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Newman, Et Al. V. Warnaco Group, Inc., Et Al. 00-CV-6266-Second Amended Consolidated Class Action Complaint

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Newman, Et Al. V. Warnaco Group, Inc., Et Al. 00-CV-6266-Second Amended Consolidated Class Action Complaint UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK IN RE THE WARNACO GROUP, INC. SECURITIES LITIGATION No. 00-C1V-6266 (LMM) THIS DOCUMENT RELATES TO: ALL ACTIONS • • SECOND AMENDED CONSOLIDATED CLASS ACTION COMPLAINT Plaintiffs, individually and on behalf of all other persons similarly situated, by their undersigned attorneys, for their Second Amended Consolidated Class Action Complaint, 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, as detailed in paragraph 16 below, made by and through their attomeys: 1. NATURE OF THE ACTION 1. Plaintiffs bring this action as a class action on behalf of themselves and all other persons who purchased the common stock of defendant The Warnaco Group, Inc. ("Wamaco" or the "Company") on the open market during the period of September 17, 1997 through and including July 19, 2000 (the "Class Period"), to recover damages caused by Defendants' violations of the federal securities laws. During the Class Period, Defendants caused Warnaco to issue false and misleading statements in press releases and public filings concerning Warnaco's financial results for the fiscal years 1997, 1998 and 1999, and the interim periods of 1997 and 1998. Defendants overstated Warnaco's inventory, reported artificially inflated net income and earnings per share and overstated the value of Warnaco's accounts receivable. 9 . Warnaco manufactured significant amounts of merchandise each month _ . which it carried on its balance sheet as inventory. The amount of inventory Warnaco produced depended upon the amount of sales Warnaco had forecasted for each month. Warnaco's Forecasting and Planning Division, which included the heads of the various divisions within Warnaco, regularly met along with Defendants to forecast sales numbers for the upcoming quarters. The Forecasting and Planning Division based its forecasts on orders received from the various department stores to which Warnaco sold its goods. 3. During the Class Period, however, Warnaco's Chief Executive Officer, defendant Linda J. Wachner ("Wachner") forced the Forecasting and Planning Division to increase its sales projections far beyond the Forecasting and Planning Division's attainable sales projections. Unlike the Forecast and Planning Division's sales forecasts which were based upon actual demand, Wacluier's sales forecasts were based on nothing more than sales numbers she had previously provided to analysts. Warnaco's manufacturing plants would operate around-the-clock in an effort to manufacture the amount of product that Wachner had publicly forecasted would be sold. Defendants were aware or recklessly disregarded various fraudulent practices that employees of the Company were undertaking to meet such unrealistic sales goals, including the following: (i) At the end of each quarter, sales representatives, as directed by Defendants, would engage in the practice Defendants dubbed "dialing for dollars." This practice entailed calling customers and persuading them to accept new merchandise in the current quarter and permitting the customer to return in the next quarter older goods that the customers had difficulty selling; 2 (ii) Some goods were simply "pulled, packed and held" at Warnaco distribution centers and gradually shipped over time althou gh booked as a sale in the quarter the product was "pulled, packed and held"; (iii) Sales representatives, as directed by Defendants, routinely asked department stores to accept a new shipment of goods, to hold the shipment at the department store and either to return the product or to pay for it in the next quarter; and (iv) Sales representatives, as directed by Defendants, deliberately shipped to department stores excess inventory during the quarter. By the time the department stores returned the unwanted inventory, a new quarter had begun. 4. Defendants were also aware or recklessly disregarded the fact that the failure to meet such unrealistic sales goals would inevitably lead to an excessive build-up of inventory. Indeed, the amount of merchandise being returned coupled with the surplus being produced resulted in an enormous excess of inventory which soon became obsolete or "distressed," and, thus, should have been written down in value or written off entirely in accordance with Generally Accepted Accounting Principles ("GAAP") and the Company's own publicly stated accounting policy. During 1998, Warnaco leased additional warehouses to store excess inventory. Likewise, during 1998 two Warnaco facilities leased a total of twelve warehouses to store excess material. Similarly, in 1999 Warnaco's Duncansville, Pennsylvania warehouse leased four or five additional warehouses to store merchandise. By December 1999, the amount of inventory offered by Warnaco to department stores resulted in so much merchandise being returned to Warnaco's Murfreesboro, Tennessee warehouse that trucks sat outside the building packed with intimate apparel merchandise returns. 5. In addition to knowingly or recklessly disregarding the build-up of excess inventory, during the Class Period, Wachner and the other Defendants ignored repeated 3 warnings from Warnaco senior management that Wacluier's manipulated and unreasonable forecasts were causing this massive build-up of excess inventory. Defendants even went so far as to terminate members of Senior Management who complained about Wachner's unreasonable forecasting practices. 6. Rather than properly account for the excess inventory in accordance with GAAP and the Company's own publicly stated accounting policy, Defendants knowingly or recklessly overstated Warnaco's inventory throughout the Class Period. As a result, the Company was able to report "record" earnings for the third quarter of 1997, fiscal year 1997 and the first and second quarters of 1998. As a result of the fraud, Warnaco was able to announce that the Company had either met or exceeded earnings analysts' expectations for the third quarter of 1997 and the first three quarters of 1998. 7. On April 2, 1999, the Company disclosed that it had to "revise" its previously reported financial results for fiscal years 1996, 1997 and the first three quarters of 1998. The Company attributed the need to "revise" its financial results to the Company's early adoption of a change in accounting principle. The "revisions" resulted in significant reductions to the value of Warnaco's inventory and, consequently, reductions in the Company's net income and earnings. In "revising" its results, Warnaco reduced its net income by 154%, 263%, 49.3% and 38.9% for fiscal year 1997 and the first, second and third quarters of 1998, respectively. Further, unlike its previously reported financial results, Warnaco's "revised" earnings per share fell significantly below the earnings expectations of analysts which the Company had previously appeared to meet or exceed. 4 8. On May 16, 2000, only six months after retaining new independent auditors, the Company filed amended financial results for fiscal years 1998 and 1999 and the interim periods of 1998 and 1999. In addition, the Company's amended financial filings detailed the true nature of the restatements and a sizeable write-down of inventory for fiscal years 1996, 1997 and 1998. In these amended filings, the Company admitted that it actually "restated" its financial results for fiscal years 1996, 1997 and the first three quarters of 1998. Wamaco no longer claimed that its April 1999 "revisions" (which the Company now deemed "restatements") resulted from the Company's early adoption of a new accounting principle. Indeed, the accounting principle upon which the Company claimed to have caused the April 1999 "revision" specifically prohibits a Company from restating its financial results due to its adoption. Contrary to Defendants' earlier, and seemingly benign, explanation for the April 1999 "revisions," the Company's May 2000 disclosure attributed the restatement to "flaws in the Company's Intimate Apparel Division inventory costing control system" and claimed that the Company had since rectified such "flaws." 9. As a result of the Company's disclosure on May 16, 2000, Warnaco's stock fell from a closing price of $8.56 on May 16, 2000 to $8.00 on May 18, 2000, a drop of 6.5%. 10. Despite this new information relative to fiscal years 1996 and 1997 and the first three quarters of 1998, Warnaco still kept hidden the true state of affairs at the Company. Indeed, the Company blithely and falsely claimed in the 1998 10-IQA that the "restatement resulted from flaws in the Company's Intimate Apparel Division inventory costing control system that have since been addressed." (Emphasis added.) 5 11. On July 20, 2000, before the opening of the market, Warnaco revealed that, despite its recent public assurances in May 2000 of having addressed and resolved all inventory issues, Warnaco anticipated taking an afier-tax charge in the second quarter of fiscal year 2000 of approximately $60 million to $70 million due in part to further inventory reductions. Consequently, the Company revealed that the so-called "flaws" in its inventory costing system had not been fixed. hi truth, the Company's restatement and further reduction in inventory resulted from Defendants': (i) knowing or reckless disregard for a tremendous build-up of excess, obsolete and distressed inventory; and (ii) improper accounting for inventory. 12. As a result of the Company's July 20, 2000 disclosure, the Company's stock dropped from
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