 (November 1978), one of th e fundamental objectives of financial reporting is that it provide accurate and reliable informatio n concerning an entity's financial performance during the period being presented . Concepts
Statement No. 1, paragraph 42, states :
Financial reporting should provide information about an enterprise's financial performance during a period . Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' and creditors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance .
191. As set forth in SEC Rule 4-01(a) of SEC Regulation S-X, "[flinancial statements filed with the [SEC] which are not prepared in accordance with [GAAP] will be presumed to be misleading or inaccurate ." 17 C.F.R. § 210.4-01(a)(1). Management is responsible for preparing financial statements that conform with GAAP. As noted by the AICPA professional standards:
financial statements are management's responsibility . . . . [M]anagement is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, record, process, summarize, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities and equity are within the direct
76 knowledge and control of management . . . . Thus, the fair presentation of financial statements in conformity with Generally Accepted Accounting Principles is an implicit and integral part of management's responsibility.
The Company's Improper Failure to Disclose Contingent Liabilities and Significant Risks and Uncertainties
192. The Defendants attempted to deceive investors during the Class Period evidenced by the failure to disclose contingent liabilities and significant risks and uncertainties related to the EPA investigation into the newly acquired Earthgrains Company .
193. GAAP requires that financial statements disclose contingencies when it is at least reasonably possible (i .e. a greater than slight chance) that a loss may have been incurred .
Statement of Financial Accounting Standard ("SFAS") No. 5, Accounting for Contingencies ,
(March 1975) 1 10. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss, a range of loss, or state that such an estimate cannot be made . Id.
194. The SEC considers the disclosure of loss contingencies to be so important to an informed investment decision that it issued Article 10-01 of Regulation S-X [17 C.F.R. § 210.10-
01], which provides that disclosures in interim period financial statements may be abbreviated and need not duplicate the disclosure contained in the most recent audited financial statements , except that "where material contingencies exist, disclosure of such matters shall be provide d even though a significant chance since year end may not have occurred ."
195. In violation of GAAP, Sara Lee 's Class Period financial statements improperly failed to disclose that the acquired Earthgrains Company engaged in certain practices tha t violated U.S . EPA standards exposing the Company to certain contingent liabilities and risks an d uncertainties. Indeed, Sara Lee was assessed penalties as reported by the U .S. EPA on July 31,
2003:
77 . ON
The settlement requires Earthgrains to pay a $5 .25 million civil penalty for having committed the largest ever corporate-wide violations of stratospheric ozone protection regulations . In addition, Earthgrains must convert all of its industrial process refrigeration appliances to refrigerant systems that do not deplete the ozone layer. EPA estimates that the injunctive relief will cost in excess of $5 million dollars.
196. Elaborative GAAP (FIN 14 : Reasonable Estimation of the Amount of a Loss a n interpretation of FASB Statement No. 5) states :
As indicated in paragraph 59 of FASB Statement No . 5, the purpose of the two conditions in paragraph 8 of the Statement is "to require accrual of losses when they are reasonably estimable and relate to the current or a prior period." Condition (b) in paragrraph 8, that "the amount of loss can be reasonably estimated," does not delay accrual of a loss until only a sin le amount can be reasonably estimated. To the contr when condition (a) in paragraph 8 is met, i .e. "it is probable that an asset had been impaired or a liability had been incurred," and information available indicates that the estimated amount of loss is within a ran a of amounts it follows that some amount of loss has occurred and can be reasonably estimated. . .When some amount within the range appears at the time to be a better estimate than any other amount within the range, that amount shall be accrued. When no amount within the range is a better estimate than any other amount, however, the minimum amount in the ran a shall be accrued. [Emphasis added.]
As an example, assume that an enterprise is involved in litigation at the close of its fiscal year ending December 31, 1976 and information available indicates that an unfavorable outcome is probable. Subsequently, after a trial on the issues, a verdict unfavorable to the enterprise is handed down, but the amount of damages remains unresolved at the time the financial statements are issued. Although the enterprise is unable to estimate the exact amount of loss, its reasonable estimate at the time is that the judgment will be for not less than $3 million or more than $9 million. No amount in that range appears at the time to be a better estimate than any other amount. FASB Statement No. 5 requires accrual of the $3 million at December 31, 1976, disclosure of the nature of the contingency and the exposure to an additional amount of loss of up to $6 million, and possibly disclosure of the amount of the accrual .
78 {
The same answer would result under the example . . . above if it is probable that a verdict will be unfavorable even though the trial has not been completed before the financial statements are issued. In that situation, condition (a) in paragraph 8 would be met because information available to the enterprise indicates that an unfavorable verdict is probable. An assessment that the range of loss is between $3 million and $9 million would meet condition (b) in paragraph 8 . If no single amount in that range is a better estimate than any other amount, FASB Statement No. 5 requires an accrual of $3 million at December 31, 1976, disclosure of the nature of the contingency and the exposure to an additional amount of loss of up to $6 million, and possibly disclosure of the amount of the accrual. Note, however, that if the enterprise had assessed the verdict differently (e.g., that an unfavorable verdict was not probable but was only reasonably possible), condition (a) in paragraph 8 would not have been met and no amount of loss would be accrued but the nature of the contingency and any amount of loss that is reasonably possible would be disclosed.
Assume that in the examples given , . .above condition (a) in paragraph 8 has been met and a reasonable estimate of loss is a range between $3 million and $9 million but a loss of $4 million is a better estimate than any other amount in that range. In that situation, FASB Statement No. 5 requires accrual of $4 million, disclosure of the nature of the contingency and the exposure to an additional amount of loss of up to $5 million, and possibly disclosure of the amount of the accrual .
197. In disregard of the mandates of GAAP (FASB Statement No. 5 and the elaborative interpretation discussed above), Defendants failed to accrue any amount i n connection with the impairment to its refrigerant-using equipment although a material multi-
million dollar liability existed. Moreover, in disregard of the mandates of GAAP, Defendants failed to accrue any amount in connection with penalties arising from the Company's illegal
activities despite the fact that Defendants had "offered to pay a stipulated penalty" (thereb y establishing a minimum in the range of loss).
79 The Company's Improper Acceleration and Recognition of Revenue
198. Sara Lee's financial statements throughout the Class Period were materially fals e
and misleading because the Company improperly recognized revenue through the practice of
"channel stuffing ." Channel stuffing is the practice of inducing purchasers to increase their
purchases before they would, in the normal course, otherwise purchase products from the
company. It has the result of shifting revenues into earlier quarters, likely to the detriment o f revenues in later quarters.
199. GAAP provides that revenue should not be recognized until it is realized or realizable and earned . FASB Concepts Statement No . 5, Recognition and Measurement in
Financi al Statements of Business Enterprises ("CON 5") (December 1984), 183-84; Accounting
Research Bulletin ("ARB") No . 43, Restatement of Accounting Research Bulletins (June 1953),
Chapter 1A 1 1 ; Accounting Principles Board Opinion ("APB") No. 10, Omnibus Opinion
(December 1966), 1 12. The conditions for revenue recognition ordinarily are met when persuasive evidence of an arrangement exists , delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, collectibility is reasonable assured, and the seller has substantially accomplished what it must do to be entitled to th e benefits represented by the revenues . Staff Accounting Bulletin ("SAB") No . 101, Revenue
Reco iint Financial Statements (December 1999) and CON 5, 183.
200. By offering discounts and other incentives and by engaging in other manipulative and deceptive practices with the Company's major retailers, Sara Lee knowingly and/o r recklessly overstated the Company's reported revenue and earnings throughout the Class Period by engaging in channel stuffing,
80 The Company's Failure to Timely Expense Uncollectible Receivables
201 . Sara Lee's reported financial results during the Class Period were materially fals e
and misleading because the Company failed to timely expense uncollectible receivables, or carr y
an adequate reserve against the receivables due from the now bankrupt Fleming Companies, Inc.
202. GAAP provides that an estimated loss from a loss con tingency, such as the ability
to collect receivables, "shall be accrued by a charge to income" if . (i) information available prior to issuance of the financial statements indicated that it is probable that an asset had bee n impaired or a liability had been incurred at the date of the financial statements ; and (ii) the amount of the loss can be reasonably estimated . SFAS No. 5, 1 8. SFAS No. 5 also requires that financial statements disclose contingencies when it is at least reasonably possible (e.g., a greater than slight chance) that a loss may have been incurred. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss, a range of loss or state that
such an estimate cannot be made.
203. The SEC considers the disclosure of loss contingencies to be so important to an informed investment decision that it promulgated Regulation S-X, which provides tha t disclosures in interim period financial statements may be abbreviated and need not duplicate th e disclosure contained in the most recent audited financial statements, except that, "where material contingencies exist, disclosure of such matters shall be provided even though a significant change since year end may not have occurred ." 17 C.F.R. § 21010-01 .
204. In addition, ARB No . 43, Chapter 3, Section 9 provides that the objec tive of providing for reserves against receivables is to assure that, "[a]ccounts receivable net o f
allowances for uncollectible accounts . . . are effectively stated as the amount of cash estimate d as realizable ."
81 205. Sara Lee violated GAAP by failing to take a provision for bad debt in its interim financial statements , as indicated by APB No. 28, Interim Financial Reporting (May 1973),J 17:
The amounts of certain costs and expenses are frequently subjected to year-end adjustments even though they can be reasonably approximated at interim dates . To the extent possible such adjustments should be estimated and the estimated costs and expenses assigned to interim periods so that the interim periods bear a reasonable portion of the anticipated annual amount .
206. In addition, CON 5 states, "[a]n expense or loss is recognized if it become s evident that previously recognized future economic benefits of an asset have been reduced o r eliminated . . ."
207. Moreover, GAAP considers "[t]he conditions under which receivables exist [to] usually involve some degree of uncertainty about their collectibility, in which case a contingency exists . . . . [Contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur . ..] Losses from uncollectible receivables shall be accrued when both conditions in paragraph 8 are met. Those conditions may b e considered in relation to individual receivables or in relation to groups of similar types of receivables. If the conditions are met, accrual shall be made even though the particular receivables that are uncollectible may not be identifiable . SFAS No. 5, 122.
208. The Company also violated its own disclosed internal accounting policy . Sara
Lee's fiscal 2002 report on Form 10-K filed with the SEC on September 25, 2002, signed b y
Defendants C. Steven McMillan and Lambertus M . DeKool, represented that "At the time o f sale, management records provisions for any uncollectible amounts based upon historical collection statistics and current customer information . These estimates are reviewed each quarte r and adjusted based upon actual experience ."
82 209. In order to falsely and materially inflate earnings during the Class Period, Sara
Lee violated GAAP, SEC rules and its own accounting policy by failing to record additional provisions for uncollectible receivables in its financial statements related to its receivables, specifically from Fleming Companies, Inc . The Company's failure to properly account for and disclose Sara Lee's deteriorating receivables was materially misleading to investors . Indeed, as the Company was forced to admit in its April 24, 2003 Q3 2003 Financial Release Conference
Call, Sara Lee recorded a $6 million pretax charge to increase the reserves for payments due from Fleming Companies, Inc .
The Company's Undisclosed Deferred Expenses for Self Insurance
210. Sara Lee's accounting for insurance expenses during the Class Period provided a vehicle by which such expenses could be deferred to future accounting periods violated GAAP.
211 . GAAP (Statement of Financial Accounting Standards No . 5, Accounting for
Contin encies) provides:
An estimated loss from a loss contingency... shall be accrued by a charge to income if both of the following conditions are met :
a) Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or that a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss .
b) The amount of the loss can be reasonably estimated .
212. In addition, FASB Statement No . 5 (paragraph 59) elaborates as follows:
"Paragraph 8 requires that a loss contingency be accrued if the two specified conditions are met.
83 The purpose of those conditions is to require accrual of losses when they are rea .sonabl estimable and relate to the current or a prior period."
213. During the Class Period, Defendants violated this GAAP by failing to accrue, by a charge to income, an amount which represented a reasonable estimate of the amount of losse s expected from its newly adopted self-insurance program . As a result of this GAAP violation, the
Company's financial statements during the Class Period materially understated expenses and therefore materially overstated income .
The Company's False and Misleading Class Period Financial Statements Were Material
214. The foregoing violations of GAAP were material. SAB 99, Materiality (August
1999) emphasizes the need to assess and take into account the qualitative aspects of materiality , including but not limited to:
• Whether the misstatement arises from an item capable of precise measurement
or whether it arises from an estimate and, if so, the degree of imprecision
inherent in the estimate;
• Whether the misstatement masks a change in earnings or other trends;
• Whether the misstatement hides a failure to meet analysts' consensu s
expectations for the enterprise;
• Whether the misstatement changes a loss into income or vice versa ;
• Whether the misstatement concerns a segment or other portion of th e
registrant's business that has been identified as playing a significant role in th e
registrant's operations or profitability; and
84 X
094
9 Whether the misstatement has the effect of increasing management' s
compensation - for example, by satisfying requirements for the award o f
bonuses or other forms of incentive compensation.
215 . More specifically, on June 30, 1999, the SEC imposed a "Cease-and-Desis t
Order" on W.R. Grace, noting that after Grace's management rejected PwC's proposed reversa l of reserves, PwC applied a liberal materiality standard to justify management's decision, an d rendered the Company a clean opinion . Although, the amount was too small to be material by conventional standards, the SEC found their financial statements to be materially false an d misleading because the: Company failed to disclose the excess reserves; Company failed to accurately portray its earning trends ; and Company' s senior management was engaged in th e scheme to manipulate reported earnings. In the Matter of W.R. Grace & Co ., Accounting and
Auditing Enforcement Release No. ("AAER") 1140 (June 30, 1999 ); In the Matter of Eugen e
Gaughan, AAER 1141 (June 30, 1999); In the Matter of Thomas Sc anlon, AAER 1142 (June 30,
1999).
216 . In order to meet analyst earnings expectations and to falsely inflate Sara Lee' s reported revenues and earnings, Defendants knowingly failed to properly disclose contingent liabilities and risks and uncertainties surrounding the Earthgrains EPA investigation, improperly accelerated and recognized revenue through the scheme of channel stuffing and failed to timel y expense uncollectible receivables, specifically those of Fleming Companies, Inc . Consequently the Company's Class Period financial statements were materially false and misleading .
The Company 's Lack of Proper Internal Controls
85 217. According to SEC rules, to accomplish the objectives of accurately recording,
processing, summarizing and reporting financial data, a company must establish an internal
control structure . Section 13(b) (2) of the Exchange Act requires that Sara Lee :
make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the issuer; and devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that : transactions are executed in accordance with management's general or specific authorization ; and transactions are recorded as necessary (I) to permit preparation of financial statements in conformity with generally accepted accounting principles . . . and (II) to maintain accountability for assets.
218. Contrary to the requirements of GAAP and SEC rules, Sara Lee either failed to implement and maintain an adequate internal accounting control system, or knowingly or recklessly tolerated the failure to use existing internal controls in a manner that would ensur e compliance with GAAP.
219. The Defendants knew or recklessly disregarded that Sara Lee was suffering from a chronic and systematic breakdown of its internal controls and procedures such that its financia l reporting was inherently corrupted, subject to manipulation , and unreliable, resulting in the issuance of materially false and misleading financial statements.
The Company's Yolations of SEC Regulations
220. Item 7 of Form 10-K for fiscal year 2002 and Item 2 of Form 10-Q,
Management's Discussion and Analysis of Financial Condition and Results of Operations
("MD&A") require the issuer to furnish information required by Item 303 of Regulation S-K [1 7
C.F.R. 229.3031. In discussing results of operations, Item 303 of Regulation S-K requires th e registrant to:
86 [d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations .
The Instructions to Paragraph 303(a) further state: The discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results . . .
221. In addition, the SEC, in its May 18, 1989 Interpretive Release No . 34-26831, has
indicated that registrants should employ the following two-step analysis in determining when a
known trend or uncertainty is required to be included in the MD&A disclosure pursuant to Ite m
303 of Regulation S-K :
A disclosure duty exists where a trend, demand, commitment, event or uncertainty is both presently known to management and is reasonably likely to have a material effect on the registrant's financial condition or results of operations .
222. The MD&A requirements are intended to provide, in one section of a filing,
material historical and prospective textual disclosure enabling investors and other users to asses s
the financial condition and results of operations of the registrant, with particular emphasis on th e
registrant's prospects for the future . As the Securities Act Release No. 6711 states:
The Commission has long recognized the need for a narrative explanation of the financial statements, because a numerical presentation and brief accompanying footnotes alone may be insufficient for an investor to judge the quality of earnings and the likelihood that past performance is indicative of future performance . MD&A is intended to give the investor an opportunity to look at the company through the eyes of management by providing both a short and long-term analysis of the business of the company . . .
Sec. 229.303 (Item 303), MD&A states :
To the extent that the financial statements disclose material increases in net sales or revenues, provide a narrative discussion of the extent to which such increases are attributable to increases in prices or to increases in the volume or amount of goods or services being sold or to the introduction of new products or services .
According to Securities Act Release No . 6349, n.5, at 964:
87 [i]t is the responsibility of management to identify and address those key variables and other qualitative and quantitative factors which are peculiar to and necessary for an understanding and evaluation of the individual company .
223 . Nonetheless, Sara Lee's Class Period Forms 10-K and 10-Q failed to disclose
during the Class Period the result of improper revenue recognition, including "channel stuffing,"
failing to timely expense uncollectible receivables, including those related to Fleming
Companies, Inc., and failing to accrue a reasonable estimate of the amount of losses expected from its newly adopted self-insurance program, for the purpose of inflating Sara Lee's operating results, which was a necessary disclosure for a proper understanding and evaluation of the
Company's operating performance and an informed investment decision.
The Company 's Additional GAAP Violations
224. As a result of the foregoing accounting improprieties, the Defendants caused Sara
Lee's reported financial results to violate, among other things, the following provisions of GAA P for which each defendant is necessarily responsible :
a) The principle that financial reporting should provide information that i s useful to present and potential investors in making rational investment decisions and tha t information should be comprehensible to those who have a reasonable understanding of busines s and economic activities (FASB Statement of Concepts No. 1, 134);
b) The principle of materiality, which provides that the omission or misstatement of an item in a financial report is material if, in light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by th e inclusion or correction of the item (FASB Statement of Concepts No . 2, (May 1980) 1 132).
88 c) The principle that financial reporting should provide information abou t how management of an enterprise has discharged its stewardship responsibility to owners
(stockholders) for the use of enterprise resources entrusted to it . To the extent that managemen t offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities fo r accountability to prospective investors and to the public in general. (FASB Statement of
Concepts No. 1, 150);
d) The principle that financial reporting should provide information about an enterprise's financial performance during a period . Investors and creditors often use information about the past to help in assessing the prospects of an enterprise . Thus, although investment and credit decisions reflect investors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance .
(FASB Statement of Concepts No. 1, 1 42);
e) The principle that financial reporting should be reliable in that i t represents what it purports to represent . The notion that information should be reliable as well as relevant is central to accounting . (FASB Statement of Concepts No. 2, ¶q 58-59);
f) The principle of completeness, which means that nothing is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions. (FASB Statement of Concepts No. 2, 180); and
g) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations ar e adequately considered. The best way to avoid injury to investors is to try to ensure that what i s reported represents what it purports to represent . (FASB Statement of Concepts No. 2, 9" 95,
97).
89 . 00i
FRAUDULENT SCHEME AND COURSE OF BUSINESS
225. The market for Sara L.ee's securities was open, well-developed and efficient at all relevant times. As a result of these materially false and misleading statements and failures to disclose, Sara Lee's common stock traded at artificially inflated prices during the Class Period .
Plaintiffs and the other members of the Class purchased or otherwise acquired Sara Le e securities relying upon the integrity of the market price of Sara Lee's securities and marke t information relating to Sara Lee, and have been damaged thereby .
226 . During the Class Period, Defendants materially misled the investing public , thereby inflating the price of Sara Lee's common stock, by publicly issuing false and misleading statements and omitting to disclose material facts necessary to make Defendants' statements, a s set forth herein, not false and misleading. Said statements and omissions were materially false and misleading in that they failed to disclose material adverse information and misrepresente d the truth about the Company, its business and operations, as alleged herein .
227 . At all relevant times, the material misrepresentations and omissions particularized in this Complaint directly or proximately caused or were a substantial contributing cause of th e damages sustained by Plaintiffs and the other members of the Class. As described herein, during the Class Period defendant made or caused to be made a series of materially false or misleadin g statements about Sara Lee's business, prospects and operations . These material misstatements and omissions had the cause and effect of creating in the market an unrealistically positiv e assessment of Sara Lee and its business , prospects and operations, thus causing the Company's securities to be overvalued and artificially inflated at all relevant times . Defendants' materiall y false and misleading statements during the Class Period resulted in Plaintiffs and the othe r
90 members of the Class purchasing the Company's securities at artificially inflated prices, thus causing the damages complained of herein .
PLAINTIFFS' CLASS ACTION ALLEGATIONS
228, Plaintiffs bring this action as a class action pursuant to Federal Rule of Civil
Procedure 23(a) and (b)(3) on behalf of all those who purchased the securities of Sara Lee during the Class Period and who were damaged thereby (the "Class") . Excluded from the Class are
Defendants, the officers and directors of the Company during the Class Period, members of their immediate families and their legal representatives, heirs, successors or assigns and any entity in which Defendants have or had a controlling interest .
229. The members of the Class are so numerous that joinder of all members is impracticable . Throughout the Class Period, Sara Lee common shares were actively traded o n the NYSE. While the exact number of Class members is unknown to Plaintiffs at this time and can only be ascertained through appropriate discovery, Plaintiffs believe that there are thousand s of members in the proposed Class . Record owners and other members of the Class may be identified from records maintained by Sara Lee or its transfer agent and may be notified of th e pendency of this action by mail, using the form of notice similar to that customarily used i n securities class actions.
230. Plaintiffs' claims are typical of the claims of the Class, as all Class members are similarly affected by Defendants' wrongful conduct in violation of federal law that is complained of herein .
231 . Plaintiffs will fairly and adequately protect the interests of the Class and ha s retained counsel competent and experienced in class and securities litigation.
91 232. 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 and operations of Sara Lee ; and
(c) to what extent the members of the Class have sustained damages and the proper measure of damages.
233. A class action is superior to all other available methods for the fair and efficien t
adjudication of this controversy since joinder of all members is impracticable . Furthermore, as
the damages suffered by individual Class members may be relatively small, the expense an d
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.
ADDITIONAL SCIENTER ALLEGATION S
234. As alleged herein, Defendants acted with scienter in that Defendants knew tha t the public documents and statements issued or disseminated in the name of the Company wer e materially false and misleading, knew that such statements or documents would be issued, o r acquiesced in the issuance or dissemination of such statements or documents as primar y violations of the federal securities laws. As set forth elsewhere herein in detail, Defendants, by virtue of their receipt of information reflecting the true facts regarding Sara Lee, their contro l over and/or receipt of information of Sara Lee's allegedly materially misleading misstatements
92 and/or their associations with the Company that made them privy to confidential proprietary
information concerning Sara Lee, participated in the fraudulent scheme alleged .
235. As alleged herein, the Company's accounting systems and internal controls were plagued by problems and wholly unreliable during the Class Period . Nevertheless, Defendants elected to include specific projections, including EPS projections, in each of its press release s
and SEC filings announcing earnings, and these forecasts were communicated to analysts durin g conference calls and other presentations . As the Company's accounting systems and internal controls were in disarray, Defendants knew their projections were materially false an d misleading, did not believe the projections or had no reasonable basis for them . Thus,
Defendants conduct in disseminating the materially false and misleading projections wa s intentional, or at a minimum, reckless .
236. In addition, Sara Lee's executive compensation program gave the Individual
Defendants, especially McMillan, a motive to ensure that the truth about the Company's ongoin g business and financial problems were not disclosed to the investing public . Sara Lee's compensation program demonstrates both McMillan's control of the Company, including it s
Board of Directors, as well as an intense focus on his own compensation . Sara Lee's Board approved an executive compensation plan that assured McMillan large rewards even if, as wa s the case in fiscal 2003, the Company's publicly reported financial performance failed to live up to McMillan's promises, and, instead, fell materially below what McMillan had repeatedly le d the market to believe it could expect in his presentations to market analysts, and in statements b y the Company and McMillan in Sara Lee press releases targeted directly to the investing public.
237. Had McMillan been able to continue to cover up the failure of the Reshaping program and its widespread adverse impact on virtually all of Sara Lee's critical indicia of
93 performance - sales, margins, cost reductions and net income - McMillan knew he stood t o collect a potentially huge bonus that would propel his professional standing as a corporat e manager to the very highest levels. Indeed, after Defendants' false and misleading claims that th e
Reshaping program under McMillan's leadership had been, and continued to be successful an d brought Sara Lee out of its stagnant and mediocre earnings doldrums were ultimately exposed as such, McMillan, and his Chief Financial Officer de Kool, nevertheless received extraordina ry bonuses based on criteria that even professional compensation consultants are unable to unravel .
238. Articles about McMillan's compensation in the financial press strongly corroborate his sharp focus on the amount of his bonus and his willingness to use his control of the Company to manipulate its practices for his own benefit . These articles paint a telling, and disturbing, picture. For example, an October 20, 2003 article in Crain's Chicago Business ("Sara
Lee's Pay Policy: Let Steve Eat Cake As Shareholders Diet, CEO McMillan Chows Down") , described McMillan's exorbitant compensation as follows :
At a time when excessive executive compensation has become a kind of corporate scarlet letter bringing down the likes of New York Stock Exchange CEO Richard Grasso Mr . McMillan still collects top-tier pay while his shareholders settle for sub par returns.
Mr. McMillan's nearly $5 million in salary and bonus for the fiscal year ended June 28 [2003] puts him at the head of the pack among CEOs of companies in the Standard & Poor's 500 Packaged Foods Index. During the same period, Chicago-based Sara Lee's stock slumped 11%, more than twice the 5% decline for the index.
Most striking is Mr. McMillan 's $3 .7-million bonus, a figure more than three times his $1 . 1-million salary. CEOs at even the best-performing companies rarely receive bonuses greater than twice their s alaries .
"The board didn't just give (Mr. McMillan) a normal bonus, they gave him an exemplary bonus," says Don Delves, president of Chicago-based executive pay consultancy Delves Group. "They seem to think he did something heroic, but the numbers don't bear it out."
94 Notably, the Delves Group's web site lists Sara Lee as one its clients.
239. In fact, McMillan 's compensation in fiscal 2003, the period during whic h
Defendants were fraudulently deceiving public investors about Sara Lee's business and financia l performance, substantially exceeded what he received in the prior fiscal year . The October 20,
2003 Crain's Chicago Business article reported that in "2003, W. McMillan's salary and bonus climbed 38%, exceeding those of all but one CEO in the peer group of food, consumer products and apparel companies Sara Lee uses for comparative stock performance in its proxy statement."
This is consistent with a report from USA Today, dated June 3, 2003 ( "How CEO Compensation
Packages Compare"). USA Today reported that for fiscal 2002 , Sara Lee paid McMillan near
$3.5 million, consisting of over $1 million in salary and an approximately $2 .5 million payment as a performance bonus Ltd://www .usatoday.com/money/companies/management/2003-03-31- ceo-comp-chart-alpha.htn).
240. Defendant de Kool was also the beneficiary of Sara Lee' s executive compensation policies in fiscal 2003. In fiscal 2002, de Kool received approximately $678,000, consisting of
$301,000 in salary and a bonus of $376,000 . This comparatively paltry compensation reflected the fact that de Kool joined McMillan as his CFO in January 2002, about halfway into fiscal
2002. But his stewardship of the Company's finances under McMillan's leadership was wel l rewarded in the Company's 2003 fiscal year. For the period during which the fraud and financial manipulations complained of here were taking place, de Kool's total compensation in 2003 was over $1 . 2 million, consisting of $395,000 in salary and, a bonus of $839,000. Like McMillan, de
Kool's bonus was more three times his salary .
95 241 . If the Individual Defendants had been able to continue to mislead the investing
public to believe that Sara Lee's performance was improving and more than meeting their
projected earnings, their bonuses would likely have set records for corporate managers in the
United States. Both McMillan and de Kool had a keen interest and powerful motive to keep the
truth about the Company's business and financial condition from the market during the Class
Period.
242. That compensation was a motivating issue for the Individual Defendants is als o
shown by the unique and obscure bonus formula Sara Lee used in fiscal 2003, which included a measurement of "value added earnings," the details and nuances of which Sara Lee has been loath to share with the public, but which, not coincidentally, was consistently favorable to
McMillan's bottom line compensation. Again, from Crain's Chicago Business:
Sara Lee rates Mr. McMillan on this score through a measurement called "value- added earnings "(VAE) -- the company's operating profits minus taxes and an undisclosed charge for capital. VAE accounted for 25% of Mr. McMillan's 2003 bonus, the spokeswoman says.
In 2002, Sara Lee disclosed a VAE of $650 million, but didn't reveal the number for 2003. The spokeswoman says new disclosure policies at the Securities and Exchange Commission in . the wake of the Sarbanes-Oxley Act discourage the release of such numbers, which are not derived from generally accepted accounting principles .
243. This purported sudden scrupulous adherence to federal antifraud securities statutes and GAAP is likely not unrelated to informed estimates that Sara Lee's fiscal 2003 VAE actually declined significantly from 2002, which simply doesn't square with McMillan' s dramatic bonus increase in 2003 . As Crain's reported, Mr. Delves, "applying a standard
'economic value added' (EVA) formula comparable to Sara Lee's VAE calculation, estimates that the company's EVA declined 18% in fiscal 2003 . [A Sara Lee] spokeswoman declined to
96 comment on Mr. Delves' estimate ." Thus, Individual Defendants had a strong conscious motive to "make their numbers" in order to further boost the amount of their already bloate d compensation.
APPLICABILITY OF PRESUMPTION OF RELIANCE : FRAUD-ON-THE-MARKET DOCTRIN E
244. At all relevant times, the market for Sara Lee's securities was an efficient market for the following reasons, among others :
(a) Sara Lee's stock met the requirements for listing, and was listed and actively traded on the NYSE, a highly efficient and automated market;
(b) As a regulated issuer, Sara Lee filed periodic public reports with the SEC and the NYSE ;
(c) Sara Lee regularly communicated with public investors via established market communication mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and
(d) Sara Lee was followed by several securities analysts employed by major brokerage firms who wrote reports that were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace .
245. As a result of the foregoing, the market for Sara Lee 's securities promptly digested current information regarding Sara Lee from all publicly available sources and reflected such information in Sara Lee's stock price. Under these circumstances, all purchasers of Sar a
Lee's securities during the Class Period suffered similar injury through their purchase of Sar a
Lee's securities at artificially inflated prices and a presumption of reliance applies .
97 tos
NO SAFE HARBOR
246. The statutory safe harbor provided for forward-looking statements under certai n circumstances does not apply to any of the allegedly false statements pleaded in this Complaint.
Many of the specific statements pleaded herein were not identified as "forward-lookin g statements" when made . To the extent there were any forward-looking statements, there were n o 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 pleade d herein, Defendants are liable for those false forward-looking statements because at the time eac h of those forward-looking statements was made, the particular speaker knew that the particula r forward-looking statement was false, and/or the forward-looking statement was authorize d and/or approved by an executive officer of Sara Lee who knew that those statements were false when made.
COUNT I Violation Of Section 10(b) The Exchange Act And Rule 10b-5 Promulgated Thereunder Against All Defendants
247. Plaintiffs repeat and reallege each and every allegation contained above as if fully set forth herein.
248 . Throughout the Class Period, Sara Lee and the Individual Defendants, carried ou t a plan, scheme, and course of conduct that was intended to and did: (i) deceive the investing public, including Plaintiffs and the other Class members, as alleged herein ; (ii) artificially inflate and maintain the market price of Sara Lee's securities ; and (iii) cause Plaintiffs and the other
98 members of the Class to purchase Sara Lee's securities at artificially inflated prices. In
furtherance of this unlawful scheme and course of conduct, Defendants took the actions set forth herein.
249. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material fact and/or omitted to state material facts necessary to make th e
statements not misleading ; and (c) engaged in acts, practices, and a course of business that operated as a fraud and deceit upon the purchasers of the Company's securities in an effort t o maintain artificially high market prices for Sara Lee's securities in violation of Section 10(b) of the Exchange Act and Rule lOb-5. Defendants are sued either as primary participants in the wrongful and illegal conduct charged herein or as controlling persons as alleged below .
250. In addition to the duties of full disclosure imposed on Defendants as a result of their making of affirmative statements and reports, or participation in the making of affirmative statements and reports to the investing public, Defendants had a duty to promptly disseminate truthful information that would be material to investors in compliance with the integrated disclosure provisions of the SEC as embodied in SEC Regulation S-X (17 C .F.R. §§ 210.01 et seq.) and Regulation S-K (17 C .F.R. §§ 229.10 et seq.) and other SEC regulations, including accurate and truthful information with respect to the Company's operations, financial condition , and earnings so that the market price of the Company's securities would be based on truthful , complete, and accurate information .
251. Sara Lee and the Individual Defendants, individually and in concert, directly an d indirectly, by the use, means or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal material, adverse information about the business, operations, and future prospects of Sara Lee as specified herein .
99 i OON
252. Defendants employed devices, schemes and artifices to defraud, while i n possession of material, adverse, non-public information and engaged in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of Sara Lee's value an d performance and continued substantial growth, which included the making of, or th e participation in the making of, untrue statements of material facts and omitting to state materia l facts necessary in order to make the statements made about Sara Lee and its business operation s and future prospects in the light of the circumstances under which they were made, no t misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business that operated as a fraud and deceit upon the purchasers of Sara Lee' s securities during the Class Period .
253. The Individual Defendants' primary liability, and controlling person liability, arises from the following facts : (i) the Individual Defendants were high-level officers and/or directors at the Company during the Class Period; (ii) the Individual Defendants were privy to and participated in the creation, development and reporting of the Company's internal budgets, plans, projections and/or reports ; and (iii) the Individual Defendants were aware of the
Company's dissemination of information to the investing public that they knew or recklessly disregarded was materially false and misleading.
254. Defendants had actual knowledge of the misrepresentations and omissions o f material facts set forth herein, or acted with reckless disregard for the truth in that they failed t o ascertain and to disclose such facts, even though such facts were available to them . Such
Defendants' material misrepresentations and/or omissions were done knowingly or recklessl y and for the purpose and effect of concealing Sara Lee's operating condition and future business prospects from the investing public and supporting the artificially inflated price of its securities .
100 s
As demonstrated by Defendants' overstatements and misstatements of the Company's business,
operations and earnings throughout the Class Period, Defendants, if they did not have actual
knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtai n
such knowledge by deliberately refraining from taking those steps necessary to discover whether
those statements were false or misleading.
255. As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market price of Sara Lee's securities
was artificially inflated during the Class Period. In ignorance of the fact that market prices of
Sara Lee's publicly-traded securities were artificially inflated, and relying directly or indirectly
on the false and misleading statements made by Defendants, or upon the integrity of the market
in which the securities trade, and/or on the absence of material, adverse information that was
known to or recklessly disregarded by Defendants but not disclosed in public statements by
Defendants during the Class Period, Plaintiffs and the other members of the Class acquired Sara
Lee securities during the Class Period at artificially high prices and were damaged thereby .
256. At the time of said misrepresentations and omissions, Plaintiffs and the other
members of the Class were ignorant of their falsity, and believed them to be true. Had Plaintiffs
and the other members of the Class and the marketplace known of the true financial conditio n
and business prospects of Sara Lee, which were not disclosed by Defendants, Plaintiffs and the other members of the Class would not have purchased or otherwise acquired their Sara Le e
securities, or, if they had acquired such securities during the Class Period, they would not hav e
done so at the artificially inflated prices that they paid .
257 . By virtue of the foregoing, Defendants have violated Section 10(b) of th e
Exchange Act and Rule lOb-5 promulgated thereunder .
101 258. As a direct and proximate result of Defendants' wrongful conduct , Plaintiffs and the other members of the Class suffered damages in connection with their respective purchases and sales of the Company's securities during the Class Period .
COUNT II Violation Of Section 20(a), O f The Exchange Act Against the Individual Defendants
259. Plaintiffs repeat and reallege each and every allegation contained above as if fully set forth herein.
260. The Individual Defendants acted as controlling persons of Sara Lee within the meaning of Section 20(a) of the Exchange Act as alleged herein . By virtue of their high-level positions, and their ownership and contractual rights, participation in and/or awareness of th e
Company's operations and/or intimate knowledge of the statements filed by the Company wit h the SEC and disseminated to the investing public, the Individual Defendants had the power t o influence and control and did influence and control, directly or indirectly, the decision-making of the Company, including the content and dissemination of the various statements that Plaintiffs contend are false and misleading. The Individual Defendants were provided with or had unlimited access to copies of the Company's reports, press releases, public filings, and othe r statements alleged by Plaintiffs to be misleading prior to and/or shortly after these statement s were issued and had the ability to prevent the issuance of the statements or cause the statement s to be corrected.
261 . In particular, the Individual Defendants had direct and supervisory involvement i n the day-to-day operations of the Company and, therefore, are presumed to have had the power t o control or influence the particular transactions giving rise to the securities violations as allege d herein, and exercised the same .
102 262. As set forth above, Sara Lee and the Individual Defendants each violated Section
10(b) and Rule lOb-5 by their acts and omissions as alleged in this Complaint . By virtue of their positions each as controlling persons, the Individual Defendants are liable pursuant to Sectio n
20(a) of the Exchange Act . As a direct and proximate result of Sara Lee's and the Individua l
Defendants' wrongful conduct, Plaintiffs and the other members of the Class suffered damages in connection with their purchases of the Company's securities during the Class Period .
PRAYER FOR RELIEF
WHEREFORE, Plaintiffs pray for relief and judgment , as follows:
A. Determining that this action is a proper class action, and certifying Plaintiffs as class representatives under Rule 23 of the Federal Rules of Civil Procedure ;
B. Awarding compensatory damages in favor of Plaintiffs and the other members o f the Class against all Defendants, jointly and severally, for all damages sustained as a result o f
Defendants' wrongdoing, in an amount to be proven at trial, including interest thereon ;
C . Awarding Plaintiffs and the Class their reasonable costs and expenses incurred i n this action, including attorneys' fees and expert fees ; and
D. Such other and further relief as the Court may deem just and proper.
JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury.
103 OWN
Dated: January 20, 2004 MUCH SHELIST FREED DENENBERG AMENT & RUBENSTEIN, P.C.
I.
Carol V. Gilden Louis A. Kessler 191 North Wacker Drive Suite 2100 Chicago, Illinois 60601 Telephone: (312) 521-2000 Facsimile.: (312) 521-2100
Member of Plaintiffs' Counsel's Executive Committee
MAGER WHITE & GOLDSTEIN, LLP Jayne Arnold Goldstein Abraham Rappaport 2825 University Drive Suite 350 Coral Springs, Florida 33065 Telephone: (954) 341-0844 Facsimile: (954) 341-0855
Chair of Plaintiffs' Counsel's Executive Committe e
MILBERG WEISS BERSHAD HYNES & LERACH. LLP Lee A. Weiss Jeffrey T. Spinazzola One Pennsylvania Plaza New York, New York 10119-0165 Telephone: (212) 594-5300 Facsimile: (212) 868-1229
Member of Plaintiffs' Counsel's Executive Committee
104