In re Scientific Atlanta Inc. Sec. Litig..

754 F.Supp.2d 1339

In re SCIENTIFIC ATLANTA, INC. SECURITIES LITIGATION.

Civil Action No. 1:01–CV–1950–RWS.

United States District Court, N.D. Georgia, Atlanta Division.

Nov. 18, 2010.

ORDER

RICHARD W. STORY, District Judge.

This case is before the Court on Defendants' Motion for Summary Judgment [412, 420] and Defendants' Motion to Strike and Motion in Limine Concerning Inadmissible Evidence of Collateral Government Proceedings [439, 445]. After reviewing the record and considering the arguments of the parties, the Court enters the following Order.

Background

The Court here summarizes Plaintiffs' case as set forth in the Consolidated Class Action Complaint (“the Complaint”) [35], Defendants' Rule 56.1 Statement of Undisputed Material Fact (“SOF”) [412–2 and 412–3],¹ Plaintiffs' Rule 56.1 Statement of Material Facts (“SMF”),² and SMF Ex. 3u: Amended Expert Report of Steven L. Henning, Ph.D., CPA dated November 14, 2008 (“Henning Am. Rep.”). Nothing in this opinion should be construed as deeming admitted or undisputed the facts asserted in these filings.

The above captioned lawsuit is a putative securities class action. The Complaint alleges that Defendants engaged in channel stuffing and improper accounting practices in an effort to conceal decreasing demand for the products of Defendant Scientific–Atlanta, Inc. (“S–A”). Plaintiffs further allege that the persons controlling S–A during the relevant time period disseminated to the investing public both materially false and misleading information, as well as omitted material information, with the result that Plaintiffs and others purchased S–A securities at an artificially inflated price in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“the Exchange Act”), as amended by the Private Securities Litigation Reform Act of 1995 (“PSLRA”) and Rule 10b–5 promulgated thereunder.

A. Defendants' Alleged Wrongful Conduct

Defendant S–A is a cable equipment manufacturer which manufactures and sells products for the cable television industry, including digital video, voice, and data communications products. (SOF ¶ 1.) Defendants James F. McDonald (“McDonald”) and Wallace G. Haislip (“Haislip”) served during the relevant time period as S–A's Chief Executive Officer and Chief Financial Officer respectively. (SOF ¶¶ 2–3.) During the class period, S–A had two primary business units: the subscriber and transmission business units. The subscriber unit manufactured, among other products, digital set-top boxes, digital head ends, and cable modems. The transmission unit manufactured products that allowed cable operators to transmit signals, including video, data, and voice, to cable subscribers over the cable network. S–A's main customers during the class period were cable companies, otherwise known as Multiple System Operators (“MSOs”). (SOF ¶¶ 5, 7–8, 10.)

The Complaint focuses on fiscal year 2001, which began in July 2000 and ended in June 2001. S–A performed well in the first fiscal quarter of fiscal year 2001, as evidenced by the fact that it experienced record levels of net earnings, subscriber bookings and revenue, and transmission bookings for any first quarter in S–A's history. (SOF ¶ 109.) These results also reflected year-over-year and quarter-over-quarter growth in bookings, sales, backlog, and gross margin. (SOF ¶ 110.)

Plaintiffs allege, however, that this positive news was tempered by S–A's awareness that transmission sales were declining and trending lower each quarter. Faced with this weakening demand in its transmission business, S–A looked to offset a potential decline in overall sales by increasing sales of subscriber-related products. (Henning Am. Rep. at 8–9.)

To that end, S–A engaged in a number of aggressive sales practices over its second and third quarters intended to offset (and in some cases, to obscure) this decline in demand. One such practice involved quarterly efforts to pull in sales from later quarters. (SMF ¶¶ 10b-e, 18a-b, h.) To effect these pull-ins, Defendants offered incentives for MSOs to take products earlier than these customers would have otherwise done. These incentives included discounts coupled with unusually liberal return policies, warehousing credits, and unusually permissive extended payment terms. (SMF ¶¶ 10a-c, e, g, i, 27g.)

As a result of these efforts, S–A's customers accumulated inventories well above the typical baseline for these companies. While a MSO would typically maintain inventories consisting of four to six weeks worth of deployments, the average inventory for S–A's customers reached 11.7 weeks during the class period. (SMF ¶¶ 2b, 36e.) On average, monthly shipments exceeded deployments by twenty-five percent over the course of the class period, with total inventory by S–A's customers exceeding five months of deployments by June 2001. (Henning Am. Rep. at 10.) Moreover, S–A was likely aware of these excessive customer inventories, as it was standard practice for S–A's sales staff to monitor inventory levels through constant communication with customers. (SMF ¶¶ 2b, 3b-c, g, j.) Plaintiffs allege that such practices amount to actionable channel-stuffing.

In addition to its aggressive sales practices, S–A allegedly boosted its quarterly results by improperly recognizing revenue on several transactions in violation of policies outlined in the Generally Accepted Accounting Principles (“GAAP”). (SOF ¶ 316; SMF ¶ 31b, e, f; Henning Am. Rep. at 3–2 to 3–5.)

B. Defendants' Alleged Misrepresentation

The class period begins on January 18, 2001. (Complaint ¶ 72.) On that date, S–A issued a press release reporting “record financial results” of $707.3 million for the second quarter, a fifty-two increase over the previous year's second quarter. The press release attributed these results to increases in both subscriber and transmission bookings, as well as the business strategies underlying those results, but omitted information relating to S–A's alleged channel stuffing and accounting practices. (SMF ¶ 11a.) In a second press release the same day, S–A stated that it was increasing manufacturing capacity “[i]n response to the continuing acceleration in customer demand.” (SMF ¶ 11b.) In a conference call following the release of S–A's second quarter earnings, Defendant Haislip forecasted continued growth in S–A's subscriber business, particularly sales of digital set-top boxes, which would offset any decline in transmission revenue. (SOF ¶ 178.)

Furthermore, on April 19, 2001, S–A reported third quarter sales of $663.7 million, a fifty-one percent year-over-year increase. (SMF ¶ 22a.) In an April 20, 2001 interview, Defendant McDonald described rising consumer demand for S–A's digital set-tops and emphasized analysts' optimism about SA's future earning potential. In another interview the same day, McDonald predicted similarly strong sales during the fourth quarter. (SOF ¶ 119.) Once again, none of the public statements regarding S–A's sales disclosed its practices of pulling in sales from later quarters or recognizing revenue in violation of GAAP.

For each quarter, Plaintiffs allege that the announcement of the quarter's results was misleading because Defendants did not disclose the pervasive channel stuffing or the prematurely recognized revenue during the third quarter. (Complaint ¶¶ 82, 85, 165.) Furthermore, Plaintiffs allege that Defendants McDonald and Haislip had access to adverse information about the business, finances, markets, and present and future prospects of S–A during the class period. As such, Plaintiffs aver that Defendants McDonald and Haislip were obligated to disseminate accurate information about S–A's operations and financial condition and to correct misinformation that could deceive the public. According to the Complaint, Defendants' failure to meet this obligation caused the price of S–A securities to be inflated artificially, damaging Plaintiffs and the putative class.

C. Correction of the Alleged Fraud

In a series of disclosures in July and August of 2001, S–A announced that it had failed to meet revenue forecasts for fiscal year 2001 due to decreased demand for its products, thereby reducing its earnings forecasts for the first quarter of fiscal year 2002. In its press release on July 19, S–A reported that sales had decreased during its fourth fiscal quarter. (SMF ¶ 29a.) S–A attributed the year-over-year decline in total bookings for that quarter to “the uncertain economic climate and reduced digital marketing efforts by cable operators during the slower summer vacation period, in addition to customer inventory levels and the slower than expected deployment of interactive applications.” (SMF ¶ 33a.)

On the same date, in the conference call discussing the press release, Defendant McDonald told investors that part of the decline in new bookings resulted from MSOs absorbing inventory that had accumulated earlier in the fiscal year. (SMF ¶ 33b.) S–A's July 19 statements also attributed the unexpected downturn to a lack of historical data that would have allowed S–A to gauge the “sensitivity of demand to changes in the economy,” as well as the declining economy's adverse effect upon “consumer purchases of new digital services, and thus purchases of the [S–A's] digital products by the MSOs.” (SOF ¶ 252.)

As a result of these announcements, the price of S–A common stock plummeted, dropping from $35.08 per share to $22.80 per share. (SOF ¶ 222.) In the following days, several analysts discussed the various factors that resulted in S–A's disappointing fourth quarter results. Several focused on industry-wide factors as well as the role played by excess customer inventories. (SOF ¶ 253.) Some analysts placed greater emphasis on the inventory correction, while others highlighted the impact of the softening economy and unexpectedly slow deployment of interactive applications associated with digital cable. (SMF ¶ 35 d-i; SOF Ex. 109.)

The class period ends on August...