Page 1 of 223 Consolidated Complaint for Violation of the Federal Securities Law Source: Milberg Weiss Date: 05/15/02 Time: 9:43 AM MILBERG WEISS BERSHAD HYNES & LERACH LLP WILLIAM S. LERACH (68581) DARREN J. ROBBINS (168593) SPENCER A. BURKHOLZ (147029) DANIEL S. DROSMAN (200643) 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax) LEVIN, PAPANTONIO, THOMAS, MITCHELL, ECHSNER & PROCTOR, P.A. FREDRIC G. LEVIN (pro hac vice) J. MICHAEL PAPANTONIO (pro hac vice) TIMOTHY M. O'BRIEN (pro hac vice) 316 South Baylen Street, Suite 600 Pensacola, FL 32501 Telephone: 850/435-7000 850/436-6084 (fax) Co-Lead Counsel for Plaintiffs UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA SAN JOSE DIVISION PLUMBERS & PIPEFITTERS NATIONAL ) Master File No. C-01-20418-JW ) PENSION FUND, et al., On Behalf of ) CLASS ACTION Themselves and All Others Similarly ) Situated, ) CONSOLIDATED COMPLAINT ) FOR VIOLATION OF THE http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../3 8/7/02 Page 2 of 223 FOR VIOLATION OF THE Plaintiffs, ) FEDERAL SECURITIES LAWS vs. ) ) CISCO SYSTEMS, INC., JOHN T. ) CHAMBERS, LARRY R. CARTER, GARY ) ) J. DAICHENDT, JUDITH L. ESTRIN, ) CARL REDFIELD, MICHELANGELO ) VOLPI, CAROL A. BARTZ, STEVEN M. ) WEST, EDWARD R. KOZEL, ROBERT L. ) ) PUETTE, DONALD J. LISTWIN, ) DONALD T. VALENTINE, and ) PRICEWATERHOUSECOOPERS LLP, ) ) Defendants. ) ____________________________________ ) ) In re CISCO SYSTEMS, INC. ) SECURITIES LITIGATION ) ____________________________________ ) ) DEMAND FOR JURY TRIAL This Document Relates To: ALL ACTIONS. ____________________________________ SUMMARY OF THE ACTION 1. This is a securities class action on behalf of all purchasers of the common stock of Cisco Systems, Inc. ("Cisco" or the "Company") between 8/10/99 and 2/6/01 (the "Class Period"), arising out of defendants' manipulative conduct, fraudulent course of business and false statements regarding Cisco's business - including its orders and demand for its products, the reasons for and the impact of the growth in its inventories, the quality of and accounting for its "vendor financing" program, the development and sales of its new Monterey fiber optic switch, the capability of its Cerent product, its success in penetrating the customer service software market, its success in penetrating the telecommunications service provider market with new fiber optic products, the success and continuation of Cisco's acquisition program, and Cisco's forecasted growth and its F01-F02(1) revenues, net income and earnings per share ("EPS"), as well as Cisco's actual reported financial results throughout the Class Period. 2. For years, Cisco achieved rapid growth by selling data transmission equipment (routers) to corporate customers and government agencies to network their computer systems and to provide access and data communications via the Internet. However, by 99, these markets were maturing and so to try to sustain its rapid growth, Cisco began to try to sell data and voice transmission equipment to telecommunications service providers, including both large established telephone carriers, as well as new Competitive Local Exchange Carriers ("CLECs"). Also, beginning in 93 Cisco had begun an acquisition binge to try to obtain new technology and new products to stimulate Cisco's revenue and EPS growth, using Cisco stock as the currency to pay for these acquisitions. By 98-99, Cisco's ability http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../3 8/7/02 Page 3 of 223 to obtain top flight engineering talent, cutting edge technology and new products to boost its revenues and EPS had become dependent upon its ability to continue to make large numbers of acquisitions. Cisco's pace of acquisitions accelerated rapidly during 99-00, with Cisco acquiring 18 companies in 99 and 23 companies in 00. Between 93 and 00, Cisco acquired 71 companies - 95% of which were for Cisco stock. During the Class Period, Cisco's ability to continue to make these types of acquisitions, which were vital to its continued business success and EPS growth, was dependent on Cisco's stock price increasing. 3. By 99, Cisco was also operating in an environment of intense competition to hire and retain talented, technically competent employees. This was due to a critical shortage of such people in Silicon Valley, in part because new dot.com and Internet-related companies were offering these types of employees very lucrative stock option-based compensation programs. Cisco's compensation system for its employees was predominantly based on stock options to buy Cisco stock, with employees regularly receiving option grants at Cisco's then market price, varying in size by the recipient's position in the corporate hierarchy. By 00, Cisco had over 530 million employee stock options outstanding. Cisco's stock options, which were critical to enabling Cisco to retain existing employees and attract new employees, became more valuable only if Cisco's stock increased in price. 4. By 99, because of Cisco's need to continue to constantly make acquisitions using its stock and its dependence on stock options to compensate its executives and attract and retain high-quality employees, Cisco's top executives were under tremendous pressure to push Cisco's stock price ever higher. Because Cisco's business and growth strategy had become so dependent upon its stock price, Cisco's stock price was a fixation among its top executives, who monitored the trading of the stock on a daily - even hourly - basis! 5. Due to Cisco's rapid growth, by 98 its sales had reached an annual level of over $8 billion. Due to Cisco's increasing size, analysts and investors became concerned over Cisco's ability to continue to achieve the strong 30%-50% annual revenue growth it had been reporting. Moreover, because Cisco controlled some 45% of the enterprise market, its ability to grow at the same rate as in the past was doubtful. As a result of these concerns, Cisco's stock, which had been a very strong performer, increasing from approximately $8 in early 98 to more than $30 in early 99, stagnated during 99, trading at $29-3/8(2) on 2/1/99 and $29-3/8 on 8/10/99 - the start of the Class Period - meaning Cisco's stock - a supposedly unique growth stock - had shown no net price gain in over six months! This stock price stagnation was a major concern to Cisco's top executives. Worse yet, they feared that if analysts and investors perceived that Cisco's revenue and EPS growth rates were slowing, they would be unwilling to pay the type of huge premium that Cisco's stock had historically enjoyed and this would result in a sharp decline in Cisco's stock price. They knew that any such decline in Cisco's stock would be a disaster for Cisco and its top executives, as it would curtail (if not eliminate) Cisco's ability to continue to make the large numbers of acquisitions upon which Cisco's business plan and financial growth had become dependent. Such a price decline would also reduce (if not eliminate) the value of the stock options held by Cisco's executives, management and other employees, resulting in a huge loss of wealth for Cisco's executives and even an exodus of valued employees, who would be lured elsewhere by more lucrative stock option programs of smaller, still rapidly growing companies that had stocks which would more likely appreciate in price. 6. So, in order to make it appear that Cisco was maintaining its phenomenal growth, Cisco consistently "beat the Street" - reporting quarterly revenue growth that exceeded forecasted levels and, beginning in 87, quarterly EPS that were $.01 better than consensus forecast every quarter, creating a Cisco "cult" following among analysts and investors. The importance of Cisco http://securities.milberg.com/mw-cgi-bin/view_story?uid=filings&conf=/disk22/websites/MW.../3 8/7/02 Page 4 of 223 consistently beating the Street's EPS consensus forecast by $.01 each quarter was highlighted by Cisco in a 5/00 Fortune magazine article: Wall Street ... has fallen hopelessly in love with Cisco. But managing Wall Street is also a textbook operation. "The company reports like clockwork," says George Kelly, a Morgan Stanley Dean Witter analyst who has had a buy on the company since it went public. Says Larry Carter: "We focus on communicating and being consistent. There is nothing Wall Street likes more than that." That attitude helps explain why of the 33 analysts covering Cisco, 12 have buys and 21 have strong buys.... And it helps explain why Carter was able to point out to a group of institutional investors at a Merrill Lynch conference this year - right after the company's tenth anniversary as a public company - that Cisco had just logged its 40th quarter in a row of record revenues and profits, without ever missing expectations. Music to Wall Street's ears. 7. When reporting its 4thQ F99 and F99 results after the close of trading on 8/10/99 - the beginning of the Class Period - and then, throughout the Class Period, Cisco continued its pattern of beating consensus forecasted EPS by one cent each quarter - defying skeptics, critics and bears on Wall Street. During virtually the entire Class Period, Cisco assured analysts and investors that it was enjoying strong demand for all its products in all geographic regions, while consistently reporting a book-to-bill ratio above one, supposedly concrete evidence that new orders for its products were exceeding shipments, demonstrating that Cisco was continuing to enjoy strong demand for its products, which would allow Cisco to continue its exceptional revenue, net income and EPS growth for the next several years. In fact, so strong was demand for Cisco's product that in late 00, Cisco actually increased its forecasted growth rate and its F01 and F02 revenues, net income and EPS.