C!' ORIGINAL h 1 f ,:- il 1 MILBERG WEISS BERSHAD ; .I 1.,. :*-, HYNES t LERACH LLP -- 2 WILLIAM S. LERACH (68581) DAVID C. WALTON (167268) 3 MICHAEL L. SCHRAG (185832) 600 West Broadway, Suite1800 - San Diego, CA Diego,4 San 92101 .I Telephone: 619/231-1058 5 LAW OFFICES OF BRUCE G. MURPHY 6 BRUCE G. MURPHY 265 Llwyds Lane 7 Vero Beach, FL 32963 Telephone: 561/231-4202 8 Attorneys for Plaintiff 9
10 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA 11 1 12 rn 1 ;:, '4 BRIAN JOHNSON, On Behalf of Himself ) No.93 Cv 0 9 2 ratl 13 and All Others Similarly Situated, ) ) CLASS ACTION 14 Plaintiff, 1 0 ) COMPLAINT FOR VIOLATIONOF 15 vs . ) THE SECURITIES EXCHANGE ACT ) OF 1934 16 ASHWORTH, INC., RANDALLL. HERREL, 1 SR. , GERALD W. MONTIEL, JOHN L. 1 17 ASHWORTH, A. JOHN NEWMAN, ANDRE P.1 GAMBUCCI, FRED COUPLES and MARY 1 18 MONTIEL, 1 1 19 Defendants. ) Plaintiff Demands A ) Trial BY Jury 20
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26 e 27 28 I e 1 SUMMARY AND OVERVIEW 2 1. This is a securities class action on behalf of all
3 purchasers of the common stock of Ashworth, Inc. (tqAshworthlt or the
4 ttCompanytq)between 9/4/97 and 7/15/98 (the ttClassPeriodtt), against
5 Ashworth and certain of its officers and directors for violations
6 of the Securities Exchange Act 1934 of (the qq1934Actqt).
7 2. Ashworth designs, markets and distributes sports apparel,
0 headwear and shoes with products retailing in golf proshops,
9 resorts and department stores. After a successful 1993-1994,
10 during which Ashworth was profitable and its stock traded in the
11 $10-$14 range, Ashworth‘s business performed very poorly1995 from
12 to mid-97 due to serious inventory problems, quality-control
13 issues, and flat sales. As a result, Ashworth’s stock plungedto
14 the $5-$7 range for much 1995of and 1996, as Ashworth experienced
15 no sales growth and declining gross margins due to poor forecasting
16 and extensive mark-down activity. This resulted in Ashworth
17 reporting earnings per share(tqEPStt) of only $0.12 in each ofF95
18 and F96 afterreporting $0.34 and $0.40 in F93 and F94,
19 respectively.’ Because of these results, Ashworth hireda new CEO
20 in 12/96 and started several new initiativesto improve operating
21 results, including hiring new heads of design,of retail sales,Of
22 information systems and sourcing; increasing the percentage of
23 offshore production (or sourcing) from 10% to 50%; improved
24 forecasting; and new sales programs, in ordernot only to increase
25 sales butto also reduce the likelihoodof future inventory write-
26 downs. e 27 28 1 Ashworth’s fiscal year ends on 10/31.
-1- e 1 3. As a result of Ashworth's low stock price, executives and 2 directors had thousands of optionsto purchase Ashworth's stock at
3 $5.75 to $6.50 per share and were desirous to see Ashworth's stock
4 price increaseso they could exercise their options and immediately
5 sell the shares for risk-free profits. Additionally, the executive
6 officers were paid bonuses based on Ashworth's EPS.
7 4. In F97, Ashworth's business appeared to stage a major
8 recovery, as Ashworth reported increasing gross margins and strong
9 EPSgrowth. As a resultof Ashworth's F97 andearly F98
10 performance, which was coupled with (and made more credible)
11 forecasts of even strongerEPS growth in F98 and F99, Ashworth's
12 stock wasa very strong performer, moving up $14 to by early 1/98
13 and on toa Class Period high $18of per share in3/98. During the @ 14 ClassPeriod, Ashworth's executives made extremely positive 15 statements about Ashworth's business. They told investors Ashworth
16 was enjoying strona demand for most of its products and was
17 successfully moving its production operations offshore, which was
18 providing operating efficiencies and reducing costs which would
19 boost Ashworth's gross margins 40%to in F98. Ashworth management
20 also said the Company made its products at more than one offshore
21 plant, thereby dismissing concerns that offshore production was
22 risky in terms of quality,f.g., if one factory had manufacturing
23 problems, the same product could be secured from another factory.
24 Ashworth assured investors that its redeveloped infrastructure was
25 yielding stronger demand and higher margins. When investors noted
26 that inventories appeared high compared to Ashworth's sales, Ashworth management represented that inventories were appropriate a 27 28 for theCompany's future growth and that inventories were
-2- intentionallyhigh to satisfy order bookings. According to
2 Ashworth, inventory Itincreased35% and was on plan" for year-end
3 and Ashworth was essentially on toplan achieve F98 gross margins
4 of 40% and EPS of$0.60+.
5 5. However, Ashworth's apparent return to prosperity, higher
6 gross margins and strong EPS was quite short lived. In 7/98,
7 Ashworth revealed very disappointing 3rdQF98 results, well below
8 forecasted levels, and that it expected poor results for the
9 balance of F98. Ashworth later admitted that it had experienced
10 production problems in offshore factories and had inadequate
11 quality control in those facilities and that it was going to
12 implement double sourcing (essentially admitting that, contraryto
13 prior representations, it did not have double .sourcing) Upon this news, Ashworth's stock declined to $8-1/8 on huge volume of 7.9
15 million shares, more than 19 times its daily average. Ashworth
16 later disclosed that bookings itsfor Basics line were well below
17 prior levels and that overall orders were well below prior
18 forecasts. Ashworth's 4thQ F98 results were horrible witha net
19 loss due to Ilinventory adjustments. Ashworth's stock has never
20 recovered and subsequent to the Class Period has traded$5 at below
21 per share.
22 6. Ashworth's poor 2ndH F98 results, compared to the strong
23 earnings growth forecast during the Class Period, which resulted 24 from adverse conditions and trends in Ashworth's business durinq
25 the Class Period which defendants concealed, are shown below:
26 a 27 28
-3- 1 Ashworth Quarterly and Annual Results e (in thousands, exceptEPS) 2 1994 3 01/31 04/30 07/31 10/31 Year Revenues $ 11,040 $ 21,270 $ 16,960 $ 11,570 60,840 Net income $ 720 $ 2,480 $ 1;530 13 0 4,860 4 EPS $.06 $.20 $. 13 ($. 01) $ .40 5 -1995 01/31 04/30 07/31 10/31 Year Revenues $ 14,590 $ 26,440 $ 20,390 $ 13,110 74,520 6 Net income $ 810 $ 1,810 $ 810 ($ 2,020) 1,400 EPS $.07 $. 15 $.07 ($ .17) .12 7 1996 01/31 04 /3 0 07/31 10/31 Year 8 Revenues $ 17,070 $ 26,360 $ 17,880 $ 14,100 75,410 Net income $ 830 $ 2,520 $ 200 ($ 2,150) 1,400 9 EPS $.07 $.21 $.02 ($.I81 $.12 1997 10 01/31 04/30 07/31 10/31 Year Revenues $ 19,840 $ 30,620 $ 21,700 $ 16,990 89,150 11 Net income $ 1,160 $ 2,890 $ 770 $ 4 $ 4,830 EPS $.lo $ .24 $.06 $0.00 $0.37 12 -1998 01/31 04/30 07/31 10/31 Year 13 Revenues $ 24,030 $ 38,060 $ 25,600 $ 19,660 107,340 Net income $ 1,860 $ 4,520 $ 782 $ (1,860) $ 5,300 EPS $.14 S.30 $0.05 $(0.13) $0.36 7. Ashworth's CEO, Randall Herrel,was compensated basedon 15 EPS growth and thus benefitted from Ashworth reporting favorable 16 F97 results and was on track to benefit from Ashworth'sF98 EPS 17 growth. Herrel received a $50,000 bonus based onF97 results and 18 was to receive $75,000 if Ashworth reported $0.55 in F98 plus 19 $25,000 for each$0.01 by which Ashworth exceeded$.55 per share. 20 While Ashworth's stock was inflated during the Class Period, 21 certain of Ashworth's top executives and directors named as 22 defendants also unloaded more than 1.5 million shares of their 23 Ashworth stock-- reaping $20.7 million in illegal insider-trading 24 proceeds! Ashworth's top executives sold between41%-100% of the 25 Ashworth stock they actually --owned 75% of their collective stock 26 ownership.
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-4- 1 8. Defendants' insider trading was substantial, as shown by
2 the table and chart below:
3 0 of Shares Shares Actually Owned Defendants Sold Proceeds -Sold 4 Ashworth $609,922 $7,358,512 99% 5 couples 325,000 $4,681,250 41% Gambuc c i 31,500 $ 367,095 59% G. Montiel 452,000 $6,622,072 95% 6 M. Montiel 61,000 $ 982,000 100% Newman 48,000 710,320 -1000 7 TOTALS : 1,527,422$20,721,249 -75% 8
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10 Ashworth, Inc.
11 August 1,1997 - September 28,1998 12 Daily Stock Prices 13 20 Insider defendants 14 sell 613,000 shares 611 9-29/90 18 for $10,453,070 Insider defendants sell 7,000shares for $104,122 15 919-1 0117/97 Insider defendants 16 16 - sell 661,422 shares for $6,920,807 17 I \ c 14 cn 18 s \ 12 19 E -I 20 po 10
21 8 Insider defendants sell 236,000 shares 22 for $3,113,250 6 23
24 4 I I I I I I I ! I I I 08/01I97 09/29/97 11/24/97 01 126198 03/24/9805/20/98 0711 7/98 09114/98 25 08/29/9710/27/97 2/23/971 02/24/98 04/22/98 0611 8/98 0811 4/98 26
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-5- @ 1 9. Ashworth's stock-price action between 1/96 and 1/99 -- 2 showing how Ashworth's stock price was artificially inflated during 3 the Class Period-- is set forth below:
4 Ashworth, Inc.
5 January 2,1996 - January 11,1999 6 Daily Stock Prices 20 7 - a 18
9 16 -
10 D 14 - 11 E 52 . 5 12 L IVO . 13 5 '8'
1E 6
1C 4- 1; I ! I I 1 I I ! I ~ i I1 2 ! 12 01IOU96 06105196 11/06/96 04114/970911 6/97 02/20198 07/27/98 12/29/98 0311 9/9608/21 196 01124197 06/30/9712/02/97 05/08/98 1 011 2/98
10. The positive representations and forecasts made about 2: Ashworth during the Class Period were false. During the Class 2: Period, defendants knowingly or recklessly failedto disclose the 2: following actual facts about Ashworth: 2, (a)Ashworth's new, redeveloped infrastructure, 2 including its increasing use of offshore factories, was extremely 2 troubled with inadequate quality-control testing and insufficient a 2 supervision which, while generating short-term cost Savings, would 2 require dramatically higher costs in futureto periodssuccessfully manufacture,supervise and monitor manufacturing in these locations; 3 (b) Due to problems in matching production with demand,
4 Ashworth had accumulated large amounts of excessive inventories of
5 its Basics product line which were encountering extreme price
6 pressure in the marketplace while at the same time Ashworth was
7 unable to promptly produce significant amounts of other products which were in strong demand and commanded higher, more profitable,
9 prices;
10 (c) Ashworth's attempts to accelerate the relocation of
11 larger amounts of its manufacturing operations offshore were
12 resulting in significant operational inefficiencies and greatly
13 increased expense which was much more than offsetting the wage
14 savings obtained by such offshore production;
15 (d) Ashworth's offshore sewing production was not double
16 sourced, meaning Ashworth in fact did not have multiple sources for
17 its products so that if one of theoff shore facilities ran into
1% production problems, another of the facilities would not have
19 replacement product available for shipment. Also, Ashworth could
20 not control the inventories at the offshore factories, resulting in
21 the accumulation of excessive inventories and an inability to
22 produce other in-demand products;
23 (e) Ashworth's European operations were plagued by
24 outmoded and inefficient management, manufacturing and distribution
25 facilities and very soft demand for Ashworth's products there,
26 resulting in excessive inventories and operational results far a 27 below those internally budgeted and forecasted and necessary for 28
-7- J.. Ashworth to meet the revenue and EPS growth it was publicly e2forecasting; (f) Ashworth's financial results during the Class Period were falsified, manipulated and overstated as detailedqq52-62, in includingthe failure to properly write down excessive inventories, which falsification was done to conceal from the market the true negative conditions in Ashworth's business which were, in fact,
8 then adversely affecting its results from operations and which
9 demonstrated that Ashworth's supposed turn-arounda failurewas --
10 not a success;
11 (9) Ashworthwas suffering from weakening demand,
12 particularly for its Basics product line which was an important
13 part of its overall product line and would adverselyF98 affect its
14 and F99 results;
15 (h) Ashworth's inventories were not on plan but in fact
16 were above Ashworth's internal budgets and forecasts and excessive
17 in light of the actual demand for Ashworth's products and
18 Ashworth's actual rate of sales;
19 (i) New management had notI'f ixed" Ashworth's inventory
20 problems;
21 (j) Ashworth's financial strategy was not unfolding in
22 a positive manner or as planned, but rather, was failing, which
23 failurewas being covered up and concealed by Ashworth's
24 misrepresentationsand the falsification of its financial
25 statements detailed inqq52-62;
26 (k) Ashworth's selection of offshore sourcing was not e 27 the careful, detailed process described by defendants, but in fact 28
-8- 't J. was done haphazardly without implementing procedures which would e 2 assure quality throughout the manufacturing process;
3 (1) Ashworth's restructuring and/or turn-around had not
4 and was not succeeding, but rather, was failing due to the problems
5 afflicting its business as set forth above, which failure was being
6 covered up and concealed by defendants' false statements as
7 detailed herein;
8 (m) As a result of the foregoing adverse conditions in
9 Ashworth's business, defendants knew that their offorecasts strong
10 earnings for Ashworth during F98-F99 would not materialize and
11 therefore Ashworth would not achieve the EPS growth being forecast
12 by it forF98-F99 and beyond; and
13 (n) As a result of the foregoing negative conditions
14 which were adversely affecting Ashworth's business during the Class @ 1c Period, defendants knew that the forecastsof revenue growth in
16 F98-F99 and growth in EPS$.61+ to and $.85 respectively, were each
17 false when made, as those results could not and would not be
18 achieved.
19 JURISDICTION AND VENUE
20 11. Jurisdiction is conferred by S27 of the 1934 Act. The
21 claims asserted herein arise under SSlO(b) and20(a) of the 1934
22 Act and Rule lob-5.
23 12. Venue is proper in this District pursuantto §27 of the
24 1934 Act. Many of the false and misleading statements were made in
25 or issued from this District.
26 13. The Company's operational headquarters are in San Diego, California, where the day-to-day operations of the Company are
28 directed and managed.
-9- THE PARTIES e 2 14. Plaintiff Brian Johnson purchased shares of Ashworth
3 common stock as described in the attached certification and was 4 damaged thereby. 5 15.Defendant Ashworth is a designer,marketer, and
6 distributor of sports apparel, headwear and shoes under the 7 Ashworthbrand name. Ashworth's common stock trades in an
8 efficient market on the NASDAQ National Market System.
9 16. (a) Defendant RandallL. Herrel, Sr. (llHerrelll) beenhas
10 President and CEO of Ashworth 12/96since and isa director of the
11 Company. During the Class Period and as part of the fraudulent
12 scheme, Herrel receiveda $50,000 bonus for Ashworth's F97 results
13 and was set to receive additional bonuses based on F98 results. 14 (b)Defendant Gerald W. Montiel (IIG. Montiel")is 15 Chairman of the Board of Ashworth. G. Montiel announced his
16 retirement after Ashworth disclosed its poor 2ndH F98 results and
17 diminished prospects and after he unloaded 95% of his stock 18 holdings. During the Class Period, andas part of the fraudulent
19 scheme, G. Montiel sold 452,000 shares of Ashworth stock at prices
20 as highas $17.93 per share basedon inside information, pocketing
21 over $6.6 million.
22 (c) Defendant A. John Newman ( llNewmangg) is Chief
23 Financial Officer of the Company. During the Class Period, and as
24 part of the fraudulent scheme, Newman sold 48,000 shares of 25 Ashworth stock at prices as highas $16.14 per share, pocketing
26 over $710,000. These sales constituted100% of the Ashworth stock Newman actually owned. 28
- 10 - 1 Defendant John L. Ashworth ("J. Ashworthll) is a e 2 director of the Company. During the Class Period, and as part of
3 the fraudulent scheme,J. Ashworth sold 609,922 shares of Ashworth
4 stock at prices as high as $16.37 per share based on inside
5 information, pocketing over$7.3 million. These sales constituted
6 99% of the Ashworth stockJ. Ashworth actually owned.
7 (e) Defendant Andre P. Gambucci ( ltGambuccif1) is a
8 director of the Company. During the Class Period, and as part of
9 the fraudulent scheme, Gambucci sold 31,500 shares of Ashworth
10 stock at prices as high as $13.00 per share based on inside
11 information, pocketing over$367,000. These sales constituted59%
12 of the Ashworth stock Gambucci actually owned.
13 (f) Defendant Fred Couples ("Couples")is a director of
14 the Company. During the Class Period and as part of the fraudulent
15 scheme, Couples sold325,000 shares of Ashworth stock at prices as
16 high as $17.00 per share based on inside information, pocketing
17 over $4.6 million. These sales constituted 41% of the Ashworth
18 stock Couples actually owned.
19 (9) Defendant Mary Montiel (*'Mary Montiell!) is Vice
20 President-Manufacturing of the Company. During the Class Period,
21 and as part of the fraudulent scheme, Mary Montiel sold 61,000
22 shares of Ashworth stock at prices as high $17.00as per share,
23 based on inside information, pocketing $982,000. These sales
24 constituted 100% of the Ashworth stock Mary Montiel actually owned.
25 17. The individuals named as defendants inn16 (a)- (9) are
26 referred to herein as the IIIndividual Defendants. The Individual Defendants, because of their positions with the Company, possessed
28 the power and authority to control the contents of Ashworth's
- 11 - 1 A quarterly and annual reports, press releases and presentations to e 2 securities analysts, money and portfolio managers and institutional
3 investors, i.g., the market. Each defendant was provided with
4 copies of the Company's reports and press releases alleged herein
5 to be misleading prior to or shortly after their issuance and had
6 the ability and opportunity to prevent their issuance or cause them 7 to be corrected. Because of their positions and toaccess material a non-public information available to them but not to the public, 9 each of these defendants knew,that the adverse facts specified
10 herein had not been disclosed to and were being concealed from the
11 public and that the positive representations which were being made 12 were then materially false and misleading. Despite their duty not
13 to sell their Ashworth stock under such circumstances, defendants
14 nonetheless did so. The Individual Defendants are liable for the
0 15 false statements pleaded hereinnn23, at26, 30-31 and 36, as those
16 statements were each 91group-published99 information,the result of
17 the collective action of the Individual Defendants.
18 MOTIVE AND OPPORTUNITY
19 18. Defendants Herrel, Newman, G. Montiel, J. Ashworth,
20 Couples, Gambucci, and Mary Montiel each also the had motive and
21 the opportunity to make the false statements and perpetrate the
22 scheme described herein.
23 19. The Individual Defendants had the opportunityto Commit
24 the fraud complained of. Ashworth's top executives and directors
25 controlled or supplied Ashworth's publicly issued financial state-
26 mentsand the disclosures made in them, Ashworth's public statements and its SEC filings and thus could falsify them. Each
28 of the Individual Defendants were in a position to learn about
- 12 - Ashworth's true operating results and prospects due to their
2 attendance at management and board meetings and/or in conversations
3 with other directors and executive officers.
4 20. During 11/96, as Ashworth's stock had been in a down
5 cycle for overa year and Ashworth reported disappointing results,
6 Ashworth hired Herrel to replaceG. Montiel asCEO after G. Montiel
7 hadserved as interim CEO since 1/96. Partof Herrel's
8 compensation involved bonuses based on EPS growthF97 and F99in as
9 follows: 10 A $50,000 bonus was awarded to Mr. Herrel, payable in January 1998, based on the Company's improved earnings 11 per share in fiscal year1997. For fiscal year1998, Mr. Herrel will be paida bonus basedon earnings per share. 12 If the earnings per share are at least$.55 he will be paid a bonus of $75,000. For each $.01 increase in 13 earnings per share over $. 55 he will be paid an additional $25,000, to maximuma total bonusof $200,000. 14 FRAUDULENT SCHEMEAND COURSE OF BUSINESS @ 15 21. Each defendant is liable for (i) making false statements, 16 -or (ii) failing to disclose adverse facts known to him about 17 Ashworth while selling Ashworth stock,or (iii) participating ina 18 fraudulent scheme which permitted defendantsto sell more than1.5 19
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inflated prices; and (iv) permitted the defendantsto sell off more 1 than 1.5 million shares of their Ashworth stock, pocketing$20.7 0 2 million in insider-trading proceeds. 3 BACKGROUND TO THE CLASS PERIOD
4 22. Ashworth designs, markets and distributes sports apparel,
5 headwear and shoes under the Ashworth name with products sold at
6 the retail level through golf pro shops, resorts and department
7 stores. After its IPO, the Company's stock wasa good performer,
8 trading in the $10 to $14 dollar range, as the Company reported
9 growing revenues and earnings during1993 and 1994. In 1995 and
10 1996, Ashworth's revenue growth ceased and it reported EPS of only
11 $. 12 per share in each of F95 and F96, respectively, after
12 reporting $. 34 and $.40 per share in F93 and F94, respectively.
13 The Company'sresults were adversely affected by excessive
14 inventory and extensive mark-downs. This led to the ouster of e 15 Ashworth's former CEO and the restructuring of the business. 16 Defendant G. Montiel served as interimCEO during 1996 until 11/96
17 whenHerrel was named CEO. The Company restructured it's
18 operations and madea decision to move much it's of production to
19 off shore factories where wages were lower and the Company could
20 achieve higher gross margins and earnings. In 2/97, Ashworth
21 represented that inventory levels had decreased Itprimarily due to
22 better forecasting and tighter control on inventory levels." The
23 Company alsostartedto increase its sales presence internationally
24 to increase its growth prospects beyond the United States.
25 Therefore,defendants sought to report favorable earnings
26 consistent with a growing company that had recovered from its 0 27 earlier problems, and that had corrected its inventory problems 28 that adversely affected earnings in past years.
- 14 - FALSE AND MISLEADING STATEMENTS e 2 23. On 9/4/97, Ashworth reported improved 3rdQF97 results -- 3 revenues of $21.7 million, net income of$767,000 and EPS of$.06
4 -- all increases over results in the same period in F96.
5 Ashworth's release also stated:
6 Randall L.Herrel, Sr., President and Chief Executive Officer of Ashworth, Inc. (Nasdaq: ASHW) today 7 announced an improvement in financial results for the third quarter and nine months ended 31,July 1997. 8 *** 9 In reviewing operations,Mr. Herrel stated thatthe 10 improvement in operating income for the third quarter resultedprimarily from a substantialincrease in 11 domestic sales, which reflectedthe increasing demand for theAshworth brand. . . . TheCompany added an 12 additional 40 locations to its in-store shop program during the third quarter bringingthe total number of 13 commitments since November 1996 to 165. Mr. Herrel reported that accounts receivable had increased 15.8% 14 from a year ago and inventories by 2.6%, but these increases were lower than the sales increase21.4% for of 15 the quarter.The Company's liquidity has improved substantially from a year go. There were no bank 16 borrowings at July31, 1997, compared with $3,725,000 a yearearlier. Working capital has increased by 17 $5,838,000 sinceJuly 1996 to $39,184,000. Early customer reaction to the new lines for Spring& Summer 18 1998 has been noticeably stronger than it was at this time last year. 19 Ashworth,Inc. is a SouthernCalifornia-based 20 designer and manufacturer of golf-inspired sportswear distributed domestically and internationally in golf pro 21 shops, resorts and upscale department and specialty stores. 22 24. After releasing its 3rdQF97 results, Ashworth management 23 (Herrell/Newman) spoke to analysts, money managers and large 24 stockholders regarding the Company's business and prospects, 25 telling them that: 26 0 Pre-booking activity for the spring of 1998 was UP sharply and the outlook for both domestic and European business was excellent. 28
- 15 - 1 I a Inventory was well balanced and prior season merchandise would be depleted by year-end, positioning Ashworth for a e 2 strong F98. 3 a Ashworth's initiatives to reduce selling, general and administrative expenses were successful and would lead to 4 superior profit margins F98in and beyond.
5 a Ashworth was expanding its basics line which would cause sales growth in the green grass shops to continue. 6 a Ashworth was openinga full-priced retail outlet in9/97 7 which would promote Ashwortha lifestyleas brand and leadto strong sales and margins. 8 a Ashworth received ordersto open 40 Golfman shops in 3rdQ 9 F97 and was on track to 400have shops open by10/98.
10 a Ashworth was on track to have EPS $0.56of in F98.
11 Analysts repeated this information to the market including ina
12 report by Wedbush Morgan Securities dated9/5/97.
13 25. On 12/8/97, Ferris, Baker Watts, Inc. issueda report on
14 Ashworth, written by Joseph Teklits, which was based on, and
@ 15 repeated, information provided him in conversations withG. Herrel,
16 Montiel or Newman. The report forecast 1998 EPS of $.56 and
17 stated:
18
19
20 Investment Thesis:
21 Ashworth broke out a ofdifficult transition period in 1997, and we believe it will break away from much of 22 the competition in 1998. Ashworth is proving to be another example of an investment theme we cater to: a 23 very strong franchise that falls on hard times but maintains its brand equity, and with the help of new 24 management and/or other initiatives, emerges stronger than ever (L.S., Timberland, Liz Claiborne, Pacific 2E Sunwear, Sears, etc. ) . Another perfect example is Quicksilver. Randy Herrel, Ashworth's Pres.& CEO, took 2E over as Presidentof Quicksilver (surf-inspired apparel) in 1993. At that time, Quicksilver was very similarto Ashworth when Herrel joined in December1996 in terms of size, market position and infrastructure. In roughly 2E three years, Quicksilver shares appreciated from$6 to
- 16 - 1 I $47. ASHW shares have doubled over the past 12 months, but we believe another similar move is verypossible over e 2 the next 18 months.
3 The company is expected to report Q4 (Oct):97 results on December 17; we are estimating EPS of $(.01) 4 but believe the company could report its first ever break-even fourth quarter. Our price target for Ashworth 5 shares is $18 in 12 months based on 22-times (on 46% growth) projected fiscal 1999 EPS of $0.82. We rate ASHW 6 a Strong Buy. 7 Why are we confident in our thesis? Everything is jellingvvperfectly for Ashworth. Golf and 8 golf-lifestyle apparel are hot and the demographics are strongly in favor of the industry (see Industry Overview 9 report). The company has the number one brand in its industry according to various polls, and it has the 10 strongest management team in its history including a proven new CEO. Also, bookings suggest that the Ashworth 11 product isin great demand, and redevelopeda infrastructure is allowing for improved margins. 12 26. On 12/17/97, Ashworth reported improved results for the 13 4thQ and year ended 10/31/97, including annual sales of $89.1 14 million, net income of$4.8 million and EPS of $.37 and quarterly e ?E sales of $17.0 million, net income of $4,000 and break-even 16 earnings compared to a loss of $. 18 in the 4thQ of F96. The 17 release also stated: 18 Randall L. Herrel, Sr., President and Chief 19 Executive Officer of Ashworth, Inc. (Nasdaq: ASHW) today announced an improvement in financial results for the 20 year end and fourth quarter ended October 31, 1997.
21 *** 22 In reviewing operations, Mr. Herrel stated that the improvement in overall operating performance in fiscal 23 1997 was a result of a substantial increase in Domestic and European sales which reflected the increasing demand 24 for theAshworth brand and increased market share in its Core green grass accounts. As previously stated, during 25 the year the Company implemented a number of programs including reducing SG&A and overhead by approximately 26 $2,000,000, significantly reducing prior season inventory, strengtheningthe infrastructure, including an improved information system and related procedures, adding key personnel to themanagement team and generally 28 streamlining the overall operations of the Company. ~r.
- 17 - Herrel further commented that the Company's product development process including coordination of design, e 2 production and sourcing, was significantly strengthened and streamlined. ***
Mr. Herrel reported that inventories increased 36% and was on plan for Year end. The Company's growth in inventory reflects future booking trends as well as additional inventory to fulfill its new young men's business, additional department store penetration and its new corporate sales division. Accounts receivable increased 35% which reflected stronger sales trends as well as extended dating for its new basics program launched in mid1997.
27. Subsequent to the release of (its 4thQ and F97 results, 10 Ashworth management (Herrel and Newman) spoke to securities 11 analysts, money and portfolio managers, institutional investors, 12 large Ashworth shareholders, brokers and stock traders to discuss 13 Ashworth's business and its prospects. During the conversations, 14 Ashworth management directly disseminated important information to @ 15 the market by stating: 16 e Ashworth's better-than-expected results were the result 17 of new management's initiatives and successful new product development. 18 e Demand for and sales of Ashworth's core products was 19 strong, and new order bookings were up significantly for the next fiscal year. 20 e Ashworth's relocation of its manufacturing operations 21 offshore was agreat success and was yielding cost savings and operating efficiencies, which would lead to continued gross 22 margin growth to 40%+ in F98.
23 e Ashworth had signed on new Japanese and Asian distributors which would contribute to increased earnings in 24 F98 and beyond.
25 e Inventory had increased 36% but this was intentionally done to accommodate future sales due to strong bookings. 26 Ashworth had hired a new sourcing director who would make sure Ashworth had a smooth transition to outsourcing in Asia, South America and Europe. 28
- 18 - 0 Ashworth was on track to haveEPS of $0.57 and $0.82 in F98 and F99. 0 2 28. On 12/18/97, Ferris, Baker Watts issued a report on Ashworth which was written by Teklits and was based on and repeated
Ashworth management's statements. The report rated Ashworth a "strong buy and forecast the followingF98 EPS: 6 1998 7 Jan .12 APr .30 8 Jul .ll Oct -.05 9 FY .57
10 The report also stated:
11 * Bookingsare up significantly for Spring/Summer 1998. Green grass (gold course shop) core distribution 12 bookings are 40%,up and department store bookings are up over 50%. We are raising ourFY98 top-line growth rate 13 projection by 100 basis points to19.4%.
14 ***
15 * We are fine-tuning our fiscal 1998 estimate up by $0.01 to $0.57; maintaining fiscal1999 at $0.82 on more 16 shares than originally projected; and continue to rate the stock a Strong Buy witha 12-month price target of 17 $18.
18 * Summary and Valuation
19 Ashworth concluded fiscal1997 with its strongest- ever fourth quarter (first time the company has not lost 20 money in the quarter), and with very healthy bookings trends for Spring/Summer 1998. After two flat years, 21 Spring/Summer bookings are up over40% in the company's core green grass (golf course pro shop) distribution 22 channel, and over 50% in the newer department store channel. Such numbers, combined with1) the introduction 23 Of a women's line in Fall 1998, 2) the signing of new Asian and Japanese distributors, and3) a cushion from 24 incremental corporate business, gives us comfort in our new 19.4% revenue growth estimate (raised from18.4%). 25 1997 was a big year for Ashworth, but not justin 2€ terms of earnings. The company has emerged froma two- yearlull, and with new management and product development talent has positioned itself for significant future growth. EPS are projected to grow at an average 2E of 50% over the next two years. We believe Ashworth
- 19 - shares can appreciate to$18 in 12 months based on22- times projected fiscal (October) 1999 EPS of 0.82. We e 2 rate ASHWa Strong Buy. 3 29. On 1/7/98, a story on Ashworth was published by The Wall
4 Street Journal, authored by Mark Veverka, which stated:
5 Ashworth has its eye on the ball.
6 After a couple of years in the rough, the Carlsbad- based maker of golf togs started to find its game last 7 year. Today, the company is in the middle of a nifty turnaround, and could possibly climb back onto the leader 8 board of apparel growth stocks this year, analysts say.
9 tlThey're positioned for a great '98,!* says stock analyst JohnD. Olinski of Wedbush Morgan Securities in 10 Los Angeles, who rates the stocka 19buytv witha 12-month price target of $16. It now trades around $11.50. 11 Just into his second year as Ashworth's chief 12 executive, former surf-wear executive Randall Herrel has restored Ashworth's earnings growth. The company only 13 earned 12 cents a share in the fiscal years 1995 and 1996, compared with 41 cents a share in fiscal 1994. 14 He's done it by fixing some of the 10-year-old COmPanY'S seasonal inventory problems, and by refocusing the firm 15 on its primary sales outlets: pro shops at golf and country clubs. 16 As a result, Mr. Olinksi says Ashworth is teed up 17 for some solid growth in sales through400 orthe so pro shops in theU. S. that carry its clothing. Orders for 18 the critical spring-summer season are up 40% from pro shops, which accounted for about 52% of Ashworth's $89.1 19 million in sales for the fiscal year that ended on Oct. 31. 20 "Ashworth has been dominant in golf shops and 21 there's still room to run there," says Mr. Olinski, who forecasts 15%to 20% in pro-shop sales growth this fiscal 22 year.
23 Indeed, a growth spurt in the core business alone should drive earnings. But Ashworth is a doingnumber Of 24 things away from the links that could spur some potent long-term growth. 25 Among them, Ashworth has selectively increased the 26 number of high-end department stores that carry its brand by 25% to 350 stores, including Bloomingdale's and 27 Nordstrom. The company has just begun to tap the e corporate-promotions market (selling to companies that 28 put their names on golf shirts), and introduceda llhipQg
- 20 - young men's line aimed at capturing some of the Tiger Woods phenomenon. And it plans to launcha women's line e 2 later this year. 3 But given that golf clothinga seasonal is business, Ashworth's stock may experience a bit of a lull before 4 the company unveils new lines and its latest business strategies at two trade shows this winter. 5 "1 think the stock will move by then,"Mr. Olinski 6 says. '#That's whyI think it's a good time rightnowtt to consider it. 7 Adds analyst Diane Daggatt of Dain Bosworth in 8 Seattle: '!With strong brand recognition, better-than- ever industry fundamentals, and the spring season just 9 around the corner. . . I think this year will reap big benefits. Ms. Daggatt rates the stock a "strong buy" 10 and placed it on her brokerage's "prioritylisttt of top stock picks. Her 12-month price target is$15, and she 11 predicts thatlong-term per-share earnings can grow about 30% a year. 12 *** 13 "We clearly are the niche leader. We really don't 14 have to ao out and create demand. We just need to chase it,says Mr. Herrel,who as president and chief 15 operating officer of Quicksilver helped build that once- tiny Costa Mesa company intoa major surf-wear brand. 16 *** 17 To be sure, no clothing manufacturer's stock isa 18 Itgimmetg-- especially one in a special category that's undergoing an onslaught of competition from apparel 19 makers previously not in the game. For example, in recent years, Chicago-based Hartmarx has made aggressive 20 inroads in golf apparel with its Bobby Jones and Nicklaus golf-wear lines. Even top fashion designers, such as 21 Tommy Hilfiger, are taking a swing at the market, analysts say. 22 What's more, in an effort to reduce overhead and 23 widen operating margins, Ashworthis in the process of shifting about half of its manufacturing from Southern 24 California to offshore factories in South America, Asia and Europe. And any time a clothing company moves its 25 production to other countries, there is alwaysa risk that product quality could suffer, Wedbush Morgan'sMr. 26 Olinski warns. But Mr. Herrel dismisses such concerns, pointing out that the companv is makins some key products at more than 28 one plant durina the transition. And foreian factory
- 21 - -l I selection is based on quality and on-time deliver records beforetakinq cost savinqs into consideration, h: e 2 says. 3 The new sourcing strategy will get some of its products closer to important foreign markets, such as 4 Japan and Europe. European sales already account for about 15% of the company's total revenue, mostly coming 5 from pro-shop dealers in the United Kingdom.
6 International revenue slipped 4% to $3.1 million during the fourth quarter of last fiscal year,a despite 7 32% rise in European revenue. The falloff was due largely to the fact that Ashworth was searching for new 8 trading partners in Asia, which it recently accomplished, Mr. Olinksi says. 9 Now the pieces are in place for the next phase of 10 the turnaround. Says Mr. Olinski: @lit's a real strong growth story going forward.'# 11 30. On or about2/3/98, Ashworth filed its Annual Reportto 12 Shareholderswith the SEC and mailed the report to its 13 shareholders. The report included Ashworth's previously reported 14 F97 financial results. The report attributed part of the reason 15 for its increase in gross margins36.3% from in F96 to 38.3% in F97 16 to tlcostreductions obtained from contractors and from raw material 17 suppliers,Il The Company represented that: ItInventories are valued 18 at the lowerof cost (first-in, first out) or market." The Annual 19 Report also included a letter to shareholders signed by Herrel 20 which stated: 21 My first year with the Company was a year of 22 transition and change, strengtheninga management team as well as the Company's product line, and putting in place 23 aggressive growth strategies.
24 ***
25 The improvement in overall operating performance in fiscal 1997 was a result of a substantial increase in 26 domesticand European sales which reflected the increasing demand for the Ashworth brand and increased market share in its core green grass accounts.
28 ***
- 22 - I OPERATING IMPROVEMENTS During the past year, the Company made significant improvements in many operational e 2 areas. A couple of significant ones were:
e A strengthened management team with new heads of design, retail sales, information systems, sourcing and field merchandising.
0 A new international sourcing department, increasing our worldwide production offshore 10 frompercent in1996 to more than 25 percent. This increases gross prof it margin but also improves our ability to produce garments with more technical aspects and features.
e An enhanced product design and development process to focuson collections, lifestyle sportswear and expanded product line.
10 e An increasedorder fill rate with improved forecasting and improved system controls. 11 e The creation of a customer service call center for 12 improved account servicing, decreased processingtime, and less phone waiting time. 13 e The opening of a concept store in October 1997 in 14 South Coast Plaza located in Orange County, California. The store was developed to showcase our entire line as 15 well as test presentation of new products.
16 e A new field merchandising coordinator program to service our Golfman, in-store shops and to increase sell 17 through.
18 0 The implementation of new sales programs which have clearly increased brand penetration and market As share. 19 a result, future bookings increased significantly for Fall 1997 as well as for Spring/Summer1998. 20 e A largeremphasis on developing the Company's 21 corporate sales function, formally appointinga corporate sales rep team as well as entering into a strategic 22 alliance with a major outside corporate sales and promotion company. 23 e While we are still finalizing an agreement with a 24 new Japanese distributor, we have signed an exclusive agreement with a publicly traded company based in Hong 25 Kong, to distribute and manufacture Ashworth sportswear to better department and specialty stores as well as pro 26 shops in Hong Kong, Macau, Malaysia, China and Singapore.
GROWTH STRATEGY The Company's growth strategies1998 for and beyond can best be summarized into five major points. 28
- 23 - 1 A The first and most important strategy is to continue to expand our core Ashworth business in existing green e 2 grass, and retail operations. This will be achieved by improved designs and color stories, a more aggressive 3 sell-in program for our new expanded young men'sline, and participation in the PGA Retirement Plus Program 4 which identifies PGA professionals to increase their average order size. With these efforts and a more 5 aggressive Golfman Shop (in-store shop) program,we have captured a growing amount of floor space and are riding 6 a trend that has seen apparel become a much larger component of pro shop sales. 7 Today, your Company has just started to aggressively 8 grow its new youngmen's line and is beginning designof a new, highly requested women's line which Will Provide 9 new growth opportunities for its existing distribution as well. 10 Our second strategy is to selectively expand into 11 new high image accounts. This includes new distribution in green grass, specialty stores and upscale department 12 stores such as Bloomingdales. While Ashworth sells to approximately 4,500 pro shops and resorts out of a 13 possible 13,000, the Company has not yet come closeto fully penetrating its core market. 14
15
16
17
18 Our fourth strategy is to continue to pursue 19 sourcing strategies that fill the needs of our worldwide distribution.In 1998, Ashworthproduct is being 20 produced in Europe, South America, Asia and the United States. This new strategy will minimize importduties, 21 improve the Company's overall gross profit margin and makeAshworth more price competitive in foreign 22 countries. We expect offshore sourcing to grow to 50 percent by the end of the fiscal year. 23 Our fifth strategy a issimple but ever challenging 24 one. And that is to always be a product-driven and innovative company. The Ashworth product line takes its 25 inspiration fromthe lifestyle elements and traditions of the game itself. Product is everything,we andcan never 26 rest on our laurels. We are totally dedicated to theselong-term growth strategies as we are dedicated to maintaining the 28
- 24 - traditions of our company that made us the leader we are today. 2 e ***
I firmly believe we've set the stagea solid for new year of continued growth and improved sales and profits and I look forward to the opportunities 1998.in
31. On 3/4/98, Ashworth reported its lstQ98 results -- which
again were much above expectations-- sales of $24 million, net 8 income of $1.9 million and EPS of $0.14. Ashworth's release
9 stated:
10 In reviewing operations, Mr. Herrel stated that the improvement in overall operating performancethe first in 11 quarter of fiscal 1998 was a result of a substantial increase in domestic and European sales which reflected 12 the increasing demand for the Ashworth brand, as as well improved margins and controlled operating expenses. 13 Domestic sales increased47.9%to $20,246,000 as compared to $13,688,000 for the same period of the prior year due 14 to strong demand. Foreign sales decreased 38.6% to $3,780,000 as compared to$6,153,000 for the same period @ 15 of the prior year due to the Company's decision to terminate the contract with its Japanese distributor and 16 exploreoptions to sell directly to its Japanese accounts. Sales to Japan in the first quarter of1997 17 were approximately $3,500,000. Strong demand for the Ashworth brand in Europe resulteda 45.5%in increase in 18 sales when comparedto the first quarter 1997.of
19 Gross margin for the quarter improvedto 39.6% as compared to 37.6% a year earlier. This improvement was 20 a result of international sourcing and reduced production related expenses. 21 *** 22 Mr. Herrel reported that inventories increased28.6% 23 from a year earlier. The Company has increased inventory levels for several reasons including: a substantial 24 increase in bookings; earlier production of goods to ensure higher order fill rates; and offshore production 25 of goods requiring larger minimum buys.
26 32. Subsequent to the release of its lstQ F98 results, Ashworthspoke to securities analysts, money and portfolio
28 managers, institutional investors, large Ashworth shareholders,
- 25 - 1 I brokers and stock traders to discuss Ashworth's business and its e 2 prospects. During the conversations, Ashworth management directly 3 disseminated important information to the market by stating:
4 0 Sales of Ashworth's core products were strong, bookings were strong and Ashworth's inventory was appropriate compared 5 to demand.
6 0 Ashworth had multiple sourcing for its products and would therefore not be severely impacted if it were to have 7 manufacturing problems at one of its facilities.
8 0 Ashworth's relocation of its sewing operations offshore was a great success and was yielding cost savings and 9 operating efficiencies, which would leadto continued gross margin growth in F98. 10 0 Ashworth's sales were strong and would compare favorably 11 year-over-year despite a very strong F97.
12 0 Ashworth was conservative in its inventory valuation and had adequately reserved for excess or obsolete inventory. 13 0 Ashworth was raising its F98 EPS forecast to $.62+ and 14 its F99 EPS forecast to $.85+. 15 33. On 3/5/98, Ferris, Baker Watts issued a report on
16 Ashworth, written by Teklits, which was based on and repeated 17 information provided him in conversations with Ashworth management.
18 The report forecast F98 andEPS F99of $. 62 and $.85, respectively,
19 for Ashworth and the following quarterlyEPS: F98
20 41 $ .13 42 $ .30 21 43 $ .12 44 $ .06 22 Year $ .62 23 The report also stated:
24 Basedon domestic bookings trends that are continuing on pace with the company's40%+ green grass 25 and department increases for Spring/Summer, we are increasing our 43 and 44 sales estimates. Our new1998 26 EPS estimate is $0.62, up from $0.57, and our1999 EPS estimate is being raised to $0.85 from $0.82. A 12-15 month price target of $23 is roughly 25-times our calendar 1999 EPS estimate of $0.90 (35% discount1999 to 28 growth rate). Givena 52% compound annual growth rate of
- 26 - 1 I highly visible earnings over the next two years,50% and appreciation potential of its shares, we continue to rate e 2 Ashworth a Strong Buy.
3 ***
4 Gross margin jumped 39.6%, to 200 basis points above a year ago. We were projecting a 40% gross margin and 5 believe the company could have surpassed that level if it hadn't continued to build its inventory reserve. We 6 suspect, given President Randy Herrel's history of managing earnings, that gross margin could be kept 7 artificially low in1998 to leave room for expansion in 1999. Better margins are being driven by overseas 8 sourcingand reduced production related expenses associated with management's cost cutting efforts. 9 Operating expenses (SG&A) increased15%, well below the 21% sales growth and also below our estimate. 10 *** 11 * Balance Sheet: Cash up 51% and current liabilities 12 down 46% -- current ratio of 8 :1 is the company's strongest ever; line of credit nil vs. $4.5 million a 13 year ago; inventory in-line with bookings trends.
14 34. The positive representations and forecasts made about
15 Ashworth during the Class Period were false. During the Class
16 Period, defendants knowingly or recklessly failed to disclose the
17 following actual facts about Ashworth:
18 (a)Ashworth's new, redeveloped infrastructure,
19 including its increasing use of offshore factories, was extremely
20 troubled with inadequate quality-control testing and insufficient
21 supervision which, while generating short-term cost savings, would
22 require dramatically higher costs in future periods to sUCCeSSfullY
23 manufacture,supervise and monitor manufacturing in these
24 locations;
25 (b) Due to problems in matching production with demand,
26 Ashworth had accumulated large amountsof excessive inventories of its Basics product line which were encountering extreme price
- 28 pressure in the marketplace while at the same time Ashworth was
- 27 - 1 unable to promptly produce significant amounts of other products 2 which were in strong demand and commanded higher, more profitable, 3 prices;
4 (C) Ashworth's attempts to accelerate the relocation of 5 larger amounts of its manufacturing operations offshore were 6 resulting in significant operational inefficiencies and greatly 7 increased expense which was much more than offsetting the wage
8 savings obtained by such offshore production;
9 (d) Ashworth's offshore sewing production was not double
10 sourcedl meaning Ashworth in fact did not have multiple sources for
11 its products so that if one of the offshore facilitiesran into
12 production problems, another of the facilities would not have
13 replacement product available for shipment.Also, Ashworth could
14 not control the inventories at the offshore factories, resulting in 15 the accumulation of excessive inventories and an inability to
1C > produce other in-demand products;
1;7 (e)Ashworth's European operations were, in fact, 3 plagued by outmoded and inefficient management, manufacturing and
1' 3 distribution facilities and very soft demand for Ashworth's
2(1 products there, resulting in excessive inventories and operational
2:L results far below those internally budgeted and forecasted and
2;2 necessary for Ashworth to meet the revenueEPS and growth it waE
2:3 publicly forecasting;
24 4 (f) Ashworth's financial results during the Class Perioc
2!5 were falsified, manipulated and overstated as detailedgg52-62, in
21 6 including the failure to properly write down excessive inventories, 7 which falsification was doneto conceal from the market the true
2 8 negative conditions in Ashworth's business which were, in fact,
- 28 - 1 I then adversely affecting its results from operations and which
0 2 demonstrated that Ashworth's supposed turn-around a failurewas --
3 not a success; (9)Ashworth was suffering from weakening demand, particularly for its Basics product line which was an important
part of its overall product line and would adversely~98 affect its
and F99 results; (h) Ashworth's inventories were not on plan but in fact
9 were above Ashworth's internal budgets and forecasts and excessive
10 in light of the actual demand for Ashworth's products and
11 Ashworth's actual rate of sales;
12 (i) New management had not "fixedvt Ashworth's inventory
13 problems ;
14 (j) Ashworth's financial strategy was not unfolding in
15 a positive manner or as planned, but rather, was failing, which
16 failurewas being covered up and concealed by Ashworth's
17 misrepresentationsand the falsification of its financial
18 statements detailed ingn52-62;
19 (k) Ashworth's selection of offshore sourcing was not
20 the careful, detailed process described by defendants, but in fact
21 was done haphazardly without implementing procedures which would
22 assure quality throughout the manufacturing process;
23 (1) Ashworth's restructuring and/or turn-around had not
24 and was not succeeding, but rather,was failing dueto the problems
25 afflicting its business as set forth above, which failure was being
26 covered up and concealed by defendants' false statements as detailed herein;
28
- 29 - 1 I (m) As a result of the foregoing adverse conditionsin e 2 A shworth Is business, defendants knew that their forecasts of strong
3 earnings for Ashworth during F98-F99 would not materialize and
4 therefore Ashworth would not achieveEPS thegrowth being forecast
5 by it for F98-F99 and beyond; and
6 (n) As a result of the foregoing negative conditions
7 W.hich were adversely affecting Ashworth's businessthe duringClass
8 P'eriod, defendants knew that the forecasts of revenue growth in
9 F'98-F99 and growth inEPS to $. 62 and $.85, respectively, were each
10 false when made, as those results could not and would not be
11 achieved.
12 35. On 5/12/98, Ferris, Baker Watts issued a report on
13 Ashworth, written by Teklits, which was based on and repeated
14 i.nformation provided him in conversations with Herrel and other @ 15 Ashworth management. The report forecastF98 and F99 EPS of $.62
16 amd $.85 and also stated:
17 Fall Bookings Supporting Earnings Estimates
18 Ashworth reported that is worldwide Fall (42season and Q3) bookings are up in excess 30% of as compared to this time a year ago. In speaking with management, we believe the company's message was that it is comfortable 2c 1 with guidance of at least30% revenue growth in42 and Q3:98. Better orders are typically booked early, with 23 L smaller orders taken late;so even though bookings are most likely much higher than30% today, we believe the 2; ! company is estimating that final order will be up at least 30%. We are projecting25% top-line growth in the 2: ! respective quarters, andan incremental 5% would add EPS of roughly $0.02 per quarter. 24L *** 2E > Summary and Valuation 2f 3 Not including sales of $3.5 million to Japan in 7 Q1:97, Ashworth's total sales increased by 38.7% in Q1:98, negatively impacting growth(Q2 earnings released 2t 3 June 3) . We are projecting20% top-line growth inQ2,
- 30 - 1 with an acceleration to at least the25% level in the back half of fiscal1998 and into fiscal1999. Continued 2 top-line growth in1999 aided by new lines (women's and expanded AGCo.) and distribution (Asia), coupled witha 3 higher gross margin, offers a high degree of earning visibility. 4 We increased our 43 and Q4:98 sales and EPS 5 estimates on March 5, 1998, and raised our 1999 EPs estimate $0.85 from $0.82. A 12-15 month price target of 6 $23 is roughly25 times our calendar1999 EPS estimate of $0.90 (35% discount to 1999 growth rate). We continue to 7 rate Ashwortha Strong Buy.
8 36. On 5/27/98, Ashworth reported IlSignificant Improvement"
9 in its 2ndQF98 results, including net sales $38.1 of million, net
10 income of$4.5 million and EPS of$0.30. The release also stated:
11 In reviewing operations, Mr. Herrel stated that the improvement in overall operating performance in the 12 second quarter of fiscal 1998 was a result of a substantial increase in domestic and European sales which 13 reflected the increasing demand for the Ashworth brand, as well as improved margins and controlled operating 14 expenses. Domestic sales increased22.5% to $29,970,000 as compared to $24,460,000 for the same period of the 15 prioryear, due to strong demand. Foreign sales increased 31.3% to $8,087,000 as compared to$6,158,000 16 for the same period of the prior year due to stronger growth in Europe. European sales increased 44.7% to 17 $6,628,000, as compared to $4,582,000 for the same quarter last year. 18 37. On 5/27-29/98, Ashworth's stock declined from$17 to $12 19 on extremely heavy volume of 1.3 million shares and 1.7 million 20 shares on5/28/98 and 5/29/98, respectively, due to concerns about 21 high inventory levelsas of 4/30/98. In response, Ashworth issued 22 a press release which stated: 23 Randall L. Herrel, Sr., President and Chief Executive 24 Officer of Ashworth, Inc. (Nasdaq: ASHW), stated today that manaaement is unawareof any events or developments 25 with respect to either the Company or its business that wouldaccount for the heavina tradina volume or 26 siqnificant drop in share price over the last several days. 27
28
- 31 - 1 38. Ashworth also held a conference call for securities 0 2 analysts, money and portfolio managers,. institutional investors,
3 large Ashworth shareholders, brokers and stock traders to discuss
4
5
6 to prop up Ashworth's stock by downplaying the significance of
7 Ashworth's 2ndQ F98 inventory and making very bullish statements
8 about Ashworth's business. During the call -- and in follow-up
9 conversations with participants -- they directly disseminated
10 important information to the market, stating:
11 0 Sales of Ashworth's core products were strong, and Fall bookings were ahead of plan. 12 0 Ashworth's Golfman in-store shops were expectedto double 13 in 1998, enabling Ashworth to reduce its inventories markedly, and justifying the high inventory it held. 14 e Ashworth's inventory was in line with its business plan 15 and was higher not due to any problems but because the Company had introduced a new Basics line. 16 e Ashworth's relocation of its sewing operations offshore 17 was a great success and was yielding cost savings and operating efficiencies, which would leadto continued gross 18 margin growth.
19 0 Ashworth expected F98 and F99 EPS of $.61+ and $.85+.
20 39. On 6/1/98, Ferris, Baker Watts issued a report on
21 Ashworth, written by Teklits, which was based on and repeated
22 information provided him in conversations with Ashworth management.
23 The report forecastF98 and F99 EPS of $. 61 and $. 85, respectively,
24 and also stated:
25 At $33 million, Ashworth may only turn its inventory slightly over two times in fiscal1998 compared to more 26 than 2.5 times in previous years and approximately2.8 times for competitor Cutter& Buck. However, the company 27 launched a new Basics line this year and is makinga major push to capture share of this very important 28 category in green grass shops. Basics have to be
- 32 - 1 replenishable, making the$7 million in inventory at the end of 42 :98 necessary. Future bookings and the new 0 2 women's line also are supporting higher inventory levels.
3 40. On 6/11/98 Ferris, Baker Watts issued a report on
4 Ashworth which was based on and repeated Ashworth management's
5 statements to analyst Teklits. The report forecastF98 and F99 EPS 6 of $.61 and $.85, respectively. The report stated:
7 Summary of Management Meetings
8 Ashworthrecently reported Q2:98 EPSof $.30 compared to$0.23 a year ago, in line with our estimate 9 and $0.01 aboveconsensus. Sales increased 24.3%, exceeding our20% growth projection, and gross margin was 10 atits highest since Q3:94. Nonetheless,because inventories and receivables rose about50% year to year, 11 the stock has retreated 20%by from its recent highs.
12 Management is meeting with analysts and shareholders this week to address current issues business trends. High- 13 lights of our meetings are as follows:
14 The company aggressively launcheda Basics program in spring1998, which typically represents40%-50% of an 15 apparel company's business but for Ashworth has been only about 10% heretofore. Basics must be replenishable, and 16 the company built its finished goods inventory to meet pre-booked and reorder demand. Also, the company is 17 sourcing 50% of its product off-shore versus less than 10% a year ago, merchandise in transit and early fall 18 imports from new sources in Asia also boosted finished good inventory. 19 *** 20 Inventory has been flat sequentially for three 21 straight quarters since Q4:97. We expect inventory to remain at approximately$33 million for the restFY98, of 22 meaning that it will be about25% higher than the prior year figure at the end Q3:98,of or in line with sales 23 and bookings, and will be flat year over year at the end of Q4 :98 on projected revenue growth of24.1% for the 24 year. Thus, we believe that by fiscal year-end, what is now being perceived aas negative will bea positive for 25 the company.
26 ***
27 * Sales of the company's U.K. subsidiary have been growing at 35%, which is expected to continue. All of 28 Ashworth's European businessis done in green grass shops
- 33 - 1 J. andmost is in the U.K.; opportunities exist in department stores and in Continental Europe. Also, e 2 Ashworth just bought back its Canadian distribution rights and has establisheda division (full margin versus 3 30% discount given to previous distributor) to be run by a management company that currently900 hasgolf accounts 4 compared to the prior distributor's250 accounts.
5 * We believe that Ashworth's positioning for future growth is complete, and that sales growth acceleration 6 shouldcontinue through 1999. Thenew Ashworth incorporates: 7 Offshore sourcing. 8 A Basics line. A rapidly growing department store business; Fall 9 bookings up 65%. A new women's lineto be shipped for Holiday/Resort 10 1998. An infancy-stage young men's line. 11 A start-up corporate business. Burgeoning business and brand recognition in Europe. 12 A new Canadian division. A new Hong Kong distributor. 13 The best sales, design, and upper-level management team in the company's history. 14 The highest gross margin in company history in the latest quarter. @ 15 Positive cash flow which will create earnings- enhancement opportunities in1999. 16 Summary and Valuation 17 Based on our proprietary surveys as well as industry 18 surveys, Ashworth continues to be the number-one brand of apparel in the industry's core distribution channel - 19 golf course pro shops. Its positioning there combined with golf's growing popularity and participation rate and 20 the continued trend toward casual workplace dress codes lead us tobelieve that Ashworth has just begun to take 21 advantage of the growthopportunitiesthatare available.
22 41. On 7/15/98, Ashworth stunned the market whenit revealed
23 that, due to serious manufacturing problems in its offshore
24 facilities, 3rdQ F98 sales would be worse than forecasted by
25 Ashworth. The press release stated:
26 CARLSBAD, Calif., July15/ PRNewswire/ -- Randall L. Herrel, Sr., President and Chief Executive Officer of 27 Ashworth, Inc. (Nasdaq: ASHW), announced today that the quality and timeliness of a few key styles of the 28 Company's popular basics line received from offshore
- 34 - 1 Sources in the third quarter1998, of had fallen short of the Company's quality expectations and standards. In 2 keeping with the Company's ongoing commitment to premium quality and customer satisfaction, the lower quality 3 goods Were not shipped to customers and the problem is being corrected. Asa result of these production-related 4 issues, the Company's sales in the third quarter will be affected by approximately$2.0 to $3.0 million but will 5 still result in strong improvementoverthe corresponding quarter of fiscal1997. Mr. Herrel further stated that, 6 due to this problem, third quarter net income will equal or be slightly above last year and may also slightly 7 impact net earnings in the fourth quarter of the current fiscal year. 8 42. Ashworth's stock immediately droppedto as low as $8-1/8 9 on huge volume 8of million shares. 10 43. On 9/3/98, Ashworth reported its results for the 3rdQ 11 F98, including net sales of only $25.6 million, net income and 12 $782,000 and EPS of $0.05, a decline from 3rdQF97 EPS of $0.06. 13 Gross margins were only36%. 14 44. Ashworth later spoke to analysts admitting that: 15 e Some sales could not be completed due to manufacturing 16 problems.
17 e Production problems were particularly acute in Peru and Costa Rica. 18 e Sales discounts had caused both sales and gross margins 19 to be lower than expected.
20 e Quality control procedures were inadequate in overseas factories. 21 e It did not have double sourcing and was now going to 22 implement double sourcing to avoid the adverse impact of production problems in the future. 23 45. On 9/4/98, Ferris, Baker Watts published a report on 24 Ashworthwhich was written by Teklits and was based on 25 conversations with Ashworth management. The report F98lowered and 26 F99 EPS forecasts to $0.49 and $0.70, respectively, and stated: 27 Management admitted that quality control procedures 28 were not adequate at overseas factories, and believes
- 35 - 1 that future problems can be avoided by instituting quality check points at earlier stages of the production 2 process. It has taken steps to remedy the risk of similar problems in the future, including double sourcing 3 high-volume styles, putting in place a new in-house quality assurance program, and hiring an additional 4 outside serviceto check for quality at four points along the process on top of the what company's overseas agents 5 are currently doing. Each of these new processes will negativelyimpact the company's margins, but in 6 combination should protect against major problemsthe in future. 7 Conclusion and Investment Guidance 8 Ashworth's quarter was not an example of solid 9 execution and well-managed growth. Over the past 18 months, the company has attempted to: improve its product 10 and the sales effort, increase overseas sourcing50% to from lo%, grow sales aggressively in green grass and 11 traditional retail channels both domestically and abroad, add a corporate channel infrastructure(15 new salesreps 12 and division manager), start a women's business (new designers and sales staff), ramp up AGCo. (young men's 13 line), buy back distribution rights to Canada, and reduce inventory - all at the same time. 14 46. On 9/22/98, G. Montiel retired as Chairman.In thepress 15 release G. Montiel claimed the Company was rcringood shape 16 financially'" and that he plannedIrrto remain a shareholder. ')I In 17 fact, by this time G. Montiel only held25,840 shares compared to 18 the 452,000 shares he sold during the Class Period. 19 47. On 11/3/98, Ashworth announced new order bookings for 20 Spring 1999 and revealed that its Basics line bookingswere 15% 21 below the prior year, and that overall bookings were up 12% only 22 compared to defendants' prior forecasts 20% of increases. On this 23 news Ferris, Baker Watts loweredF99 its EPS forecast for Ashworth 24 to $0.60 and wrote: What is clear is that business next year is 25 not very visible and management wants to keep expectations low." 26 48. On 12/17/98, Ashworth announced 4thQF98 and F98 results 27 -- including annual sales of $107.3 million, net income of $5.3 28
- 36 - 1 I million, and EPS of $0.36 (well below Class Period forecasts of e 2 $0.62). Fourth quarter sales were only $19.6 million and the Company had a net loss of $1.9 million due to "adjustments related to prior season inventory." Ashworth also announced management changes in the European management team due to Ilinventory mix
6 problems." Ashworth's gross margins were only 28.9%.
7 49. Analysts, including Ferris, Baker Watts, cut their F99
8 EPS estimates for Ashworth yet again to $0.50 the range. Ferris,
9 Baker Watts wrote:
10 * The growth story continues to unwind. A number of factors -- too much inventory, systems problems in 11 Europe, falling salesto Asia, anda discontinuation of the AGCo. line -- are forcing the company to focus on 12 retrending in 1999 rather than growing.
13 * We are lowering our fiscal (Oct.)1999 and 2000 EPS estimates to $0.50 and $0.63, respectively; down from 14 $0.60 and $0.70. At one point early in the year, our EPS projection for fiscal1999 was $0.85. 15 *** 16 * Summary and Investment Thesis 17 Fiscal 1998: Ashworth's 4498 pretty much summed up 18 the year-- too much inventory and operational problems hurting earnings and the stock. The company hasyet to 19 recover from its untimely decisionto build inventory for its Basics program, and from its production problems that 20 cost it business and increased its cost of goods in the secondhalf of the fiscal year. If anything, the 21 negative issues seemto be snowballing rather than being fixed.The fourth quarter was plagued by systems 22 problems in Europe, which are demanding a lot of attention and may lead to management changesthe U.K. at 23 -- based subsidiary, and by inventory writedowns. The end result wasa significant loss in the quarter versus 24 the company's first break even fourth aquarter year ago. It also createda negative EPS comparison for the fiscal 25 year ($0.36 vs. $0.37) after a 215% jump in 1997.
26 Lookingahead: Based on our discussions with management after the quarterly conference call, we believe the company's focus in1999 will be on getting inventory in line with sales trends (target2.5+ turns of 28 peryear) and working on brand positioning and
- 37 - I infrastructuresoundness. With attention diverted elsewhere, we believe revenue and profit growth will e 2 suffer. We are again lowering our revenue and earnings estimates to reflect this caution. The revenue growth 3 that does occur in 1999 will come from incremental women's and corporate business, both of which are in very 4 early stages, and the department store channel. We categorize it primarily as natural growth as opposed to 5 initiated growth.
6 50. The positive representations and forecasts made about
7 Ashworth during the Class Period were false. During the Class
8 Period, defendants knowingly or recklessly failedto disclose the
9 following actual facts about Ashworth:
10 (a)Ashworth's new, redeveloped infrastructure,
11 including its increasing use of offshore factories, was extremely
12 troubled with inadequate quality-control testing and insufficient
13 supervision which, while generating short-term cost savings, would
14 require dramatically higher costs in futureto periodssuccessfully @ 15 manufacture,supervise and monitor manufacturing in these
16 locations;
17 (b) Due to problems in matching production with demand,
18 Ashworth had accumulated large amounts of excessive inventories of
19 its Basics product line which were encountering extreme price
20 pressure in the marketplace while at the same time Ashworth was
21 unable to promptly produce significant amounts of other products
22 which were in strong demand and commanded higher, more profitable,
23 prices ;
24 (c) Ashworth's attempts to acceleratethe relocation of
25 larger amounts of its manufacturing operations offshore were
26 resulting in significant operational inefficiencies and greatly increased expense which was much more than offsetting the wage
28 savings obtained by such offshore production;
- 38 - I infrastructuresoundness. With attention diverted elsewhere, we believe revenue and profit growth will e 2 suffer. We are again lowering our revenue and earnings estimates to reflect this caution. The revenue growth 3 that does occur in 1999 will come from incremental women's and corporate business, both of which are in very 4 early stages, and the department store channel. We categorize it primarily as natural growth as opposed to 5 initiated growth.
6 50. The positive representations and forecasts made about
7 Ashworth during the Class Period were false. During the Class
8 Period, defendants knowingly or recklessly failedto disclose the
9 following actual facts about Ashworth:
10 (a)Ashworth's new, redeveloped infrastructure,
11 including its increasing use of offshore factories, was extremely
12 troubled with inadequate quality-control testing and insufficient
13 supervision which, while generating short-term cost savings, would
14 require dramatically higher costs in futureto periodssuccessfully
15 manufacture,supervise and monitor manufacturing in these
16 locations;
17 (b) Due to problems in matching production with demand,
18 Ashworth had accumulated large amounts of excessive inventories of
19 its Basics product line which were encountering extreme price
20 pressure in the marketplace while at the same time Ashworth was
21 unable to promptly produce significant amounts of other products
22 which were in strong demand and commanded higher, more profitable,
23 prices ;
24 (c) Ashworth's attempts to acceleratethe relocationOf
25 larger amounts of its manufacturing operations offshore were
26 resulting in significant operational inefficiencies and greatly increased expense which was much more than offsetting the wage
28 savings obtained by such offshore production;
- 38 - 1 A (d) Ashworth's offshore sewing production was not double e 2 sourced, meaning Ashworth in fact did not have multiple Sources for 3 its products so that if one of the offshore facilities ran into
4 production problems, another of the facilities would not have
5 replacement product available for shipment. Also, Ashworth could
6 not control the inventories at the offshore factories, resulting in 7 the accumulation of excessive inventories and an inability to
8 produce other in-demand products;
.9 (e) Ashworth's European operations were plagued by
10 outmoded and inefficient management, manufacturing and distribution
11 facilities and very soft demand for Ashworth's products there,
12 resulting in excessive inventories and operational results far
13 below those internally budgeted and forecasted and necessary for
14 Ashworth to meet the revenue and EPS growth it was publicly
15 forecasting;
16 (f) Ashworth's financial results during the Class Period
17 were falsified, manipulated and overstated as detailed1152-62, in
18 includingthe failure to properly write down excessive inventories,
19 which falsification was done to conceal from the market the true
20 negative conditions in Ashworth's business which were, in fact,
21 then adversely affecting its results from operations and which
22 demonstrated that Ashworth's supposed turn-arounda failure was --
23 not a success;
24 (9) Ashworthwas suffering from weakening demand,
25 particularly for its Basics product line which wasan important
26 part of its overall product line and would adverselyF98 affect its
27 and F99 results;
28
- 39 - 1 I Ashworth's inventories were not on plan but in fact a 2 were abov e Ashworth's internal budgets and forecasts and excessive 3 in light of the actual demand for Ashworth's products and 4 Ashworth's actual rate of sales;
5 (i) New management had IIfnot ixed" Ashworth's inventory
6 problems; 7 (j) Ashworth's financial strategy was not unfolding in
8 a positive manner or as planned, but rather, was failing, which
9 failurewas being covered up and concealed by Ashworth's
10 misrepresentationsand the falsification of its financial
11 statements detailed inll52-62;
12 (k) Ashworth's selection of offshore sourcing was not
13 the careful, detailed process described by defendants, but in fact
14 was done haphazardly without implementing procedures which would
15 assure quality throughout the manufacturing process;
16 (1) Ashworth's restructuring and/or turn-around had not
17 and was not succeeding, but rather, was failing due to the problems
18 afflicting its business as set forth above, which failure was being
19 covered up and concealed by defendants' false statements as
20 detailed herein;
21 (m) As a result of the foregoing adverse conditions in
22 Ashworth's business, defendants knew that their forecasts of strong
23 earnings for Ashworth during F98-F99 would not materialize and
24 therefore Ashworth would not achieve the EPS growth being forecast
25 by it forF98-F99 and beyond; and
26 (n) As a result of the foregoing negative conditions which were adversely affecting Ashworth's duringthebusiness Class
28 Period, defendants knew that the forecasts of revenue growth in
- 40 - F98-F99 and growth in EPSto $.61+ and $.85 respectively, were each e 2 false when made, as those results could not and would not be 3 achieved. 4 51. Ashworth's poor 2ndH F98 results, compared to thestrong 5 profit growth forecast duringthe ClassPeriod, which resulted from 6 adverse conditions and trends in Ashworth's business durina the 7 Class Period, which defendants concealed, are shown below: 8 Ashworth Quarterly and Annual Results 9 (in thousands, exceptEPS) 1994 10 01/31 04/3 0 07/31 10/31 Year Revenues $ 11,040 $ 21,270 $ 16,960 $ 11,570 $ 60,840 Net income $ 720 $ 2,480 $ 1,530 13 0 $ 4,860 11 EPS $.06 $.20 $.13 $.01 $ .40 12 1995 01/31 04/30 07/31 10/31 -Year Revenues $ 14,590 $ 26,440 $ 20,390 $ 13,110 $ 74,520 13 Net income $ 810 $ 1,810 $ -810 ($ 2,020) 1,400 EPS $.07 S.15 $.07 $ -17 $.12 14 1996 01/31 04 /3 0 07/31 10/31 Year 15 Revenues $ 17,070 $ 26,360 $ 17,880 $ 14,100 $ 75,410 Net income $ 830 $ 2,520 $ 200 ($ 2,150) $ 1,400 16 EPS $.07 $.02 $.21 ($. 18) $.12 1997 17 01/31 04/30 07/31 10/31 Year Revenues $ 19,840 $ 30,620 $ 21,700 $ 16,990 $ 89,150 18 Net income $ 1,160 $ 2,890 $ 770 5 4 $ 4,830 EPS $.lo $.24 $.06 $0.00 $0.37 19 1998 01/31 04/30 07/31 10/31 Year 20 Revenues $ 24,030 S 38.060 $ 25,600 $ 19,660 $ 107,340 Net income $ 1,860 $ 4,520 s 782 $ (11860) $ 5,300 EPS $0.36 21 $.14 $.30 $0.05 $(0.13)
22 ASHWORTH'S FALSE FINANCIAL STATEMENTS
23 52. In order to overstate its earnings in the 4thQ F97 and 24 lstQ and 2ndQ F98, Ashworth violated Generally Accepted Accounting 25 Principles (aGAAP1l)and SEC rules by failing to properly report the 26 value of its inventory. Ashworth ultimately had to take charges in the 4thQ of F98 primarily to write down the reported value of 28 the Company's inventory resulting in a$2 million loss to Ashworth.
- 41 - 1 This loss exceeded 30% of the entire earnings Ashworth reported m 2 during the Class Period. 3 53. Ashworth reported the following financial results during
4 the Class Period:
5 Qtr-endYear - endQtr-end Qtr-end 10/31/97 10/31/97 11/31/98 4/30/98
6 Revenues $16.9 M $89.1 M $24.0 M $38.1 M 7 Gross profit $7.0 M $34.1 M $9.5 M $16.2 M
8 Net income $4,000 $4.8 M $1.9 M $4.5 M 9 EPS $.OO $.37 $ .14 $.30
10 Ashworth later included these results inF97 itsAnnual Report and
11 quarterly Form10-Qs which were filed with the SEC. The10-Qs Form 12 represented that the financial statements included all adjustments 13 which were, "in the opinion of management, necessary to a fair 14 statement" of the Company's results.
54. These financial statements and the statements about them 16 were false and misleading, as such financial information was not 17 prepared in conformity with GAAP, nor was the financial information 18 Ita fair presentation" of Ashworth's operations due to Ashworth's 19 improper accounting for its inventory in violationof GAAP and SEC 20 rules. 21 55. GAAP are those principles recognized by the accounting 22 profession as the conventions, rules and procedures necessary to 23 defineaccepted accounting practice at a particulartime. 24 Regulation s-X (17 C.F.R. §210.4-01(a) (I)) states that financial 25 statements filed with the SEC which are not prepared in compliance 26 with GAAP are presumed to be misleading and inaccurate. Regulation 27 s-X requires that interim financial statements must also Comply 28 with GAAP, with the exception that interim financial statements
- 42 - 1 neednot include disclosure which would be duplicative of e 2 disclosures accompanying annual financial statements. 17 C.F.R. 3 §210.10-01 (a).
4 Ashworth's Improper Accountinq For Inventory
5 56. GAAP, as set forth in Accounting Research Bulletin
6 ( "ARB" ) No. 43, Chapter 4, Inventory Pricing, requires that 7 inventories be recorded at the lower of cost or market.ARB No.
8 43, Chapter 4, Statement 5 states:
9 A departure from the cost basis of pricing the inventory is required when the utility of the goods is no 10 longer as great as its cost. Where there is evidence that the utility of goods, in their disposal in the 11 ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, 12 changes in price levels, or other causes, the difference should be recognized as a loss of the current period. 13 This is generally accomplished by stating such goods at a lower level commonly designated as market. 14 (Emphasis in original.)
57. During the Class Period, the Company suffered from 16 diminishing demand for its Basics product line resulting in 17 Ashworthaccumulating millions of dollars worth of excess 18 inventory. 19 58. Moreover, due to Ashworth's problems in its offshore 20 sewing operations in which large amounts of products were being 21 produced that were below minimum quality standards, Ashworth was 22 accumulating large amounts of irregular and obsolete inventory 23 which Ashworth would not be able to sell except at below its cost 24 at severe discounts. Also, the products which were in demand for 25 Ashworth were not being successfully manufactured in the offshore 26 facilities. As a result of these offshore problems, Ashworth was accumulating large amounts of excess and overvalued inventory. a 28
- 43 - 1 59. Ultimately, in the 4thQF98, Ashworth reporteda loss due 0 2 to Itinventory adjustmentstt to write down overvalued inventory. Had 3 Ashworth appropriately reserved for excess and overvalued inventory 4 in prior quarters, such a charge would have been unnecessary.
5 During the Class Period, Ashworth reported either comparable or
6 improving gross margins on a quarterly basis. Had Ashworth 7 properly reported its inventory in accordanceGAAP, with Ashworth's
8 gross margins and earnings during the Class Period would have been
9 materially lower in each of the quarters reported. Moreover,
10 Ashworth materially overstated its inventory as reported inits
11 financial statements during the Class Period.
12 60. Defendants were aware of the following factors which
13 required themto record material charges for excess and overvalued 14 inventories during the Class Period:
15 (a) Demand for Ashworth's Basics product line was not
16 increasing but, in fact, decreasing during the Class Period;
17 (b) Ashworth's inventories were increasing and its
18 inventory turnover was decreasing during the Class Period;
19 (c)Ashworth had to offer its customers discount
20 programs in order to artificially inflate its sales when there was
21 no increase in demand for its products, but, in fact, demand was
22 decreasing; 23 (d) Ashworth's cost of product was increasing throughout 24 the Class Period; and
25 (e) Ashworth's inventory quantities were excessive given
26 its actual sales and demand for its products (in the 4thQ F97
27 alone, inventories increased 32% to $33.6 million, and remained
28 high throughout the Class Period).
- 44 - 1 61. Due to these accounting improprieties, the Company e 2 presented its financial results and statements ain manner which 3 violated GAAP, including the following fundamental accounting
4 principles: 5 (a) The principle that interim financial reporting
6 should be based upon the same accounting principles and practices
7 used to prepare annual financial statements(APB No. 28, 910);
8 (b)The principle that financial reporting should
9 provide information that is useful to present and potential
10 investors and creditors and other users in making rational
11 investment, credit and similar decisions was violated (FASB
12 Statement of ConceptsNo. 1, 934);
13 (c)The principle that financial reporting should
14 provide information about the economic resources of an enterprise,
15 the claimsto those resources, and effects of transactions, events
16 and circumstances that change resources and claims to those
17 resources was violated(FASB Statement of ConceptsNo. 1, 940);
18 (d)The principle that financial reporting should
19 provide information about how management of an enterprise has
20 discharged its stewardship responsibility to owners (stockholders)
21 for the use of enterprise resources entrusted to it was violated.
22 To the extent that management offers securities of the enterprise
23 to the public, it voluntarily accepts wider responsibilities for
24 accountability to prospective investors and to the public in
25 general (FASB Statement of ConceptsNo. 1, 950);
26 (e)The principle that financial reporting should
27 provide information about an enterprise's financial performance e 28 during a period was violated. Investors and creditors often Use
- 45 - information about the past to help in assessing the an prospects of 0 2 enterprise. Thus, although investment and credit decisions reflect
3 investors' expectations about future enterprise performance, those
4 expectations are commonly based at least partly on evaluations of
5 past enterprise performance (FASB Statement of Concepts No. 1,
6 842) ;
7 (f) The principle that financial reporting should be
8 reliable in that it represents what it purports to represent was
9 violated. That information should be reliable as well as relevant
10 is a notion that is central to accounting (FASB Statement of
11 Concepts No. 2, fin58-59);
12 (9) The principle of completeness, which means that
13 nothing is left out of the information that may be necessary to
14 insure that it validly represents underlying events and conditions
@ . 15 was violated (FASB Statement of ConceptsNo. 2, 879); and
16 (h) The principle that conservatism be useda prudent as
17 reaction to uncertainty to try to ensure that uncertainties and
18 risks inherent in business situations are adequately considered was
19 violated. The best way to avoid injury to investors is to try to
20 ensure that what is reported represents what it purports to
21 represent (FASB Statement of ConceptsNO. 2, 8895, 97).
22 62. Further, the undisclosed adverse information concealed by
23 defendants during the Class Period is the type Of information
24 which, because of SEC regulations, regulations of the national
25 stock exchanges and customary business practice, is expected by
26 investors and securities analyststo be disclosed and is known by corporate officials and their legal and financial advisorsto be
28
- 46 - 1 the type of information which is expected to be and must be e 2 disclosed. 3 INSIDER SELLING
4 63. While Ashworth‘s top insiders were issuing favorable
5 statements about Ashworth, the Individual Defendants sold shares of
6 Ashworth stock for more than $20.7 million -- -75% of their 7 collective holdings of Ashworth stock-- to personally profit from
8 the artificial inflation in Ashworth’s stock price which their
9 fraudulent scheme had created. Notwithstanding their access to
10 confidential information aas result of their status as directors,
11 officers and/or insiders of the Company, and their corresponding
12 duty to disclose adverse material facts before trading in Ashworth
13 stock, the Individual Defendants sold significant amounts of
14 Ashworth shares at artificially inflated prices into profitorder
15 from the fraud, and didso while in possession of material non-
16 public information. Defendants’ insider selling during the Class
17 Period is detailed below:
18 % OF PRICE SHARES DATE SHARES PER PROCEEDS OWNED 19 NAME SOLD SHARE FROM SALE SOLD 20 Ashworth, John 09/18/97 2,500 $10.75 $ 26,875 09/19/97 162,422 $10.75 $1,746,037 10/01/97 235,000 $10.12 $2,378,200 21 10/15/97 35,000 $ 9.79 $ 342,650 03/09/98 175,000 $16.37 S2.864.750 22 609,922 $7,358,512 -99% Couples, Fred 01/15/98 225,000 $13.25 $2,981,250 23 03/12/98 100,000 $17.00 $1,700,000 325.000 $4.681,250 -41% 24 Gambucci , Andre P. 09/09/97 1,500 $11.13 $ 16,695 09/10/97 20,000 $11.02 $ 220,400 25 01/15/98 10.000 $13.00 $ 130,000 31,500 -59% 26 Montiel, Gerald W. 09/19/97 110,000 $10.80 $1,188,000 27 09/22/97 40,000 $10.71 $ 428,400 09/24/97 45,000 $10.59 $ 476,550 e 28 03/23/98 20,625 $17.64 $ 363,825 03/23/98 29,375 $17.64 $ 518,175 - 47 - 1 03/23/98 100,000 $17.93 $1,793,000 03/23/98 100,000 $17.50 $1,750,000 2 06/19/98 3,000 $15.13 $ 45,390 e 06/19/98 400 $15.19 $ 6,076 06/19/98 1,600 $15.06 $ 24,096 3 06/29/98 2,000 $14.28 5 28,560 452,000 $6,622,072 -95% 4 Montiel, MaryA. 01/12/98 11,000 $12.00 $ 132,000 03/12/98 50,000 $17.00 s 850,000 5 61,000 $ 982,000 -100% Newman, John 10/17/97 10,000 $ 9-70 $ 97,000 6 03/09/98 38,000 $16.14 $ 613,320 48,000 $ 710,320 100% 7 Total $20,721,249 1,527,422 -
8 64. Each Individual Defendant who exercised options to
9 purchase Ashworth stock during the Class Period sold100% of the
10 Ashworth stock he/she acquiredby option exercise.
11 FIRST CLAIM FOR RELIEF
12 For Violation Of§lO(b) Of The 1934 Act And Rule lob-5 Asainst All Defendants 13 65. Plaintiff incorporates jIjl-64 by reference. 14 66. During the Class Period, defendants disseminated or @ 15 approved the false statements specified above, which they knew or 16 recklessly disregarded were misleading in that they contained 17 misrepresentations and failed to disclose material facts necessary 18 in orderto make the statements made, in light of the circumstances 19 under which they were made, not misleading. 20 67. Defendants violated§lo (b) of the1934 Act and Rulelob-5 21 in that they: 22 (a)Employed devices, schemes, and artif ices to 23 defraud; 24 (b) Made untrue statements of material facts or omitted 25 to state material facts necessary in order to make statements made, 26 in light of the circumstances under which they were made, not 27 misleading; or 28
- 40 - 1 (c)Engaged in acts, practices, and a courseof 0 2 business that operated as a fraud or deceit upon plaintiff and others similarly situated in connection with their purchases of Ashworth's common stock and publicly traded options during the Class Period. 68. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of the market, they paid artificially 8 inflated prices for Ashworth stock and options. Plaintiff and the
9 Class would not have purchased Ashworth stock or options at the 10 prices they paid, or at all, if they had been aware that the market
11 prices had been artificially and falsely inflated by defendants'
12 misleading statements.
13 69. As a direct and proximate result of these defendants' 14 wrongful conduct, plaintiff and the other members of the Class suffered damages in connection with their purchases of Ashworth 16 common stock and its publicly traded options during the Class 17 Period. 18 SECOND CLAIM FOR RELIEF
19 For Violation Of §20(a) Of The1934 Act Asainst Defendants Herrel And Ashworth 20 70. Plaintiff incorporates qnl-69 by reference. 21 71. Defendant Herrel acted as a controlling person of 22 Ashworth within the meaning of §20(a) of 1934 the Act. By reason 23 of his positions as President, Chief Executive Officer and a 24 director of Ashworth, and his ownership of Ashworth stock, Herrel 25 had the power and authority to cause Ashworth to engage in the 26 wrongful conduct complained of herein. Ashworth controlledOf each 27 the Individual Defendants and allof its employees. By reasonOf e 28
- 49 - such conduct, Herrel and Ashworth are liable pursuant to §20(a) of e 2 the 1934 Act. 3 CLASS ACTION ALLEGATIONS 4 72. Plaintiff brings this action aas class action pursuant
5 to Rule23 of the Federal Rules of Civil Procedure on behalf of all
6 persons who purchased Ashworth stock and options (the IfClassI')on
7 the open market during the Class Period. Excluded from the Class
8 are defendants.
9 73. The members ofthe Class areso numerous that joinder of
10 all members is impracticable. The disposition of their claims in
11 a class action will provide substantial tobenefits the parties and
12 the Court. Ashworth had more than 25 million shares of stock
13 outstanding as well as publicly traded options, owned by hundreds
14 if not thousands of persons.
15 74. There is a well-defined community of interest in the
16 questions of law and fact involved in this case. Questions of law
17 and fact commonto the members of the Class which predominate over
18 questions which may affect individual Class members include:
19 (a) Whether the 1934 Act was violated by defendants;
20 (b) Whether defendants omitted and/or misrepresented
21 material facts;
22 (c) Whether defendants' statements omitted material
23 facts necessary to make the statements made, in light of the
24 circumstances under which they were made, not misleading;
25 (d) Whether defendants knew or recklessly disregarded
26 that their statements were false and misleading; (e) Whether the price of Ashworth's stock and publicly
28 traded options was artificially inflated; and
- 50 - 1 J. (f) The extentof damage sustained by Class members and
0 2 the appropriate measure of damages.
3 75. Plaintiff's claims are typical of those of the Class
4 because plaintiff and the Class sustained damages from defendants'
5 wrongful conduct.
6 76. Plaintiff will adequately protect the interests of the
7 Class andhas retained counsel who are experienced in class action
8 securities litigation. Plaintiff has no interests which conflict
9 with those of the Class.
10 77. A class action is superiorto other available methods for
11 the fair and efficient adjudication of this controversy.
12 STATUTORY SAFE HARBOR
13 78. The statutory safe harbor provided for forward-looking
14 statements under certain circumstances does not applyof the to any @ 15 allegedlyfalse forward-looking statements pleaded in this
16 Complaint. The statutory safe harbor does not toapply Ashworth's
17 false financial statements. Also, none of the particular oral
18 forward-looking statements pleaded herein were identified as
19 nforward-looking statements" when made. None of the written
20 forward-looking statements made were identifiedas forward-looking
21 statements. Nor was it stated as to either type of forward-looking
22 statement that actual results q*could differ materially from those
23 projected.11 Nor did meaningful cautionary statements identifying
24 important factors that could cause actual results to differ
25 materially from those in the forward-looking statements accompany
2€ those forward-looking statements. Each of the forward-looking statements alleged herein to be false was authorized by an
21
- 51 - executive officer of Ashworth and was actually known by each of the e 2 Individual Defendants to be false when made.
3 BASIS OF ALLEGATIONS
4 79. Because the PSLRA, §21D(c) of the 1934 Act [15 U.S.C. 5 §78u-4(c)], requires complaints to be pleaded in conformance with
6 Federal Rule of Civil Procedure 11, plaintiff has alleged the
7 foregoing based upon the investigation of his counsel, which
8 included a review of Ashworth's SEC filings, securities analysts'
9 reports and advisories about the Company, press releases issued by
10 the Company, media reports about the Company, private investi-
11 gations and discussions with consultants, and, pursuant to Rule
12 ll(b) (3), believes that after reasonable opportunity for discovery,
13 substantialevidentiary support will likely exist for the 14 allegations set forth atTTlO, 34, 50, 52, 54and 57-60. 15 PRAYER FOR RELIEF
16 WHEREFORE, plaintiff prays for judgmentas follows:
17 1. Declaring this action to be a proper class action
18 pursuant to Rule 23;
19 2. Awarding plaintiff and the members of the Class damages, 20 interest and costs;
21 3. Awarding equitable and/or injunctive relief as permitted
22 by lawor equity, including the imposition a ofconstructive trust 23 upon the proceeds of defendants' insider trading, pursuant to Rules
24 64, 65, and any appropriate state law remedies; and 25 4. Awarding such other relief as the Court may deem just and
26 proper.
28
- 52 - 1 JURY DEMAND
2 P1aintiff dem .ands a trial by jury.
3 DATED: January 22, 1999 MILBERG WEISS BERSHAD 4 HYNES & LERACH LLP WILLIAM S. LERACH 5 DAVID C. WALTON
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9 600 West Broadway, Suite 1800 San Diego, CA 92101 10 Telephone: 619/231-1058
11 LAW OFFICES OF BRUCE G. MURPHY BRUCE G. MURPHY 12 265 Llwyds Lane Vero Beach, FL 32963 13 Telephone: 561/231-4202
14 Attorneys for Plaintiff
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* 28 CASES\COWLNTS\ASHWORTH. CPT - 53 - JHN-le-lYYY l2:4b bLUUUtK
1 CERTIFICATION OF NAMED PLAINTIFF' PURSUANT TO FEDERAL SECURITIES LAWS e2
3 BRIAN JOHNSON (81Plaintiff81)declares: 4 1. Plaintiff has reviewed a complaint and authorized its
5 filing .
6 2. Plaintiff did not purchase the security that is the 7 subject ofthis action at the directionof plaintiff's .counselor a in order to participate in this private action or any other 9 litigation under thefederal securities laws. 10 3. Plaintiff is willing to serve as a representative party
11 on behalf of the class, including providing testimony at deposition
12 and trial, if necessary.
13 4. Plaintiff has made no transaction(s1 during the Class 14 Period in the debt or equity securities that are the subjectof 15 this action except thoseset forth below: Rd 16 Price Transaction 17 Security /m. % wkbmgNd Per Share Common Stock Purchased 4+%e-res 03/20/98 $17-13/16 18
19
20
21 Certificate, Plaintiff has not sought to serve Of served a5 a 22 representative party for a class in any actions filed under the 23 federal securicies laws. 24 6. The Plaintiff will not accept any payment for serving as 25 a representative party on behalf of the class beyondLhe 26 Plaintiff's pro rata share of any recovery, except such reasonable 27
28 costs and expenses (including lost wages) directly relating to the representation of the class as ordered or approved by the court. 3 I declare under penalty of perjury that the foregoing is true
4 and correct. Executed this , 1999.
5
6 JOHNSON 7
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14 15
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2s
26
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@ 28