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UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
DAVID ROTH, On Behalf of Himself and All )
Others Similarly Situated,
)
)
Plaintiff,
)
)
vs.
)
)
OFFICEMAX INC., et al.,
)
)
Defendants.
)
)
No. 05-C-0236 (Consolidated)
CLASS ACTION
Judge Gottschall
Magistrate Judge Denlow
FIRST AMENDED CONSOLIDATED COMPLAINT FOR VIOLATION OF
THE FEDERAL SECURITIES LAWS
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SUMMARY AND OVERVIEW
1.
This is a federal class action on behalf of those who purchased or otherwise acquired
the publicly traded securities of OfficeMax Inc. (“OfficeMax” or the “Company”), between
December 1, 2003 and January 11, 2005 (the “Class Period”), against OfficeMax and certain of its
current and former officers and directors for violations of the Securities Exchange Act of 1934 (the
“1934 Act”). OfficeMax was created when Boise Cascade Corporation (“Boise”), a paper products
company, bought old-OfficeMax just after the beginning of the Class Period. Boise subsequently
changed its name to OfficeMax after selling off part of its business. The name change did not
become effective until October 2004.1
2.
Defendants’ fraudulent scheme involved three related facets. First, during a critical
period before and after Boise completed its purchase of old-OfficeMax, defendants fraudulently
inflated OfficeMax’s earnings by claiming false rebates from vendors who sold products to
OfficeMax. OfficeMax has since restated its financial results, admitting the Company had issued
false financial statements to investors, wherein its reported earnings were falsely inflated. The
Individual Defendants named in this action either knew of and approved the illegal conduct or
recklessly disregarded the existence of the scheme and failed to disclose this material information to
investors. Second, during the Class Period, defendants recklessly misrepresented to investors that
OfficeMax had put in place internal controls and reporting mechanisms to prevent such illegal
conduct. OfficeMax has since admitted, these representations and its CEO’s and CFO’s certification
of the Company’s internal control were false. And, third, defendants covered-up the existence of
these accounting improprieties until December 20, 2004 – when OfficeMax “announced it has
1
References to old-OfficeMax concern OfficeMax pre-acquisition by Boise. During the Class Period,
many of the press releases by the Company refer to itself as Boise until the name change became effective in
October 2004. Lead Plaintiff refers to the combined Company as OfficeMax in this Complaint.
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commenced an investigation into certain vendor allegations” – so that OfficeMax could issue on
December 16, 2004, 5.4 million shares on favorable terms. Only two business days after issuing
$172.5 million in OfficeMax common stock, defendants disclosed the existence of the internal
investigation into significant impropriety – which investigation had already commenced “at the
direction of the audit committee of its board of directors.” Indeed, the investigation had begun
weeks, if not months, prior to when defendants formally disclosed it on December 20, 2004.
Covering-up such material information while issuing securities to the public was an independent
violation of the federal securities laws separate and apart from defendants’ violations of the
accounting rules.
3.
In the beginning of the Class Period, on December 9, 2003, both companies’
shareholders approved the sale of old-OfficeMax to Boise for $10.50 per share. Boise’s acquisition
of old-OfficeMax was an important part of Boise’s transformation from a forest products company
to a major retail distribution company. In October 2004, Boise would sell its remaining forest
product assets, adopt the name “OfficeMax,” and abandon its wood product manufacturing business
in favor of its office supply retail business. Today, OfficeMax is a multinational retail distributor of
office supplies, paper, technology products and office furniture.
4.
Investors were skeptical that the new OfficeMax could deliver on defendants’
promises of strong financial growth. Accordingly, the management of both old-OfficeMax and
Boise worked hard to get the merger approved. What investors did not know when they approved
the merger was that old-OfficeMax had falsified its financial results. And, after the merger was
approved, the combined OfficeMax continued to falsely inflate its financial results in an effort to
convince investors that the combined Company could in fact deliver on defendants’ promises.
5.
It was a common, notorious practice at OfficeMax to bill vendors for
marketing/promotion services to be rendered by OfficeMax at some time in the future, and for
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OfficeMax to book those payments in the present reporting period before the services were rendered.
For example, OfficeMax billed Microsoft for nearly a year’s worth of marketing and promotional
services it had not yet performed. This practice was sometimes referred to at the Company as
“leveraging the future.” OfficeMax’s CEO, defendant Michael Feuer, would personally instruct
OfficeMax Executive Vice-President of Merchandising Ryan Vero to oversee this process to ensure
that the Company made its numbers at the end of reporting periods during the Class Period.
6.
In addition to issuing false financial statements, defendants George J. Harad,
Theodore Crumley and Christopher C. Milliken assured investors they personally supervised the
evaluation, design and operation of the Company’s disclosure procedures, as required by the
Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), to ensure that the Company’s internal controls
would alert them to material information that would conflict with Generally Accepted Accounting
Principles (“GAAP”) and/or require disclosure. Defendants repeatedly told investors throughout the
Class Period, that there existed no disclosure issues or control problems.
7.
In fact, OfficeMax had extensive internal control weaknesses, which it has now
admitted. OfficeMax’s internal control deficiencies are alleged more fully in the section entitled
“OfficeMax’s Violations of SEC Regulations Due to Its Inadequate Internal Controls.”
8.
As accounting expert Sheldon D. Zimmerman details in his attached declaration,
retail companies like OfficeMax must have developed internal control systems and other
sophisticated mechanisms to monitor and track the revenue implications of vendor rebate programs.
Moreover, because OfficeMax operated on very thin margins (OfficeMax’s retail operations had
profits of approximately only 0.5% of revenues) and vendor rebate programs significantly
contributed to these profit margins, the Individual Defendants could not reasonably have certified the
Company’s financial statements were prepared in compliance with GAAP unless the Individual
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Defendants had themselves investigated the accuracy and the thoroughness of the Company’s
internal control and reporting mechanisms tracking the vendor rebate programs.
9.
As detailed further herein, the defendants’ scheme to inflate OfficeMax’s reported
earnings by improperly charging deductions to its vendors was discovered by certain of these
vendors in Summer 2004. Notably, as vendors realized OfficeMax’s fraudulent charges, these
vendors demanded their money be returned, threatened OfficeMax with litigation and the vendors
put an end to OfficeMax’s ability to continue such practices in the future.
10.
As a result of OfficeMax’s vendors’ discovery of the alleged scheme, at least in part,
on October 19, 2004 OfficeMax was forced to disclose to investors that OfficeMax could not meet
its previously stated 2004 financial projections. Investors were shocked, and OfficeMax’s stock
price tumbled 14% before rebounding to close down 11%.
11.
However, even though vendors had threatened OfficeMax with litigation and the
Company had been conducting an internal investigation for weeks, if not months, defendants refused
to disclose the existence of the vendor rebate scheme it had used to inflate OfficeMax’s earnings.
Rather, on December 16, 2004, defendants caused OfficeMax to issue 5.4 million OfficeMax
shares without telling investors of the fraudulent scheme.
12.
Before the market opened on December 20, 2004, two business days after OfficeMax
issued the $172.5 million in common stock, the Company again shocked the market by issuing a
press release entitled “OfficeMax Announces Financial Events, Commences Investigation.” The
release stated in part:
[A]t the direction of the audit committee of its board of directors, the company has
commenced an internal investigation into claims by a vendor to its retail business
that certain employees acted inappropriately in requesting promotional payments and
in falsifying supporting documentation for approximately $3.3 million in claims
billed to the vendor by OfficeMax during 2003 and 2004.
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13.
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On this news, OfficeMax’s stock dropped from $32.50 per share the previous trading
day to as low as $29.51 per share before closing at $31.13 per share on volume of 5.5 million shares.
The next day, the stock dropped further to $30.40 per share.
14.
The Class Period ends after OfficeMax disclosed on January 12, 2005 (before the
market opened) that it would delay the issuance of its fourth quarter of 2004 financial results in order
for the Company to complete an investigation of its 2003 and interim 2004 financial results.
15.
On this news, OfficeMax’s stock dropped from $30.30 per share to $28.88 per share
on volume of 7.8 million shares.
16.
OfficeMax subsequently admitted that it falsely recorded vendor income in its
financial results during the Class Period. OfficeMax has restated its interim 2004 results to remove
millions in improperly reported vendor income and admitted that its 2003 and interim 2004 financial
statements were not a fair presentation of OfficeMax’s financial results and were presented in
violation of GAAP and SEC rules. The Company restated its financial results to eliminate $7.1
million in income that had been improperly recognized in the first quarter of 2004, and recognized
the existence of vendor manipulations in its 2003 financial statements as well. While OfficeMax has
publicly asserted that its 2003 financial results were not materially affected by the illegal scheme,
the existence of any such illegal scheme to purposefully inflate the Company’s earnings in violation
of GAAP would have been important information to a reasonable investor in OfficeMax at all times
during the Class Period as such conduct raises grave questions concerning management credibility
and is symptomatic of, among other things, a corporate culture that tolerates and encourages
duplicitous behavior exposing investors to substantial, undisclosed risks.
17.
As the accounting scandal unfolded, OfficeMax was forced to fire the persons
responsible. The first defendant to lose his job was Theodore Crumley, the Company’s Chief
Financial Officer during most of the Class Period, who left OfficeMax on November 11, 2004.
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Then, Gary Peterson, president of the Company’s retail division, abruptly resigned “effective
immediately” on January 5, 2005. Shortly thereafter, on January 12, 2005, OfficeMax’s Chief
Financial Officer Brian Andersen resigned after only two months of employment. And, on February
14, 2005, the Company terminated its CEO, defendant Christopher C. Milliken, at least in part
because of the accounting improprieties alleged by Lead Plaintiff. These high level departures, all
occurring as the illegal accounting scheme alleged by Lead Plaintiff began to be discovered, are
strong circumstantial evidence that OfficeMax’s senior most management (the defendants in this
action) either knew or recklessly disregarded the truth during the Class Period in violation of the
federal securities laws. As one equity analyst covering OfficeMax opined concerning the departure
of defendant Milliken: “Fish always stinks from the head.”
18.
Defendants’ false statements and fraudulent scheme had its intended effect as the
merger was consummated and tens of millions of dollars in severance and change-in-control
payments were eventually paid to defendants. Following the merger, the Company’s stock was sold
at inflated prices as the OfficeMax unit reported favorable results and the Individual Defendants
received large bonuses. Lead Plaintiff brings this action to recover their losses resulting from
defendants’ fraudulent actions.
JURISDICTION AND VENUE
19.
Jurisdiction is conferred by §27 of the 1934 Act. The claims asserted herein arise
under §§10(b) and 20(a) of the 1934 Act and Rule 10b-5.
20.
Venue is proper in this District pursuant to §27 of the 1934 Act. Many of the false
and misleading statements were made in or issued from this District.
21.
The Company’s principal executive offices are in Itasca, Illinois, where the day-to-
day operations of the Company are directed and managed.
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THE PARTIES
22.
Lead Plaintiff – pursuant to the Court’s June 9, 2005 Minute Entry – Wayne County
Employees’ Retirement System (“Lead Plaintiff”) purchased OfficeMax publicly traded securities as
described in the certification previously filed with the Court and was damaged thereby.
23.
Defendant OfficeMax is a multinational contract and retail distributor of office
supplies, paper, technology products and office furniture.
24.
Defendant Christopher C. Milliken (“Milliken”) was the President, CEO and a
director of OfficeMax until he resigned on February 14, 2005. Milliken signed false and misleading
SEC filings and Sarbanes-Oxley certifications during the Class Period. Milliken received a bonus of
$396,415 for 2004 based on the reported operating results of the office products business, in addition
to his salary of $753,577. Milliken’s, as well as other OfficeMax executive officers’ incentive
compensation was based entirely on its economic value added calculation, which was based on
reported operating profit. The 2004 Proxy Statement described this measure:
In 2003, we based variable incentive compensation on a single, quantitative
measure – the company’s “economic value added.” Economic value added is
determined by calculating the company’s operating profit and then subtracting a
pretax charge for the financial cost of the capital used to generate that profit.
25.
Defendant Theodore Crumley (“Crumley”) was the CFO of OfficeMax. Crumley
signed false and misleading SEC filings and Sarbanes-Oxley certifications during the Class Period.
Crumley received a bonus of $487,829 for 2004 based in part on OfficeMax’s financial performance,
in addition to his salary of $507,586.
26.
Defendant Thomas E. Carlile (“Carlile”) was the Vice President and Controller of
OfficeMax. Carlile signed false and misleading SEC filings during the Class Period.
27.
Defendant George J. Harad (“Harad”) is the Executive Chairman of the Board of
OfficeMax and served as the CEO and Chairman of Boise until November 2004. Harad signed the
Proxy Statement to shareholders recommending approval of the acquisition of old-OfficeMax by
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Boise and issued false statements about both companies throughout the Class Period. Harad also
signed false and misleading SEC filings and Sarbanes-Oxley certifications during the Class Period.
Harad received a bonus of $1.54 million for 2004 in addition to his salary of more than $1 million
due to OfficeMax’s financial performance. This bonus was nearly double his bonus for 2003.
28.
Defendant Michael Feuer (“Feuer”) founded old-OfficeMax in 1988 and served as its
Chairman and CEO until old-OfficeMax was sold to Boise on December 9, 2003.
29.
The individuals named as defendants in ¶¶24-28 are referred to herein as the
“Individual Defendants.” The Individual Defendants, because of their executive positions with the
Company during the Class Period, had the power and authority to control the contents of
OfficeMax’s quarterly financial reports, press releases and presentations to securities analysts,
money and portfolio managers and institutional investors, i.e., the market. Each defendant received
copies of the Company’s public financial reports and press releases alleged herein to be false and
misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their
issuance or cause them to be corrected. The Individual Defendants are liable for the false statements
pleaded herein, as those statements were each “group-published” information and the result of the
collective actions of the Individual Defendants.
ADDITIONAL ALLEGATIONS OF SCIENTER
30.
Because of each Individual Defendants’ position and access to material non-public
information, each of these defendants knew and/or recklessly disregarded that the adverse facts
specified herein had not been disclosed to and were being concealed from the public and that the
positive statements that were being made were then materially false and misleading.
31.
Each of the Individual Defendants was actively involved in those areas of the
Company’s operations which would expose him to the facts alleged in this Complaint. Defendants
Crumley, as CFO, and Carlile as Controller, were responsible for financial reporting and
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communications with the market. Many of the internal reports showing OfficeMax’s forecasted and
actual financials were prepared by the finance department under Crumley’s and Carlile’s oversight
and direction. Crumley also certified that he personally supervised the evaluation of the design and
operation of the Company’s disclosure procedures and internal controls pursuant to Rule 13a-15(c)
of the 1934 Act (§392 of Sarbanes-Oxley).
32.
Defendant Milliken, as CEO and President, was responsible for the financial results
and press releases issued by the Company. Like Crumley, Milliken also certified that he personally
supervised the evaluation of the design and operation of the Company’s disclosure procedures and
internal controls pursuant to Rule 13a-15(e) of the 1934 Act (§392 of Sarbanes-Oxley).
33.
Defendant Harad, while serving as the CEO and Chairman of the Board of Directors
of Boise and OfficeMax, was responsible for financial reporting and communications with the
market. Harad also certified that he personally supervised the evaluation of the design and operation
of the Company’s disclosure procedures and internal controls pursuant to Rule 13a-15(e) of the 1934
Act (§392 of Sarbanes-Oxley).
34.
Defendant Feuer, while serving as CEO and Chairman of old-OfficeMax, instructed
subordinates to charge vendors for services not yet provided so that OfficeMax could report financial
results in line with forecasts but in violation of GAAP. Defendant Feuer’s conduct caused
OfficeMax’s 2003 financial results reported during the Class Period to be false and misleading.
35.
OfficeMax employees describe OfficeMax as having a “top-down” management style
and being very “authoritarian” such that the Individual Defendants were knowledgeable about and
involved in all aspects of the Company’s financial operations.
36.
OfficeMax’s vendor rebate program was of critical importance to OfficeMax’s
financial operations such that the Individual Defendants would undoubtedly have focused on this
aspect of the Company’s operations.
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37.
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One characteristic of the retail operations was extremely low operating margins. Due
to competition in the office superstore industry, it was crucial to keep prices low. This was
exacerbated by competition from other large retailers, including Wal-Mart and Costco.
Consequently, operating margins in the retail industry were frequently lower than 3% of sales. One
important way retailers improve their margins is through the use of vendor credits which vendors
give retailers for various items, including for levels of inventory purchases, for advertising or for
product placement. Because of the low margins, the amount of vendor credits could have a dramatic
effect on margins. Thus, OfficeMax management closely monitored the credits offered by various
vendors, to determine whether OfficeMax qualified for the credits and to determine when the credits
could be recorded.
38.
For example, in the first quarter of 2004, OfficeMax reported operating income from
the retail segment of just $24 million on sales of $1.22 billion. Of the $24 million, $7.1 million or
30% was from improperly recorded vendor credits. An additional portion of the operating income
was likely generated from legitimate vendor credits. Thus, the level of vendor credits recorded each
quarter was one of the most important business metrics OfficeMax management monitored.
39.
Moreover, as demonstrated by Lead Plaintiff’s accounting expert Sheldon D.
Zimmerman, the Individual Defendants were, at best, acting in reckless disregard for the truth by
ignoring red flags concerning the improprieties alleged. Retail companies such as OfficeMax must
maintain sophisticated internal controls to monitor vendor rebate programs and track payments.
During the Class Period, defendants Crumley, Harad and Milliken repeatedly told investors that
OfficeMax had instituted such controls and that they had personally supervised their operation.
OfficeMax subsequently admitted that these defendants’ statements (and certifications) were false
when made. Given the significance of the vendor rebate program and the substantial deficiencies the
Company had during the Class Period with regard to these internal controls, defendants were acting
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with extreme recklessness in assuring investors that OfficeMax’s financial statements were prepared
in compliance with GAAP.
40.
Defendant Feuer knew of and authorized the problematic vendor promotional abuses.
Moreover, such abuses could not have occurred without senior management’s knowledge (or
willful, reckless disregard) because OfficeMax had checks and balances in place specifically to
prevent such abuses from happening.
41.
In addition to the above-described involvement, each Individual Defendant was
motivated to conceal the accounting fraud alleged.
42.
A big part of Defendants’ strategy was to merge the two companies, sell the
manufacturing operations and then expand the Company’s retail operations. Thus, the success and
future prospects of the retail operations – including the 970 superstores – were a focus of the
Individual Defendants.
43.
The Individual Defendants were motivated to fraudulently inflate the Company’s
reported earnings and to conceal the truth concerning the fraud to convince a skeptical marketplace
that the combined Company had a positive financial future. As described herein, after its initial
public offering (“IPO”), old-OfficeMax had not been a successful company (at least not from an
investor’s perspective). Investors were similarly skeptical that new OfficeMax could do well,
particularly given the amount of debt the Company incurred as part of the acquisition. The
Individual Defendants were motivated to falsify OfficeMax’s earnings after the merger to convince
investors that the acquisition of old-OfficeMax would result in a stronger Company going forward.
44.
Defendants were also motivated to conceal the fraudulent scheme until after the
Company had issued over 5 million shares of its common stock – knowing that disclosure of an
accounting scandal would cause the Company to have to issue more shares causing dilution to the
existing shareholder base, or possibly derail the stock issuance entirely. Pursuant to a December
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2001 public offering, OfficeMax was obligated to redeem the securities issued in December 2001
with OfficeMax common stock on December 16, 2004. The amount of stock OfficeMax was
required to issue was determined by OfficeMax’s trading price in the 20 trading days prior to
December 13. The Individual Defendants were motivated to conceal the fraud until after December
16, 2004, as the Individual Defendants knew the accounting scandal was material information to
investors and that until the scandal was fully investigated the Company could not trade in its own
securities. Indeed, on December 20, 2004 – only two trading days after OfficeMax issued the 5.4
million shares – the Company admitted that the information concerning the scandal was significantly
material such that the Company had to cease all trading in its own securities:
The company also announced it has commenced an investigation into certain vendor
allegations, and that it is postponing a decision on the form and timing of equity
repurchases until the investigation is complete.
*
*
*
[A]t the direction of the audit committee of its board of directors, it had commenced
an internal investigation into claims by a vendor to its retail business that certain
employees acted inappropriately in requesting promotional payments and in
falsifying supporting documentation for approximately $3.3 million in claims billed
to the vendor by OfficeMax during 2003 and 2004. Because the company’s
investigation has only recently begun, the company is postponing a decision as to
the form and timing of share repurchases until the investigation is complete.
45.
In truth, the internal investigation had been ongoing for weeks, if not months prior to
the December 20, 2004 disclosure. It became apparent to certain OfficeMax employees that the
OfficeMax Technology product category was a subject of the internal investigation, which
employees were working on the integration process for the legacy Boise Cascade and legacy
OfficeMax Technology departments after the merger. Because the OfficeMax Technology group
was the subject of this investigation, certain information had been “frozen” and could not be
transferred or reviewed – and much of this information remained frozen into 2006 as part of the
SEC’s investigation of OfficeMax.
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The senior executives of both Boise and old-OfficeMax also stood to gain
substantially by completing the sale of OfficeMax to Boise:
(a)
Defendant Michael Feuer, CEO and Chairman of old-OfficeMax, would
obtain about $60 million in severance and other cash payments upon closing of the sale. Feuer
would also receive a consulting contract worth $5 million. On December 15, 2003, Feuer caused the
Company to register for sale 542,469 shares of Boise common stock he received in the acquisition.
(b)
During the Class Period, defendant Harad, as CEO of Boise and Executive
Chairman of the combined company satisfied the financial performance requirements for 260,300
shares of restricted stock the Board granted him in 2003, then worth just more than $8 million. On
October 29, 2004, Harad signed a new employment agreement with OfficeMax containing a
substantial severance package. Pursuant to the new agreement, when Harad stepped down as the
Executive Chairman of OfficeMax in June 2005 he would be guaranteed an incentive and severance
package worth over $10 million, including a $1.32 million incentive bonus, a $1.5 million retention
payment, and a $7.26 million severance payment.
(c)
Other Executives. OfficeMax entered into change-in-control employment
agreements with each of its executive officers that provided each executive officer with millions of
dollars worth of severance benefits if their employment with OfficeMax was terminated after the
merger, and additional tax gross-up payments. All vested and unvested OfficeMax stock options
would be cashed out for millions of dollars. Additionally, thousands of shares of restricted stock
would prematurely vest upon consummation of the sale.
FRAUDULENT SCHEME AND COURSE OF BUSINESS
47.
Each defendant is liable for: (i) making false statements; (ii) failing to disclose
adverse facts known to him about OfficeMax; or (iii) participating in a fraudulent scheme to falsify
OfficeMax’s reported earnings in violation of GAAP. Defendants’ fraudulent scheme and course of
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business operated as a fraud or deceit on those who purchased or otherwise acquired OfficeMax
publicly traded securities because it: (i) deceived investors about OfficeMax’s financial
performance; (ii) allowed defendants to obtain shareholder approval of Boise’s acquisition of
OfficeMax, triggering tens of millions of dollars in severance and related payments to defendants;
(iii) artificially inflated the prices of OfficeMax’s publicly traded securities; (iv) enabled the
Company to issue $172.5 million in OfficeMax common stock two trading days before a material
disclosure; and (v) allowed the Individual Defendants to receive large bonuses based on OfficeMax’s
apparent operating performance.
BACKGROUND
48.
Boise Cascade Corporation was a major distributor of building materials and an
integrated manufacturer and distributor of paper, packaging, and wood products. In March 2004,
Boise owned or controlled approximately 2.4 million acres of timberland in the United States.
49.
In 1988, defendant Feuer founded OfficeMax, a chain of high-volume office products
superstores. In 1994, Feuer launched what was then the largest retail IPO, receiving $675 million in
proceeds. As of January 25, 2003, OfficeMax owned and operated 970 superstores in 49 states,
Puerto Rico, the U.S. Virgin Islands and, through a majority-owned subsidiary, in Mexico.
50.
OfficeMax’s IPO was the largest, but compared to the 1989 IPO of office supply
chain pioneer Staples, which raised just $36 million, it was not the most profitable for shareholders.
Returns for shareholders in the rival chains differed sharply. OfficeMax shares traded flat for nine
years after their debut, while Staples’ shares rose nearly 500% over that same period. By the end of
2001, OfficeMax was carrying a debt-load of at least $220 million. By the middle of 2002,
OfficeMax had posted eight straight quarterly losses. By October 2002, OfficeMax’s stock, which
had traded as high as $20 per share in 1998, reached a 52-week low of $3.05. Feuer told the Daily
Deal in April 2004 that he “knew a year and a half ago that we couldn’t stay public.”
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51.
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Feuer began discussing selling OfficeMax to paper products giant Boise. After
several months of negotiations defendants Feuer and Harad agreed to terms. On July 14, 2003,
Boise offered to purchase OfficeMax for 30% cash and 70% stock. OfficeMax’s stock price closed
at $10.50 per share.
In November 2003, Institutional Shareholder Services urged Boise’s
shareholders to vote against the acquisition because of concerns about overpaying, taking on too
much debt, and doubts about the inexperience of the ongoing management of the combined
company. Additionally, large shareholders demanded Boise divest its timberlands or building
products line before more than doubling the size of its office products unit. In late November 2003,
Boise announced that once it completed its purchase of OfficeMax, it would exit both the paper and
building products businesses.
52.
Boise consummated its acquisition of OfficeMax on December 9, 2003, for
approximately $1.06 billion.
53.
In July 2004, the Company announced that the Chicago buyout firm of Madison
Dearborn Partners LLC had agreed to buy its paper, forest products and timberland businesses for
$3.7 billion. The spun-off entity would be called Boise Cascade, LLC and the Company would
rename itself “OfficeMax Inc.”
DEFENDANTS’ FRAUDULENT VENDOR REBATES SCHEME
54.
OfficeMax has admitted that it improperly recorded vendor income in its publicly
stated financial results during the Class Period. OfficeMax has restated its interim 2004 results to
remove millions in previously reported income, such that its 2003 and interim 2004 financial
statements were false and violated GAAP and SEC rules.
55.
During the Class Period, OfficeMax improperly recognized income from vendors.
Specifically, it recognized vendor incomes even though collection was not probable. Companies like
OfficeMax receive money from vendors to feature the supplier’s products in ads and circulars.
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Frequently, an ad in the newspaper for OfficeMax for a certain brand of product was compensated in
part by the vendor of that brand. By overstating the expected amount of such compensation,
OfficeMax was able to artificially inflate its publicly reported financials.
56.
OfficeMax improperly took the same deductions from vendor invoices twice,
essentially “double dipping.” OfficeMax’s various vendors had certain “profiles” which would be
used to calculate the amount of vendor promotions the Company could deduct from payments to its
vendors. After the merger, many vendors tightened up their vendor promotion policies, which would
have resulted in much lower income for OfficeMax. To artificially inflate its income, OfficeMax did
not use the updated policies in their vendor profiles, but continued to use the old profiles. This
resulted in improper vendor allowances being deducted from payments to vendors. Another method
OfficeMax used to inflate deductions was to take deductions based on inventory that had been
returned to the vendor for which OfficeMax was already receiving a credit.
57.
Naturally, vendors would complain about the improper deductions taken from
OfficeMax’s payments to them. OfficeMax’s strategy to handle the complaints was to delay
answering the complaints as long as possible. The vendor calls were routed to the Accounts Payable
department at OfficeMax but Accounts Payable could not answer the questions since Accounts
Payable had not calculated the deductions. Accounts Payable was not allowed to forward the vendor
calls to those who had calculated the deductions. Those who calculated the deductions, the Vendor
Income Planning and Analysis (“VIPA”) group, would also pre-date the deductions, or record the
deductions months before OfficeMax had earned them. Defendant Crumley met frequently with
personnel in the VIPA group.
58.
Some vendors were so angry with these practices, they put OfficeMax on credit hold
and others even went to OfficeMax’s offices to complain and collect the monies OfficeMax had not
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paid them. Vendors Sunbeam, StudioRTA and Pintel were so angry with OfficeMax for excessive
deductions that they threatened legal actions.
59.
By way of example, OfficeMax had been making “double-dipping” deductions from
its vendor Pintel for a period of at least eight to nine months. Pintel repeatedly complained to
OfficeMax about these improper deductions. In either August or September 2004, a Pintel
representative made an unannounced visit to OfficeMax’s offices in Cleveland – flying in from
Chicago for the express purpose of reclaiming $650,000 in improper deductions. OfficeMax
employees named Kettlewell and Roche met with the Pintel representative. Ultimately, as a result of
this meeting, OfficeMax was forced to return the $650,000 in improper deductions to Pintel.
60.
Oftentimes, the Company accounted for these types of payments to angry vendors as
debits to OfficeMax’s Inventory Control account or out of a reserve account known as OfficeMax’s
general Accounts Payable Ledger account – rather than reducing an Accounts Receivable account as
required under GAAP.
61.
Ultimately, vendor complaints made it impossible for OfficeMax’s scheme to
continue. As vendors realized that they had been cheated by OfficeMax, the vendors demanded their
money back (contributing to OfficeMax, on October 19, 2004, having to lower its financial forecasts
for 2004) and more closely scrutinized OfficeMax’s payments to prevent OfficeMax from
continuing to perpetrate the fraud against the vendors.
62.
In fact, OfficeMax billed Microsoft for approximately a year’s worth of
marketing/promotional services that OfficeMax had not performed. As a result, Microsoft lodged
complaints with OfficeMax causing OfficeMax to have to initiate the investigation ultimately
revealed to the public on December 20, 2004. However, OfficeMax’s improper charges were not
limited to Microsoft. And, moreover, the internal investigation had begun weeks, if not months,
prior to the disclosure.
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DEFENDANTS’ FALSE AND MISLEADING
STATEMENTS ISSUED DURING THE CLASS PERIOD
63.
On December 9, 2003, OfficeMax’s and Boise’s shareholders approved the sale of
OfficeMax to Boise. Defendants should have, but did not, disclose the existence of the illegal
accounting manipulations and deficient internal controls existing at old-OfficeMax prior to these
shareholders meetings so that investors could make an informed decision with regard to approving
the proposed merger.
64.
On January 22, 2004, the Company issued a press release announcing its fourth
quarter and full year 2003 financial results. The press release stated in part:
Boise Cascade Corporation today reported fourth quarter 2003 net income of
$6.9 million, or 5 cents per diluted share. Before a special item and the net impact of
the OfficeMax acquisition, Boise’s net income was $18.3 million, or 24 cents per
diluted share. By comparison, Boise reported net income of $6.2 million, or 5 cents
per diluted share, in fourth quarter 2002 and $30.0 million, or 43 cents per diluted
share, in third quarter 2003, before a special item. For the full year 2003, net income
was $8.3 million, or a loss of 8 cents per diluted share. Before special items and the
net impact of the OfficeMax acquisition, Boise posted net income of $31.8 million,
or 32 cents per diluted share. In 2002, before a special item, net income was
$7.3 million, or a loss of 10 cents per diluted share.
Financial Highlights
($ in millions, except per-share amounts)
Sales
Net income
Net income (loss) per diluted share
Before special items and
net impact of OfficeMax acquisition
Net income
Net income (loss) per diluted share
*
4Q
2003
4Q
2002
3Q
2003
2003
$ 2,352
$ 6.9
$ 0.05
$ 1,801
$ 6.2
$ 0.05
$ 2,111
$ 32.9
$ 0.48
$ 8,245
$ 8.3
$ (0.08)
$ 7,412
$ 11.3
$ (0.03)
$ 18.3
$ 0.24
$ 6.2
$ 0.05
$ 30.0
$ 0.43
$ 31.8
$ 0.32
$ 7.3
$ (0.10)
*
Full Year
2002
*
Sales in fourth quarter 2003 were $2.4 billion, 31% higher than sales in fourth
quarter 2002. Sales for full year 2003 were $8.2 billion, an 11% increase over sales
in 2002. The sales increases were mostly due to strong prices for wood products and
growth in Boise Office Solutions, including the OfficeMax acquisition. Excluding
the impact of the OfficeMax acquisition, sales increased 14% and 7% for the fourth
quarter and full year, respectively.
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Boise Office Solutions
($ in millions)
Sales
Operating income
Operating income before special
items and net impact of
OfficeMax acquisition
4Q
2003
4Q
2002
3Q
2003
Full Year
2003
2002
$1,248
$40.0
$906
$32.4
$934
$31.0
$4,025
$115.5
$3,546
$123.0
$36.9
$32.4
$31.0
$121.6
$123.0
On December 9, 2003, Boise acquired OfficeMax, Inc. Following that
acquisition, the company began reporting two operating segments, Contract and
Retail, within Boise Office Solutions, its office products distribution business. Taken
together, the two operating segments make up our Boise Office Solutions business.
For fourth quarter 2003, Boise Office Solutions reported operating income of
$40.0 million, compared with $32.4 million in fourth quarter 2002 and $31.0 million
in third quarter 2003. For full year 2003, the business reported operating income of
$115.5 million, compared with $123.0 million in 2002.
Before special items and the net impact of the OfficeMax acquisition, Boise
Office Solutions earned $36.9 million, compared with $32.4 million in fourth quarter
2002 and $31.0 million in third quarter 2003. For full year 2003, the business had
operating income of $121.6 million, compared with $123.0 million in 2002.
Sales of $1.2 billion in fourth quarter 2003 were 38% higher than sales in
fourth quarter 2002 and 34% higher than in third quarter 2003, due primarily to the
acquisition of OfficeMax. Year-over-year same-store sales, which exclude
OfficeMax sales, rose 4% in the fourth quarter, with the increase attributable to
foreign exchange rates.
Full-year sales of $4.0 billion in this business were 14% higher than the year
earlier, while same-store sales rose 5%, with 4% of the lift generated by foreign
exchange rates. Sales volume of Boise’s office papers increased 4% to 568,000 tons.
Boise Office Solutions, Contract Segment
($ in millions)
Sales
Operating income
Operating income before special items
and impact of OfficeMax acquisition
4Q
2003
4Q
2002
3Q
2003
Full Year
2003
2002
$965
$33.9
$906
$32.4
$934
$31.0
$3,742
$109.4
$3,546
$123.0
$36.9
$32.4
$31.0
$121.6
$123.0
For fourth quarter 2003, Boise Office Solutions, Contract, reported operating
income of $33.9 million, compared with $32.4 million in fourth quarter 2002 and
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$31.0 million in third quarter 2003. For full year 2003, this segment reported
operating income of $109.4 million, compared with $123.0 million in 2002.
Before special items in fourth quarter 2003 and full year 2003 and the impact
of the OfficeMax acquisition, operating income in Boise Office Solutions, Contract,
in the fourth quarter was $36.9 million, up from $32.4 million in fourth quarter a year
ago and $31.0 million in third quarter 2003. When excluding the same items for full
year 2003, the segment reported operating income of $121.6 million, compared with
$123.0 million in 2002.
Sales of $965 million in fourth quarter 2003 were 6% higher than sales in
fourth quarter 2002 and 3% higher than in third quarter 2003. Year-over-year samestore sales in the fourth quarter rose 4%; however, excluding foreign exchange rates,
same-store sales were essentially flat.
Full-year sales of $3.7 billion for this segment were 6% higher than the year
earlier, while same-store sales rose 5%, fueled by a 4% lift from foreign exchange
rates.
Excluding special items and the impact of the OfficeMax acquisition, the
fourth-quarter operating margin for the Contract segment was 3.9%, up from 3.6% in
the fourth quarter a year ago and 3.3% in the third quarter. For the full year, the
operating margin, before special items and the impact of the OfficeMax acquisition,
was 3.3%, compared with 3.5% in 2002.
Boise Office Solutions, Retail Segment
($ in millions)
4Q
2003
Sales
Operating income
$
$
283
6.1
Boise began reporting its Boise Office Solutions, Retail, segment on
December 10, 2003. For 17 selling days in fourth quarter 2003, the segment
recorded sales of $283 million, operating income of $6.1 million, and an operating
margin of 2.2%.
*
*
*
“Boise’s sales and income should increase substantially in 2004,” said
George J. Harad, chairman and chief executive officer.
“With the acquisition of OfficeMax, Boise Office Solutions will post
sharply higher sales and operating income in 2004. Same-store sales growth
should continue to be positive. However, operating margins will be lower in 2004
than in 2003, as we integrate the lower-margin retail business into our operations,”
Harad said.
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65.
Document 110-1
Filed 11/09/2006
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On March 2, 2004, the Company filed its Form 10-K for the fiscal year ended
December 31, 2003, including the Company’s results previously reported for 2003. The Form 10-K
was signed by defendants Harad as Chairman and CEO, Crumley as CFO and Carlile as Controller.
In their Sarbanes-Oxley Certifications, defendants Harad and Crumley also claimed that they
personally supervised the evaluation of the design and operation of the Company’s disclosure
procedures pursuant to Rule 13a-15(e) of the 1934 Act (pursuant to §392 of Sarbanes-Oxley) (“Rule
13a-15(e)”), to ensure that the Company’s controls would alert them to material information which
would conflict with GAAP and/or require disclosure. Defendants affirmatively stated on March 2,
2004 that no such disclosure issues or control problems existed.
66.
In fact, OfficeMax did have internal control weaknesses which were required to be
disclosed. Ultimately, in March 2005, when OfficeMax filed its Form 10-K for 2004, it would admit
to the internal control deficiencies. OfficeMax’s internal control deficiencies are alleged more fully
in the section entitled “OfficeMax’s Violations of SEC Regulations Due to Its Inadequate Internal
Controls.”
67.
On April 20, 2004, the Company announced its first quarter 2004 financial results.
The press release stated in part:
Boise Cascade Corporation today reported first quarter 2004 net income of
$63.5 million, or 66 cents per diluted share, compared with a net loss of
$27.5 million, or 53 cents per diluted share, in first quarter 2003. Fourth quarter
2003 net income was $6.9 million, or 5 cents per diluted share.
The quarter’s results include a pretax gain of $59.9 million, or 40 cents per
diluted share, from the sale of 79,000 acres of timberland in Louisiana. Before this
special item, the company posted first quarter 2004 net income of $26.9 million, or
26 cents per diluted share.
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FINANCIAL HIGHLIGHTS
($ in millions, except per-share amounts)
Sales
Net income (loss)
Net income (loss) per diluted share
1Q
2004
1Q
2003
4Q
2003
$3,530
$63.5
$0.66
$1,853
$(27.5)
$(0.53)
$2,352
$6.9
$0.05
$26.9
$0.26
$(12.6)
$(0.27)
$15.9
$0.18
BEFORE SPECIAL ITEMS
Net income (loss)
Net income (loss) per diluted share
Sales in first quarter 2004 nearly doubled to $3.5 billion, compared with $1.9
billion in the first quarter a year ago. Sales in fourth quarter 2003 were $2.4 billion.
Sales increased primarily because of the acquisition of OfficeMax in December 2003
but were also aided by strong product prices in Boise Building Solutions.
REVIEW OF OPERATIONS
Boise Office Solutions
($ in millions)
Sales
Operating income
Operating margin
1Q
2004
$2,341
$58.4
2.5%
1Q
2003
$938
$20.7
2.2%
4Q
2003
$1,248
$40.0
3.2%
$58.4
2.5%
$29.9
3.2%
$40.0
3.2%
BEFORE SPECIAL ITEM
Operating income
Operating margin
*
*
*
On December 9, 2003, Boise acquired OfficeMax, Inc. Following that
acquisition, the company began reporting two operating segments, Contract and
Retail, within Boise Office Solutions, its office products distribution business. Taken
together, the two operating segments make up the company’s Boise Office Solutions
business.
For first quarter 2004, Boise Office Solutions sales increased 150% to $2.3
billion, compared with the same quarter a year ago. Sales for locations operating in
both periods, including OfficeMax locations on a pro forma basis, increased 5%.
Total pro forma sales of office supplies and paper increased 4%, sales of technology
products increased 5%, and sales of furniture were up 4%. Boise’s office papers sold
through Boise Office Solutions increased 16% to 167,000 tons, compared with a year
ago.
Boise Office Solutions operating income was $58.4 million, up from $20.7
million in first quarter 2003 and $40.0 million in fourth quarter 2003. The results
increased, relative to comparison periods, due to the OfficeMax acquisition. The
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operating margin was 2.5%, compared with 3.2%, before a special item, in first
quarter 2003 and 3.2% in fourth quarter 2003.
In first quarter 2004, Boise Office Solutions achieved $12.6 million of the
$80 million in integration synergies expected for the year. Integration costs of $8.9
million occurred primarily in the contract segment, as the business began to
consolidate delivery warehouses, customer service centers, and administrative
staffing. Boise Office Solutions also recorded acquisition-related step-up costs of
$4.5 million.
Below is the review of operations for the Boise Office Solutions Contract and
Retail segments.
Boise Office Solutions, Contract Segment
($ in millions)
Sales
Operating income
Operating margin
BEFORE SPECIAL ITEM
Operating income
Operating margin
1Q
2004
1Q
2003
4Q
2003
$1,120
$34.4
3.1%
$938
$20.7
2.2%
$965
$33.9
3.5%
$34.4
3.1%
$29.9
3.2%
$33.9
3.5%
Boise Office Solutions, Contract, sales of $1.1 billion in first quarter 2004
were 19% higher than sales in first quarter 2003 and 16% higher than in fourth
quarter 2003. Excluding foreign exchange gains, sales rose 15%. Year- over-year
same-location sales, excluding foreign exchange gains, in the first quarter rose 4%.
This segment reported first quarter 2004 operating income of $34.4 million,
compared with $29.9 million, before a special item, in first quarter 2003 and $33.9
million in fourth quarter 2003. The operating margin was 3.1%, compared with 3.2%
before a special item, in first quarter 2003 and 3.5% in fourth quarter 2003.
Boise Office Solutions, Retail Segment
($ in millions)
Sales
Operating income
Operating margin
1Q
2004
4Q
2003
$1,220
$24.0
2.0%
$283
$6.1
2.2%
Boise began reporting its Boise Office Solutions, Retail, segment on
December 10, 2003. In first quarter 2004, segment sales of $1.2 billion were 1%
higher, and same-store sales were 3% higher, than pro forma sales in first quarter
2003. Boise Office Solutions, Retail, reported operating income of $24.0 million and
an operating margin of 2.0% in first quarter 2004.
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*
Filed 11/09/2006
*
Page 25 of 58
*
OUTLOOK
“For Boise overall, we continue to expect significantly higher sales and
income for full year 2004, relative to 2003, both as the result of the acquisition of
OfficeMax and strong or improving performance in all of our businesses,” said
George J. Harad, chairman and chief executive officer.
“In Boise Office Solutions, the second quarter of the year is always
seasonally weak, for both the Contract and Retail segments. We expect sales to
decline sequentially and operating income to be substantially lower than in the first
quarter. However, we are pleased with the progress we are making in integrating
OfficeMax into our operations and continue to expect to meet our targets for the full
year of $80 million in integration synergies, same-store sales growth of 4% to 6%,
and an operating margin of 2.4% to 2.6%.
*
*
*
Effective January 1, 2003, we adopted an accounting change for vendor
allowances to comply with the guidelines issued by the Financial Accounting
Standards Board’s Emerging Issues Task Force (EITF) 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration Received From a Vendor.
Under the new guidance, vendor allowances reside in inventory with the product and
are recognized when the product is sold, changing the timing of our recognition of
these items. This change resulted in a one-time, noncash, cumulative-effect
adjustment of $4.7 million, or 8 cents per share.
68.
On May 7, 2004, the Company filed its Form 10-Q for the period ended March 30,
2004. The 10-Q was signed by defendant Carlile as Vice President and Controller. In their
Sarbanes-Oxley Certifications, defendants Harad and Crumley claimed that they personally
supervised the evaluation of the design and operation of the Company’s disclosure procedures
pursuant to Rule 13a-15(e), to ensure that the Company’s controls would alert them to material
information which would conflict with GAAP and/or require disclosure. Defendants Harad and
Crumley also affirmatively stated on May 7, 2004 that no such disclosure issues or control problems
existed.
69.
These results were viewed favorably by the market. In June 2004, OfficeMax’s stock
would reach its Class Period high of more than $38.00 per share.
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70.
Document 110-1
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In fact, OfficeMax’s financial statements for the first quarter of 2004 were materially
false and misleading and operating income was overstated by $7.1 million due to the improper
recording of vendor allowances and OfficeMax has significant internal control problems as more
fully detailed herein.
71.
On July 20, 2004, the Company announces its second quarter 2004 financial results.
The press release stated in part:
Boise Cascade Corporation today reported second quarter 2004 net income of $50.4
million, or 52 cents per diluted share, compared with a net loss of $3.9 million, or 12
cents per diluted share, in second quarter 2003. In first quarter 2004, Boise reported
net income of $63.5 million, or 66 cents per diluted share.
The quarter’s results include a pretax gain of approximately $46.5 million, or
31 cents per diluted share, on the sale of Boise’s 47% interest in Voyageur Panel in
May 2004. Before this special item, the company posted second quarter 2004 net
income of $22.0 million, or 21 cents per diluted share.
FINANCIAL HIGHLIGHTS
($ in millions, except per-share amounts)
Sales
Net income (loss)
Net income (loss) per diluted share
BEFORE SPECIAL ITEMS
Net income (loss)
Net income (loss) per diluted share
2Q
2004
2Q
2003
1Q
2004
$3,401
$50.4
$0.52
$1,929
$(3.9)
$(0.12)
$3,530
$63.5
$0.66
$22.0
$0.21
$(3.9)
$(0.12)
$26.9
$0.26
Sales in second quarter 2004 increased 76% to $3.40 billion, compared with
$1.93 billion in the second quarter a year ago. Sales in first quarter 2004 were $3.53
billion. Year-over-year sales increased primarily because of the acquisition of
OfficeMax in December 2003 but were also aided by strong product prices in Boise
Building Solutions.
REVIEW OF OPERATIONS
Boise Office Solutions
($ in millions)
Sales
Operating income
Operating margin
2Q
2004
2Q
2004
1Q
2003
$2,005
$16.0
0.8%
$905
$23.9
2.6%
$2,341
$58.4
2.5%
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On December 9, 2003, Boise acquired OfficeMax, Inc. Following that
acquisition, the company began reporting two operating segments, Contract and
Retail, within Boise Office Solutions, its office products distribution business. Taken
together, the two operating segments make up the company’s Boise Office Solutions
business.
For second quarter 2004, Boise Office Solutions sales increased 122% to $2.0
billion, compared with $905 million in the same quarter a year ago. Sales for
locations operating in both periods, including OfficeMax retail store locations on a
pro forma basis, increased 2%. Total pro forma sales of office supplies and paper and
technology products increased 1%, and sales of furniture were up 4%. Boise’s office
papers sold through Boise Office Solutions increased 23% to 177,000 tons, compared
with a year ago.
Boise Office Solutions operating income was $16.0 million, down from $23.9
million in second quarter 2003 and $58.4 million in first quarter 2004. The operating
margin was 0.8%, compared with 2.6% in second quarter 2003 and 2.5% in first
quarter 2004. Results weakened from year-ago levels primarily because of seasonal
losses in the Retail segment. The sharp decline in operating income from first to
second quarter, although more severe in Retail than in Contract, reflected normal
seasonality in both segments.
In second quarter 2004, Boise Office Solutions achieved $31.7 million of
integration synergies and recorded integration costs of $8.3 million. In the first half
of 2004, synergies totaled $44.3 million of the $80 million expected for the year.
First half integration costs were $17.2 million.
Below is the review of operations for the Boise Office Solutions Contract and
Retail segments.
Boise Office Solutions, Contract Segment
($ in millions)
Sales
Operating income
Operating margin
2Q
2003
2Q
2004
1Q
2004
$1,038
$21.4
2.1%
$905
$23.9
2.6%
$1,120
$34.4
3.1%
Boise Office Solutions, Contract, sales of $1.0 billion in second quarter 2004
were 15% higher than sales in second quarter 2003 and 7% lower than first quarter
2004. Year-over-year same-location sales on a pro forma basis rose 5% in the second
quarter. Excluding the impact of foreign exchange, same-location sales grew 3%.
This segment reported second quarter 2004 operating income of $21.4
million, compared with $23.9 million in the second quarter 2003 and $34.4 million in
first quarter 2004. The operating margin was 2.1%, compared with 2.6% in second
quarter 2003 and 3.1% in first quarter 2004. The Contract segment includes the
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former OfficeMax direct business, with its extensive warehouse infrastructure, which
recorded losses in the first and second quarters.
Boise Office Solutions, Retail Segment
($ in millions)
Sales
Operating income (loss)
Operating margin
2Q
2004
1Q
2004
$967
$(5.4)
(0.6)%
$1,221
$24.0
2.0%
Boise began reporting its Boise Office Solutions, Retail, segment on
December 10, 2003. In second quarter 2004, segment sales of $967 million were 3%
lower than OfficeMax retail sales on a pro forma basis in second quarter 2003.
Second quarter sales no longer include sales from the 45 retail stores closed in the
first quarter 2004. Same-location pro forma sales were flat. Retail segment sales
declined 21% from first quarter 2004 sales, reflecting normal seasonality.
The Retail segment reported an operating loss of $5.4 million in second
quarter 2004, compared with income of $24.0 million in first quarter 2004 and an
operating margin of (0.6)%, compared with 2.0% in first quarter 2004.
72.
On August 5, 2004, the Company filed its Form 10-Q for the period ended June 30,
2004. The 10-Q was signed by defendant Carlile as Vice President and Controller. In the 10-Q,
defendants Harad and Crumley claimed that they personally supervised the evaluation of the design
and operation of the Company’s disclosure procedures pursuant to Rule 13a-15(e), to ensure that the
Company’s controls would alert them to material information which would conflict with GAAP
and/or require disclosure. Defendants Harad and Crumley affirmatively stated on August 5, 2004
that no such disclosure issues or control problems existed.
73.
In fact, OfficeMax’s financial statements for the second quarter 2004 were materially
false and misleading due to the improper recording of vendor allowances and OfficeMax has
significant internal control problems as more fully detailed herein.
74.
On October 19, 2004, the Company announced its third quarter 2004 financial results.
The release stated in part:
Boise Cascade Corporation today reported third-quarter net income of $61.1 million,
or 63 cents per diluted share.
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The results included a $13.1 million pretax gain on the sale of certain Idaho
timberlands recorded in our Boise Building Solutions segment; $8.8 million of costs
related to the announced sale of our forest products assets in Corporate and Other;
and $5.8 million of costs and lost income in Boise Office Solutions, Retail, and Boise
Paper Solutions related to disruption from hurricanes in the southeastern United
States.
By comparison, Boise reported net income of $32.9 million, or 48 cents per
diluted share, in third quarter 2003 and $50.4 million, or 52 cents per diluted share,
in second quarter 2004. Before special items, Boise earned $30.0 million, or 43 cents
per diluted share, in third quarter 2003 and $22.0 million, or 21 cents per diluted
share, in second quarter 2004.
FINANCIAL HIGHLIGHTS
($ in millions, except per-share amounts)
Sale
Net income
Net income per diluted share
BEFORE SPECIAL ITEMS
Net income
Net income per diluted share
3Q
2004
3Q
2003
2Q
2004
$3,651
$61.1
$0.63
$2,111
$32.9
$0.48
$3,401
$50.4
$0.52
$61.1
$0.63
$30.0
$0.43
$22.0
$0.21
Sales in third quarter 2004 increased 73% to $3.65 billion, compared with
$2.11 billion in third quarter a year ago and $3.40 billion in second quarter 2004.
Year-over-year sales increased primarily because of our acquisition of OfficeMax in
December 2003. Sales were also aided by strong product prices in Boise Building
Solutions and improving product prices in Boise Paper Solutions.
Boise Office Solutions
($ in millions)
Sales
Operating income
Operating margin
3Q
2004
3Q
2003
2Q
2004
$2,235
$56.5
2.5%
$934
$31.0
3.3%
$2,005
$16.0
0.8%
On December 9, 2003, Boise acquired OfficeMax, Inc. Following that
acquisition, the company began reporting two operating segments, Contract and
Retail, within Boise Office Solutions, its office products distribution business. Taken
together, the two operating segments make up the company’s Boise Office Solutions
business.
In third quarter 2004, Boise Office Solutions sales increased 139% to $2.235
billion, compared with $934 million in the same quarter a year ago. Sales for
locations operating in both periods, including OfficeMax retail store locations on a
pro forma basis, increased 4%. Pro forma sales of office supplies and paper,
technology products, and furniture each increased 3%. Boise’s office papers sold
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through Boise Office Solutions increased 26% to 178,000 tons, compared with last
year.
Boise Office Solutions operating income in the third quarter was $56.5
million, up from $31.0 million in the same quarter a year ago and $16.0 million in
second quarter. Segment sales, income, and operating margin increased sequentially
in the third quarter. The operating margin was 2.5% in third quarter 2004, compared
with 3.3% in the third quarter a year ago and 0.8% in second quarter 2004.
In third quarter 2004, Boise Office Solutions achieved $30.8 million of
integration synergies related to its acquisition of OfficeMax and recorded integration
costs of $6.9 million. In the first nine months of 2004, synergies totaled $75.2
million of the $80 million expected for the year, and integration costs reached $24.1
million.
Below is the review of operations for the Contract and Retail office products
segments.
Boise Office Solutions, Contract Segment
($ in millions)
Sales
Operating income
Operating margin
3Q
2004
3Q
2003
2Q
2004
$1,096
$31.4
2.9%
$934
$31.0
3.3%
$1,038
$21.4
2.1%
Boise Office Solutions, Contract, sales of $1.096 billion in third quarter 2004
were 17% higher than sales in third quarter 2003 and 6% higher than in second
quarter 2004. Year-over-year same-location sales on a pro forma basis rose 7% in
the third quarter.
This segment reported third quarter 2004 operating income of $31.4 million,
compared with $31.0 million in third quarter 2003 and $21.4 million in second
quarter 2004. The operating margin was 2.9%, compared with 3.3% in third quarter
a year ago and 2.1% in second quarter 2004. The Contract segment includes the
former OfficeMax direct business, which is supported by excess warehouse capacity
and recorded losses in the first, second, and third quarters of 2004.
Boise Office Solutions, Retail Segment
($ in millions)
Sales
Operating income (loss)
Operating margin
3Q
2004
$1,138
$25.1
2.2%
2Q
2004
$967
$(5.4)
(0.6%
Boise began reporting its Boise Office Solutions, Retail, segment on
December 10, 2003. In third quarter 2004, segment sales of $1.138 billion were 1%
lower than OfficeMax retail sales on a pro forma basis in third quarter 2003 and 18%
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higher than sales in second quarter 2004. In first quarter 2004, the company closed
45 retail stores. Same-store pro forma sales were 1% higher than the year-ago third
quarter.
The Retail segment reported operating income of $25.1 million in third
quarter 2004, compared with a loss of $5.4 million in second quarter 2004, and an
operating margin of 2.2%, compared with (0.6)% in second quarter 2004. Third
quarter 2004 results were hampered by hurricanes in the southeastern United States,
which caused temporary retail store closures, lost sales, and an estimated $3.0
million in lost income.
*
*
*
OUTLOOK
In July 2004, Boise Cascade Corporation announced the sale of its paper,
forest products, and timberland assets for approximately $3.7 billion to affiliates of
Boise Cascade, LLC, a new company formed by Madison Dearborn Partners LLC
(MDP). The targeted completion date for this transaction is October 29.
*
*
*
When the transaction with MDP closes, Boise Cascade Corporation will
change its name to OfficeMax Incorporated. It will continue to operate the office
products distribution business as its principal business. OfficeMax will trade on the
New York Stock Exchange under the ticker symbol OMX, and its corporate
headquarters will be in Itasca, Illinois. Privately held Boise Cascade, LLC, will
operate from its headquarters in Boise, Idaho.
*
*
*
Effective January 1, 2003, we adopted an accounting change for vendor
allowances to comply with the guidelines issued by the Financial Accounting
Standards Board’s Emerging Issues Task Force EITF 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration Received From a Vendor.
Under the new guidance, vendor allowances reside in inventory with the product and
are recognized when the product is sold, changing the timing of our recognition of
these items. This change resulted in a one-time, noncash, cumulative-effect
adjustment of $4.7 million, or 8 cents per share.
75.
On November 9, 2004, the Company filed its Form 10-Q for the period ended
September 30, 2004. The 10-Q was signed by defendants Milliken as CEO and Crumley as CFO. In
the 10-Q, defendants claimed that they personally supervised the evaluation of the design and
operation of the Company’s disclosure procedures pursuant to Rule 13a-15(e), to ensure that the
Company’s controls would alert them to material information which would conflict with GAAP
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and/or require disclosure. Defendants affirmatively stated on November 9, 2004 that no such
disclosure issues or control problems existed.
76.
What defendants did not disclose, and which disclosure was necessary to make the
defendants’ statements not misleading, was the existence of the fraudulent scheme to improperly
charge vendors as detailed herein. Moreover, at least by October 19, 2004, OfficeMax vendors had
begun to learn of the fraudulent scheme and were then notifying the Company that the vendors
would pursue litigation to reclaim the illegal deductions if the problem was not immediately
remedied. As a result, OfficeMax’s financial statements were materially false and misleading due to
the improper recording of vendor allowances and OfficeMax had significant internal control
problems as more fully detailed herein.
DEFENDANTS’ FRAUDULENT CONDUCT IS REVEALED
77.
The defendants’ scheme to inflate OfficeMax’s reported earnings by improperly
charging deductions to its vendors was discovered by certain of these vendors at least as early as
Summer 2004. Notably, as vendors realized OfficeMax’s fraudulent charges, these vendors
demanded their money be returned, threatened OfficeMax with litigation and the vendors put an end
to OfficeMax’s ability to continue such practices in the future.
78.
Some vendors were so angry with these practices, they put OfficeMax on credit hold
and others even went to OfficeMax’s offices to get the monies OfficeMax had not paid them.
Vendors Sunbeam, StudioRTA and Pintel were so angry with OfficeMax for excessive deductions
that they threatened legal actions.
79.
By way of example, OfficeMax had been making “double-dipping” deductions from
its vendor Pintel for a period of at least eight to nine months. Pintel repeatedly complained to
OfficeMax about these improper deductions. In either August or September 2004, a Pintel
representative made an unannounced visit to OfficeMax’s offices in Cleveland – flying in from
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Chicago for the express purpose of reclaiming $650,000 in improper deductions. OfficeMax
employees named Kettlewell and Roche met with the Pintel representative. Ultimately, as a result of
this meeting, OfficeMax was forced to return the $650,000 in improper deductions to Pintel.
80.
As a result of OfficeMax’s vendors’ discovery of the alleged scheme, at least in part,
on October 19, 2004 OfficeMax was forced to reveal to investors that OfficeMax could not meet its
previously announced 2004 financial projections. Investors were shocked, and OfficeMax’s stock
price tumbled 14% before rebounding to close down 11%.
81.
The next partial revelation that all was not right at OfficeMax occurred on November
11, 2004, two days after the November 9, 2004 Form 10-Q was filed, when defendant Crumley
resigned.
82.
Then, on December 20, 2004, the Company issued a press release entitled
“OfficeMax Announces Financial Events, Commences Investigation.” The press release stated in
part:
OfficeMax Incorporated, a leader in office products and services, today announced
monetization of the promissory notes received from the sale of its timberlands and
the distribution of OMX common stock to holders of its Adjustable Conversion-Rate
Equity Security (ACES) units. The company also announced it has commenced an
investigation into certain vendor allegations, and that it is postponing a decision on
the form and timing of equity repurchases until the investigation is complete.
On October 29, 2004, OfficeMax closed the sale of its paper and forest
products businesses. At that time, the company received $2.025 billion in cash for
the assets sold, and an additional $15 million in cash and promissory notes of $1.635
billion for the timberlands portion of the sale. On December 21, 2004, the company
will realize $1.470 billion in cash, before transaction expenses and related costs,
from the monetization of those notes. In addition to $15 million received at closing
and $1.470 billion realized from the monetization, the company will retain a residual
interest in timber promissory notes of $165 million due in 2019.
On December 16, 2004, holders of OfficeMax’s outstanding 7.50% equity
security units received 5.41 million newly issued shares of OMX common stock in
exchange for cash proceeds to OMX of $172.5 million. The settlement rate was
1.5689 shares of OMX common stock for each purchase contract forming a part of
the $50 stated amount of each equity security unit. Following the conversion,
OfficeMax has approximately 95 million fully diluted shares of common stock.
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OfficeMax intends to use the proceeds from monetization of the timber
promissory notes and conversion of the equity security units to continue its debt
reduction program and to repurchase between $775 million and $815 million of its
common stock. However, at the direction of the audit committee of its board of
directors, the company has commenced an internal investigation into claims by a
vendor to its retail business that certain employees acted inappropriately in
requesting promotional payments and in falsifying supporting documentation for
approximately $3.3 million in claims billed to the vendor by OfficeMax during
2003 and 2004. Because the company’s investigation has only recently begun, the
company is postponing a decision as to the form and timing of share repurchases
until the investigation is complete.
83.
On January 5, 2005, the Company issued a press release entitled “OfficeMax
Announces Peterson Resignation.” The article stated in part:
OfficeMax Incorporated, a leader in office products and services, today announced
the resignation of Gary Peterson, president of the company’s retail division, effective
immediately. The company noted that the timing of Mr. Peterson’s departure is
unrelated to the company’s current investigation into allegations of impropriety
regarding vendor promotional payments.
84.
Then, on January 12, 2005, the Company issued a press release entitled “OfficeMax
Announces Resignation of CFO, Delays Earnings Release Pending Investigation and Reiterates
Intent to Repurchase Common Shares.” The press release stated in relevant part:
OfficeMax, Incorporated announced today that Brian Anderson, executive vice
president and chief financial officer, has resigned. Ted Crumley, the former chief
financial officer of OfficeMax, will return to that position on an interim basis. The
company has begun a search for a permanent replacement. . . .
OfficeMax also announced that it will postpone the release of its earnings for
the fourth quarter and full year 2004, pending the conclusion of its previously
announced internal investigation into issues relating to its accounting for vendor
income. The investigation is being conducted under the direction of the audit
committee of OfficeMax’s board of directors.
To date, the company’s investigation has confirmed the claims by a vendor to
its retail business that certain employees fabricated supporting documentation for
approximately $3.3 million in claims billed to the vendor by OfficeMax during 2003
and 2004. As a result of information discovered in the course of its investigation, the
company has expanded the scope of its investigation to include a review of the
manner in which it recorded rebates and other payments from vendors for fiscal years
2003 and 2004. The issues involved in this aspect of the investigation principally
involve the proper timing for the recognition of such payments. The company has
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terminated four employees, based on the information discovered through its
investigation.
85.
On January 12, 2005, CBSMarketWatch issued an article entitled “OfficeMax delays
earnings report; CFO quits.” The article stated in part:
Office Max Inc. said Wednesday it will postpone the release of its fourth-quarter and
full-year earnings reports, pending the conclusion of a now-expanded probe into an
accounting fraud.
*
*
*
In addition, the company said Chief Financial Officer Brian Anderson
resigned after two months on the job. Former CFO Ted Crumley will return to that
post on an interim basis, the company said.
OfficeMax, which first disclosed the investigation Dec. 20, said it has
confirmed claims by a vendor that certain employees created false documents to
support about $3.3 million in claims billed to a vendor in 2003 and 2004.
Four employees have been fired as a result of the investigation, the
company said.
OfficeMax spokesman Bill Bonner said the company could not reveal the
name of the employees, or the vendor, as the investigation is still underway.
The Itasca, Ill.-based office products retailer said that as a result of
information discovered in its investigation, it has expanded the scope of the inquiry
to include accounting procedures for rebates and other vendor payments in fiscal
2003 and 2004.
OfficeMax said it expects to finish the probe by the third full-week of
February, and intends to proceed with its previously stated share repurchase program
once fiscal 2004 results have been reported.
86.
After this news was released, OfficeMax’s stock declined to as low as $27.82 per
share before closing at $28.88 per share, on volume of 7.7 million shares.
87.
The New York Times reported on January 13, 2006:
Investors took a dim view of the latest news, and sent OfficeMax shares down
$1.42, or 4.7 percent, to close at $28.88.
“It’s more than a little disconcerting,” Mr. Souers said. “They’re delaying the
share repurchases; there may be more negative findings – they’ve really lost
credibility on the Street.”
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88.
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On February 14, 2005, the Company issued a press release entitled “Resignation of
CEO Sets Expected Date for Release of Fourth Quarter and Full-Year 2004 Earnings with
Preliminary Guidance Comments on Preliminary Results of Internal Investigation Reiterates Intent
to Repurchase Common Stock.” The press release stated in part:
OfficeMax Incorporated announced today that Christopher C. Milliken has resigned
as president, chief executive officer and as a director. George J. Harad, executive
chairman, has been appointed by the board of directors to serve as chief executive
officer on an interim basis. The board has formed a committee to begin immediately
a search for a permanent chief executive officer.
*
*
*
Fourth Quarter and Full-Year 2004 Earnings
OfficeMax now expects to announce fourth-quarter and full-year 2004
earnings on March 14, 2005, and to host an investor conference call on that date.
Based on preliminary unaudited results, and without considering adjustments which
may arise from the company’s investigation into its accounting for vendor income in
prior periods, operating income for the company’s office products businesses is
expected to range from $125 million to $135 million for full-year 2004.
The company does not expect to provide further information about the results
of its operations until 2004 financial results have been reported.
Internal Investigation
As previously announced, OfficeMax is currently conducting an investigation
under the direction of its audit committee into its accounting for vendor income in
prior periods. Based on the work completed to date, the company has confirmed that
certain employees fabricated supporting documents for approximately $3.3 million in
claims billed to a vendor to its retail business. In addition, the company has
determined that certain rebates and other payments from vendors in 2004 were not
recorded in the appropriate accounting periods, so that operating income in the
first fiscal quarter of 2004 was overstated and the second and third fiscal quarters
of 2004 were understated. Six employees have been terminated for cause in
connection with the investigation.
The company currently estimates that the amount of overstatement in
operating income in the first quarter of 2004 was in the range of $5 million to $10
million, and the subsequent understatements in the second and third quarters reduce
the net overstatement to a range of $4 million to $6 million through the end of the
third quarter 2004. As a result, subject to completion of the investigation, acceptance
of a final investigation report by the audit committee, and review by the company’s
auditors, OfficeMax now expects to restate quarterly income in each of the first three
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fiscal quarters of 2004. Accordingly, the company believes that its previously issued
interim statements of operating results for those periods should no longer be relied
upon.
OfficeMax believes that its financial statements as of and for the year ended
December 31, 2003, were not materially impacted.
The company expects its investigation to be complete by the third full week
of February, 2005.
89.
The next day, on February 15, 2004, the Chicago Tribune reported:
OfficeMax Inc. announced the resignation Monday of its CEO – its third high-level
departure so far in 2005 – and sacked two more employees amid an internal
investigation into billing and accounting problems that include falsified documents.
The resignation of Christopher Milliken as chief executive, president and
board member of OfficeMax coincided with an announcement by the Itasca-based
company that it overstated earnings last year by $4 million to $6 million by failing to
record certain payments to vendors.
As a result, the nation’s No. 3 office supplies retailer said it will have to redo
its financial reports for most of 2004, news that caused the company’s stock to close
Monday at $30.02, down 5.4 percent.
90.
Moreover, the Chicago Tribune further compared OfficeMax’s accounting scandal to
that of other scandal plagued icons of corporate securities fraud and implicated defendant Milliken
for the mess. Indeed, the Chicago Tribune quotes OfficeMax’s corporate representative as
acknowledging that defendant Milliken was fired because of the accounting scandal:
OfficeMax, which has nearly 950 stores and about 40,000 workers, is the
latest high-profile company to be beset by accounting problems. WorldCom Inc.,
Enron Corp. and Adelphia Communications Corp. all folded in recent years due to
creative numbers-crunching.
HealthSouth Corp.’s former CEO is on trial for overstating profits. Krispy
Kreme Doughnuts Inc. is adjusting its numbers. Fannie Mae has been on the hot
seat, with the Securities and Exchange Commission forcing it to restate years of
earnings.
Milliken resigned due to his “overall performance to date,” OfficeMax
spokesman Bill Bonner said. It’s “impossible” to say that the accounting problems
didn’t play a role, but “it was not the sole reason,” Bonner said.
“It’s inevitable that this guy would take the heat,” said Ivan Feinseth, analyst
at Matrix USA LLC in New York, who still has a strong “buy” recommendation on
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OfficeMax stock. “If you’re the CEO and there’s impropriety in your company,
you’re either part of it and get booted, or you have no idea and you’re incompetent
and get booted. Fish always stinks from the head.”
91.
On March 1, 2005, the Company issued a press release entitled “OfficeMax
Announces Completion of Internal Investigation.” The press release stated in part:
OfficeMax Incorporated, a leader in office products and services, today announced
the completion of an internal investigation into its accounting for vendor income in
prior periods. As a result of the investigation, and as previously announced, the
company expects to restate quarterly income for each of the first three fiscal quarters
of 2004.
The investigation began in December 2004 and was conducted under the
direction of the company’s audit committee. Subject to final review by the
company’s auditors, OfficeMax currently estimates that it overstated operating
income in first quarter 2004 by approximately $7 million and understated operating
income by approximately $1 million in each of the second and third quarters of 2004.
The cumulative net operating income overstatement for the first nine months of 2004
is estimated to be approximately $4 to $5 million. Accordingly, the company
expects to restate quarterly income for each of the first three fiscal quarters of
2004 and believes that its previously issued interim statements of operating results
for those periods should no longer be relied upon.
OfficeMax believes that its financial statements as of and for the year ended
December 31, 2003, were not materially impacted.
92.
On March 14, 2005, OfficeMax reported its fourth quarter of 2004 results. The retail
segment operating margin was a negative 1.5%, which was lower than prior years. OfficeMax
attributed the decline in profitability to weak sales but also to “lower vendor income.” Thus,
OfficeMax’s profitability has been adversely affected by its inability to engage in the manipulations
with vendor promotions which occurred in 2003 and interim 2004.
93.
The true facts, which were known by each of the defendants but concealed from the
investing public during the Class Period, were as follows:
(a)
that the Company had improperly booked promotional payments from
vendors and falsified supporting documentation for millions of dollars in claims billed to vendors
during 2003 and 2004;
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that the Company’s fourth quarter of 2004 results and those beyond would be
eroded by the halting of the Company’s abusive vendor rebate scheme;
(c)
that the Company lacked the necessary internal controls to ensure all revenue
reported complied with GAAP; and
(d)
that the Company had instituted an investigation of these illegal practices
weeks, if not months, before its public announcement on December 20, 2004.
OFFICEMAX’S FALSE FINANCIAL REPORTING DURING THE CLASS PERIOD
94.
To artificially inflate the price of OfficeMax’s stock, defendants caused the Company
to falsely report its financial results for 2003 through the third quarter of 2004 by improperly
accounting for vendor income.
95.
The Company’s interim 2004 results were included in Form 10-Qs filed with the
SEC. OfficeMax’s 2003 results were included in a Form 10-K filed with the SEC. The results were
also included in press releases disseminated to the public.
96.
OfficeMax has admitted that it inappropriately recorded vendor income included in its
first through third quarters of 2004 results, and has restated those results to remove millions in
improperly reported income, such that its 2003 and interim 2004 financial statements were not a fair
presentation of OfficeMax’s results and were presented in violation of GAAP and SEC rules.
97.
GAAP are those principles recognized by the accounting profession as the
conventions, rules and procedures necessary to define accepted accounting practice at a particular
time. SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with the
SEC which are not prepared in compliance with GAAP are presumed to be misleading and
inaccurate, despite footnote or other disclosure. Regulation S-X requires that interim financial
statements must also comply with GAAP, with the exception that interim financial statements need
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not include disclosure which would be duplicative of disclosures accompanying annual financial
statements. 17 C.F.R. §210.10-01(a).
98.
In OfficeMax’s 2003 Form 10-K for the year ended December 31, 2003, filed on
March 2, 2004, it represented that:
We receive rebates and allowances from our vendors under a number of different
programs, including OfficeMax advertising programs and other vendor marketing
programs. These rebates and allowances are accounted for in accordance with
Emerging Issues Task Force (EITF) 02-16, Accounting by a Customer (Including a
Reseller) for Certain Consideration Received from a Vendor. Rebates and
allowances received from our vendors are deferred in inventory with the cost of the
associated product and are recognized as a reduction of “Materials, labor, and other
operating expenses” when the product is sold, unless the rebates and allowances are
linked to a specific incremental cost to sell a vendor’s product. Amounts received
from vendors that are linked to specific selling and distribution expenses are
recognized as a reduction of “Selling and distribution expenses” in the period the
expense is incurred. See Note 5, Accounting Changes, for information related to the
2003 accounting change for vendor allowances.
Included in the vendor rebate programs referred to above are various volume
purchase rebate programs. These programs generally include annual purchase rebate
programs. These programs generally include annual purchase targets and may offer
increasing tiered rebates based on our reaching defined purchase levels. For such
tiered rebate programs, the company calculates an estimated consideration based on
expected purchases during the rebate program period. We review sales projections
and related purchases on a quarterly basis and adjust the estimated consideration
accordingly. We record consideration received for these programs as a reduction of
“Materials, labor, and other operating expenses” as the related inventory is sold.
99.
Pursuant to GAAP, as set forth in Emerging Issues Task Force (“EITF”) 02-16 which
describes the accounting for consideration received from a vendor, vendor income should not be
recognized unless it is probable and can be reasonably estimated. EITF 02-16 states in part:
4.
[C]ash consideration received by a customer from a vendor is
presumed to be a reduction of the prices of the vendor’s products or services and
should, therefore, be characterized as a reduction of cost of sales when recognized in
the customer’s income statement. However, that presumption is overcome when the
consideration is either (a) a payment for assets or services delivered to the vendor, in
which case the cash consideration should be characterized as revenue (or other
income, as appropriate) when recognized in the customer’s income statement, or (b)
a reimbursement of costs incurred by the customer to sell the vendor’s products, in
which case the cash consideration should be characterized as a reduction of that cost
when recognized in the customer’s income statement.
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*
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*
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*
7.
The Task Force reached a consensus on Issue 2 that a rebate or refund
of a specified amount of cash consideration that is payable pursuant to a binding
arrangement only if the customer completes a specified cumulative level of
purchases or remains a customer for a specified time period should be recognized as
a reduction of the cost of sales based on a systematic and rational allocation of the
cash consideration offered to each of the underlying transactions that results in
progress by the customer toward earning the rebate or refund provided the amounts
are probable and reasonably estimable. If the rebate or refund is not probable and
reasonably estimable, it should be recognized as the milestones are achieved.
8.
The Task Force observed that the ability to make a reasonable
estimate of the amount of future cash rebates or refunds depends on many factors and
circumstances that will vary from case to case. However, the Task Force reached a
consensus that the following factors may impair a customer’s ability to determine
whether the rebate or refund is probably and reasonably estimable:
a. The rebate or refund relates to purchases that will occur over a relatively
long period.
b. There is an absence of historical experience with similar products or the
inability to apply such experience because of changing circumstances.
c. Significant adjustments to expected cash rebates or refunds have been
necessary in the past.
d. The product is susceptible to significant external factors (for example,
technological obsolescence or changes in demand).
100.
During the Class Period, OfficeMax improperly recognized income from vendors
even though the conditions required by GAAP, as described in EITF 02-16, did not exist.
Specifically, it recognized vendor incomes even though collection was not probable. Companies like
OfficeMax receive money from vendors to feature the supplier’s products in ads and circulars.
Frequently, an ad in the newspaper for OfficeMax for a certain brand of product was compensated in
part by the vendor of that brand. By overstating the expected amount of such compensation,
OfficeMax was able to manipulate its reported results.
101.
On December 20, 2004, OfficeMax announced an investigation into certain vendor
allegations. The release stated in part:
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[A]t the direction of the audit committee of its board of directors, the company has
commenced an internal investigation into claims by a vendor to its retail business
that certain employees acted inappropriately in requesting promotional payments and
in falsifying supporting documentation for approximately $3.3 million in claims
billed to the vendor by OfficeMax during 2003 and 2004. Because the company’s
investigation has only recently begun, the company is postponing a decision as to the
form and timing of share repurchases until the investigation is complete.
102.
Later on January 12, 2005, OfficeMax announced that its release of its fourth quarter
of 2004 results would be delayed in order for the Company to complete its investigation of its 2003
and interim 2004 financial results. The Company subsequently restated its first through third
quarters of 2004 results to eliminate $7.4 million in income that had been improperly recognized in
the first quarter of 2004. While the Company did not restate its 2003 financial statements, it has
only represented that the vendor manipulations were not material to the results for the year ended
December 31, 2003. The 2004 10-K filed on March 16, 2005 stated:
We have amended our Quarterly Reports on Form 10-Q for the quarterly
periods in the fiscal year ended December 31, 2004. The purpose of the restatement
is to correct the accounting for vendor income, after we determined that rebates and
other payments from vendors in 2004 were not recorded in the appropriate
accounting periods. As a result, income from continuing operations was overstated
by approximately $7.1 million in the first quarter of 2004 and was understated by
approximately $1.1 million and $1.7 million in the second and third quarters of 2004,
respectively.
103.
The fact that OfficeMax has restated its financial statements for interim 2004 is an
admission that (i) the financial statements originally issued were materially false and misleading, and
(ii) the financial statements reported during the Class Period were incorrect based on information
available to defendants at the time the results were originally reported. Pursuant to GAAP, as set
forth in Accounting Principles Board Opinion (“APB”) No. 20, the type of restatement announced
by OfficeMax was to correct for material errors in its previously issued financial statements. See
APB No. 20, ¶¶7-13. As recently noted by the SEC, “GAAP only allows a restatement of prior
financial statements based upon information ‘that existed at the time the financial statements were
prepared’” and “restatements should not be used to make any adjustments to take into account
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subsequent information that did not and could not have existed at the time the original financial
statements were prepared.”2 The APB has defined the kind of “errors” that may be corrected
through a restatement: “Errors in financial statements result from mathematical mistakes, mistakes in
the application of accounting principles, or oversight or misuse of facts that existed at the time that
the financial statements were prepared.” See APB No. 20 ¶¶7-13. The restatement at issue here
was not due to a simple mathematical error, honest misapplication of a standard or oversight as
alleged below, it was due to intentional misuse of the facts that were known at the time.
104.
The SEC has reiterated its position that, in its investigations of restated financial
statements, it often finds that the persons responsible for the improper accounting acted with
scienter:
[T]he Commission often seeks to enter into evidence restated financial statements,
and the documentation behind those restatements, in its securities fraud enforcement
actions in order, inter alia, to prove the falsity and materiality of the original
financial statements [and] to demonstrate that persons responsible for the original
misstatements acted with scienter.
SEC Brief. The resignations of defendants Crumley, Peterson and Milliken after the misstatements
were discovered is strong, circumstantial evidence that OfficeMax’s senior most management (the
defendants in this action) either knew or recklessly disregarded the truth during the Class Period in
violation of the federal securities laws.
OfficeMax GAAP Violations and Restatement Were Material
105.
OfficeMax’s false and misleading Class Period statements and omissions regarding
its accounting were material, particularly in light of SEC guidance on materiality. SEC Staff
2
In re Sunbeam Sec. Litig., No. 98-8258-Civ.-Middlebrooks, Brief of the United States Securities and
Exchange Commission as SEC Amicus Curiae Regarding Defendants’ Motions In Limine to Exclude
Evidence of the Restatement and Restatement Report (S.D. Fla., filed Jan. 31, 2002) (“SEC Brief”).
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Accounting Bulletin (“SAB”) Topic 1M, Materiality, summarizes GAAP definitions of materiality.3
Among other items, SAB Topic 1M says: “A matter is ‘material’ if there is a substantial likelihood
that a reasonable person would consider it important.” It also stresses that materiality requires
qualitative, as well as quantitative, considerations. For example, if a known misstatement would
cause a significant market reaction, that reaction should be taken into account in determining the
materiality of the misstatement.
106.
SAB Topic 1M further states:
Among the considerations that may well render material a quantitatively
small misstatement of a financial statement item are –
*
•
*
*
whether the misstatement masks a change in earnings or other trends
•
whether the misstatement hides a failure to meet analysts’ consensus
expectations for the enterprise
*
*
*
•
whether the misstatement concerns a segment or other portion of the
registrant’s business that has been identified as playing a significant role in the
registrant’s operations or profitability.
107.
SAB Topic 1M also says that an intentional misstatement of even immaterial items
may be illegal and constitute fraudulent financial reporting.
108.
OfficeMax’s misstatements, by their own admissions, satisfy these criteria and, thus,
were material from both a quantitative and qualitative perspective.
109.
Due to these accounting improprieties, the Company presented its financial results
and statements in a manner which violated GAAP, including the following fundamental accounting
principles:
3
SAB Topic 1M, Materiality, represents the codification of certain Staff Accounting Bulletins,
including SAB No. 99, Materiality, as of May 9, 2003. SAB No. 99 was effective August 12, 1999.
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(a)
Document 110-1
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The principle that interim financial reporting should be based upon the same
accounting principles and practices used to prepare annual financial statements was violated (APB
No. 28, 10);
(b)
The principle that financial reporting should provide information that is useful
to present and potential investors and creditors and other users in making rational investment, credit
and similar decisions was violated (FASB Statement of Concepts No. 1, 34);
(c)
The principle that financial reporting should provide information about the
economic resources of an enterprise, the claims to those resources, and effects of transactions, events
and circumstances that change resources and claims to those resources was violated (Financial
Accounting Standards Board (“FASB”) Statement of Concepts No. 1, 40);
(d)
The principle that financial reporting should provide information about how
management of an enterprise has discharged its stewardship responsibility to owners (stockholders)
for the use of enterprise resources entrusted to it was violated. To the extent that management offers
securities of the enterprise to the public, it voluntarily accepts wider responsibilities for
accountability to prospective investors and to the public in general (FASB Statement of Concepts
No. 1, 50);
(e)
The principle that financial reporting should provide information about an
enterprise’s financial performance during a period was violated. Investors and creditors often use
information about the past to help in assessing the prospects of an enterprise. Thus, although
investment and credit decisions reflect investors’ expectations about future enterprise performance,
those expectations are commonly based at least partly on evaluations of past enterprise performance
(FASB Statement of Concepts No. 1, 42);
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(f)
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The principle that financial reporting should be reliable in that it represents
what it purports to represent was violated. That information should be reliable as well as relevant is
a notion that is central to accounting (FASB Statement of Concepts No. 2, 58-59);
(g)
The principle of completeness, which means that nothing is left out of the
information that may be necessary to insure that it validly represents underlying events and
conditions was violated (FASB Statement of Concepts No. 2, 79); and
(h)
The principle that conservatism be used as a prudent reaction to uncertainty to
try to ensure that uncertainties and risks inherent in business situations are adequately considered
was violated. The best way to avoid injury to investors is to try to ensure that what is reported
represents what it purports to represent (FASB Statement of Concepts No. 2, 95, 97).
110.
Further, the undisclosed adverse information concealed by defendants during the
Class Period is the type of information which, because of SEC regulations, regulations of the
national stock exchanges and customary business practice, is expected by investors and securities
analysts to be disclosed and is known by corporate officials and their legal and financial advisors to
be the type of information which is expected to be and must be disclosed.
OfficeMax’s Violations of SEC Regulations Due to Its Inadequate Internal Controls
111.
In addition to the foregoing improper accounting practices, the Company also
suffered from a severe breakdown of its internal accounting controls throughout the Class Period,
which tendered OfficeMax’s financial reporting inherently corrupt, subject to manipulation and
unreliable, and this problem resulted in materially false and misleading financial statements.
112.
In this regard, the Individual Defendants failed to design and implement an internal
control system over the Company’s financial reporting processes and this failure allowed the
Company, in violation of GAAP, to improperly recognize vendor income.
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113.
Document 110-1
Filed 11/09/2006
Page 47 of 58
In its Form 10-K for the year ended December 31, 2004, OfficeMax admitted that its
internal control deficiencies had contributed to the accounting problems:
Based on this assessment, management concluded that as of December 31,
2004, OfficeMax’s internal control over financial reporting was not effective due to a
material weakness in internal control associated with the control environment of an
entity acquired near the end of 2003. This material weakness resulted from the
combination of the following internal control deficiencies that, when aggregated,
resulted in there being more than a remote likelihood that a material misstatement of
the annual or interim financial statements would not be prevented or detected on a
timely basis by management or employees in the normal course of performing their
assigned functions: (i) insufficient policies and procedures to ensure that employees
in the merchandizing department of the acquired entity acted in accordance with our
Code of Conduct, (ii) insufficient policies and procedures regarding the follow-up on
communications from vendor(s) regarding disputed claims, including the lack of
adequate segregation of duties involving initiation of transactions and dispute
resolution, and (iii) inadequately trained personnel within the merchandising and
accounting departments. As a result of the deficiencies, the company overstated
operating income in the first quarter of 2004 and understated operating income in the
second and third quarters of 2004. The company has restated each of the
aforementioned quarters to properly reflect the appropriate accounting in each
period.
114.
Section 13(b)(2) of the 1934 Act states, in pertinent part, that every reporting
company must: “(A) make and keep books, records, and accounts which, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the issuer; [and] (B)
devise and maintain a system of internal controls sufficient to provide reasonable assurances that . . .
transactions are recorded as necessary . . . to permit preparation of financial statements in conformity
with [GAAP].” 15 U.S.C. §78m(b)(A). These provisions require an issuer to employ and supervise
reliable personnel, to maintain reasonable assurances that transactions are executed as authorized, to
record transactions on an issuer’s books and, at reasonable intervals, to compare accounting records
with physical assets.
115.
OfficeMax has now admitted that its disclosure controls and procedures during the
Class Period were inadequate. OfficeMax admitted to these significant and material deficiencies in
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its 2004 Form 10-K filed with the SEC on March 16, 2005, in which OfficeMax acknowledged the
necessity of making the following remediation:
•
Terminated employees who knowingly violated company policies;
•
Completed a review of all outstanding vendor claims and receivables;
•
Converted a substantial portion of our vendor credits to standard agreements
that emphasize purchase volume credits over promotion and event driven
credits, thereby ensuring the use of objective criteria to determine when a
credit has been earned and may be taken into income by the company;
•
Expanded the practice of requesting vendor confirmation of vendor credit
claims and outstanding receivables; and
•
Clarified the duties and responsibilities of the company personnel who
interact with vendors to reinforce accountability.
*
*
*
•
Improve the training of personnel in the accounting and merchandising
departments with respect to the company’s vendor income policies and
practices;
•
Enhance the skill level, staffing and reporting authority of personnel in the
accounting and merchandising departments; and
•
Vest a senior executive with the responsibility to review issues related to
vendor credits, such as outstanding receivables and disagreements with
vendors, and regularly report his or her findings directly to the audit
committee.
116.
This case is not a simple matter of a company having a few minor internal control
problems but rather the widespread nature of the deficiencies over an important part of OfficeMax’s
business.
117.
OfficeMax’s lack of adequate internal controls rendered OfficeMax’s Class Period
financial reporting inherently unreliable and precluded the Company from preparing financial
statements that complied with GAAP. Nonetheless, throughout the Class Period, the Company
regularly issued quarterly financial statements without ever disclosing the existence of the significant
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and material deficiencies in its internal accounting controls and falsely asserted that its financial
statements complied with GAAP.
118.
During the Class Period, defendants Harad, Crumley and Milliken assured investors
they personally supervised the evaluation, design and operation of the Company’s disclosure
procedures, as required by Sarbanes-Oxley, to ensure that the Company’s internal controls would
alert them to material information that would conflict with GAAP and/or require disclosure.
Defendants repeatedly misrepresented to investors, throughout the Class Period, that there existed no
disclosure issues or control problems.
119.
Given the significance of the vendor rebate program and the substantial deficiencies
the Company had during the Class Period with regard to these internal controls, defendants were
acting with extreme recklessness in assuring investors that OfficeMax’s financial statements were
prepared in compliance with GAAP. The Individual Defendants were, at best, acting in reckless
disregard for the truth by ignoring red flags concerning the improprieties alleged.
LOSS CAUSATION/ECONOMIC LOSS
120.
During the Class Period, as detailed herein, defendants engaged in a scheme to
deceive the market and a course of conduct that artificially inflated OfficeMax’s stock price and
operated as a fraud or deceit on Class Period purchasers of OfficeMax stock by misrepresenting the
Company’s financial results, the success of its integration of OfficeMax into Boise and the
Company’s future business prospects. Defendants achieved this façade of success, growth and
strong future business prospects by misrepresenting earnings through vendor rebate manipulations.
121.
Later, however, when the truth concerning OfficeMax’s troubled business operations,
finances and internal control deficiencies entered the market and became apparent to investors,
OfficeMax stock fell as the prior artificial inflation came out of OfficeMax’s stock price. As a result
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of their purchases of OfficeMax stock during the Class Period, Lead Plaintiff and other members of
the Class suffered economic loss, i.e., damages under the federal securities laws.
122.
By misrepresenting its earnings, the defendants presented a misleading picture of
OfficeMax’s business and prospects. Thus, instead of truthfully disclosing during the Class Period
that OfficeMax’s business was not as healthy as represented, defendants caused OfficeMax to falsely
report earnings and to understate its “materials, labor and other operating expense.”
123.
Defendants’ false and misleading statements had the intended effect and caused
OfficeMax stock to trade at artificially inflated levels, reaching as high as $38.01 per share,
throughout the Class Period.
124.
On October 19, 2004, at least in part because the Company’s vendors had discovered
the fraudulent scheme and were demanding reimbursements for moneys improperly withheld by
OfficeMax, defendants were forced to admit the Company could not achieve its previously forecast
2004 financial results. As a result, OfficeMax’s stock price dropped from $33.92 on October 18 to
$29.52 on October 19, 2004, with extraordinary trading volume of 9 million shares.
125.
Then, on December 20, 2004, defendants were forced to publicly announce an
investigation into inappropriate vendor deductions it had recorded due to a vendor’s complaints
regarding some $3.3 million in inappropriate promotional payments in 2003 and 2004. As investors
and the market became aware that OfficeMax’s prior financials may have been falsified, the prior
artificial inflation began to come out of OfficeMax’s stock price, dropping from above $32 per share
to $30 per share. Later, on January 12, 2005, OfficeMax announced it would delay its earnings due
to the investigation, announced the resignation of its CFO (Brian Anderson) after only two months
on the job and that OfficeMax had fired four employees. As the seriousness of the accounting issues
became apparent, OfficeMax’s stock dropped to as low as $27.82 per share before closing at $28.88
per share on January 12, 2005, damaging investors.
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Case 1:05-cv-00236
126.
Document 110-1
Filed 11/09/2006
Page 51 of 58
As a direct result of defendants’ admissions and the public revelations regarding the
truth about OfficeMax’s finances and its actual business prospects going forward, OfficeMax’s stock
price plummeted 12%, falling from $32.50 on December 17, 2004 to $28.88 per share on January 12,
2004, a 17 day drop of $3.62 per share. This drop removed the inflation from OfficeMax’s stock
price, causing real economic loss to investors who had purchased the stock during the Class Period.
In sum, as the truth about defendants’ fraud and OfficeMax’s business performance was revealed,
the Company’s stock price plummeted, the artificial inflation came out of the stock and Lead
Plaintiff and other members of the Class were damaged, suffering economic losses.
127.
The 12% decline in OfficeMax’s stock price at the end of the Class Period was a
direct result of the nature and extent of defendants’ fraud finally being revealed to investors and the
market. The timing and magnitude of OfficeMax’s stock price declines negate any inference that the
loss suffered by Lead Plaintiff and other Class members was caused by changed market conditions,
macroeconomic or industry factors or Company-specific facts unrelated to the defendants’ fraudulent
conduct. During the same period in which OfficeMax’s stock price fell 12% as a result of
defendants’ fraud being revealed, the Standard & Poor’s 500 Consumer Discretionary Index was up
1%. The economic loss, i.e., damages, suffered by Lead Plaintiff and other members of the Class
was a direct result of defendants’ fraudulent scheme to artificially inflate OfficeMax’s stock price
and the subsequent significant decline in the value of OfficeMax’s stock when defendants’ prior
misrepresentations and other fraudulent conduct was revealed.
FIRST CLAIM FOR RELIEF
For Violation of §10(b) of the 1934 Act
and Rule 10b-5 Against All Defendants
128.
Lead Plaintiff incorporates ¶¶1-125 by reference.
129.
During the Class Period, defendants disseminated or approved the false statements
specified above, which they knew or deliberately disregarded were misleading in that they contained
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misrepresentations and failed to disclose material facts necessary in order to make the statements
made, in light of the circumstances under which they were made, not misleading.
130.
Defendants violated §10(b) of the 1934 Act and Rule 10b-5 in that they:
(a)
employed devices, schemes, and artifices to defraud;
(b)
made untrue statements of material facts or omitted to state material facts
necessary in order to make the statements made, in light of the circumstances under which they were
made, not misleading; or
(c)
engaged in acts, practices, and a course of business that operated as a fraud or
deceit upon Lead Plaintiff and others similarly situated in connection with their purchase or
acquisition of OfficeMax publicly traded securities during the Class Period.
131.
Lead Plaintiff and the Class have suffered damages in that, in reliance on the integrity
of the market, they paid artificially inflated prices for OfficeMax publicly traded securities. Lead
Plaintiff and the Class would not have purchased or acquired OfficeMax publicly traded securities at
the prices they paid, or at all, if they had been aware that the market prices had been artificially and
falsely inflated by defendants’ misleading statements.
132.
As a direct and proximate result of these defendants’ wrongful conduct, Lead Plaintiff
and the other members of the Class suffered damages in connection with their purchase or
acquisition of OfficeMax publicly traded securities during the Class Period.
SECOND CLAIM FOR RELIEF
For Violation of §20(a) of the 1934 Act
Against All Defendants
133.
Lead Plaintiff incorporates ¶¶1-130 by reference.
134.
The Individual Defendants acted as controlling persons of OfficeMax within the
meaning of §20(a) of the 1934 Act. By reason of their positions as officers and/or directors of
OfficeMax, and their ownership of OfficeMax stock, the Individual Defendants had the power and
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authority to cause OfficeMax to engage in the wrongful conduct complained of herein. OfficeMax
controlled each of the Individual Defendants and all of its employees. By reason of such conduct,
the Individual Defendants and OfficeMax are liable pursuant to §20(a) of the 1934 Act.
CLASS ACTION ALLEGATIONS
135.
Lead Plaintiff brings this action as a class action pursuant to Rule 23 of the Federal
Rules of Civil Procedure on behalf of all persons who purchased or otherwise acquired OfficeMax
publicly traded securities (the “Class”) on the open market during the Class Period. Excluded from
the Class are defendants.
136.
The members of the Class are so numerous that joinder of all members is
impracticable. The disposition of their claims in a class action will provide substantial benefits to
the parties and the Court. OfficeMax had more than 94 million shares of stock outstanding, owned
by hundreds if not thousands of persons.
137.
There is a well-defined community of interest in the questions of law and fact
involved in this case. Questions of law and fact common to the members of the Class which
predominate over questions which may affect individual Class members include:
(a)
whether the 1934 Act was violated by defendants;
(b)
whether defendants omitted and/or misrepresented material facts;
(c)
whether defendants’ statements omitted material facts necessary to make the
statements made, in light of the circumstances under which they were made, not misleading;
(d)
whether defendants knew or deliberately disregarded that their statements
were false and misleading;
(e)
whether the prices of OfficeMax’s publicly traded securities were artificially
inflated; and
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Case 1:05-cv-00236
(f)
Document 110-1
Filed 11/09/2006
Page 54 of 58
the extent of damage sustained by Class members and the appropriate measure
of damages.
138.
Lead Plaintiff’s claims are typical of those of the Class because Lead Plaintiff and the
Class sustained damages from defendants’ wrongful conduct.
139.
Lead Plaintiff will adequately protect the interests of the Class and has retained
counsel who are experienced in class action securities litigation. Lead Plaintiff has no interests
which conflict with those of the Class.
140.
A class action is superior to other available methods for the fair and efficient
adjudication of this controversy.
PRAYER FOR RELIEF
WHEREFORE, Lead Plaintiff prays for judgment as follows:
A.
Declaring this action to be a proper class action pursuant to Federal Rule of Civil
Procedure 23;
B.
Awarding Lead Plaintiff and the members of the Class damages, including interest;
C.
Awarding Lead Plaintiff reasonable costs, including attorneys’ fees; and
D.
Awarding such equitable/injunctive or other relief as the Court may deem just and
proper.
JURY DEMAND
Lead Plaintiff demands a trial by jury.
DATED: November 9, 2006
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
MARK SOLOMON
WILLIAM J. DOYLE II
MATTHEW P. SIBEN
s/WILLIAM J. DOYLE II
WILLIAM J. DOYLE II
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Document 110-1
Filed 11/09/2006
Page 55 of 58
655 West Broadway, Suite 1900
San Diego, CA 92101
Telephone: 619/231-1058
619/231-7423 (fax)
Lead Counsel for Plaintiffs
MILLER FAUCHER AND CAFFERTY LLP
MARVIN A. MILLER
JENNIFER W. SPRENGEL
NYRAN ROSE PEARSON
30 North LaSalle Street, Suite 3200
Chicago, IL 60602
Telephone: 312/782-4880
312/782-4485 (fax)
Liaison Counsel
S:\CasesSD\OfficeMax 05\Cpt OfficeMax_Amended Consol.doc
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CERTIFICATE OF SERVICE
I hereby certify that on November 9, 2006, I electronically filed the foregoing with the Clerk
of the Court using the CM/ECF system which will send notification of such filing to the e-mail
addresses denoted on the attached Electronic Mail Notice List, and I hereby certify that I have
mailed the foregoing document or paper via the United States Postal Service to the non-CM/ECF
participants indicated on the attached Manual Notice List.
s/ WILLIAM J. DOYLE II
WILLIAM J. DOYLE II
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
655 West Broadway, Suite 1900
San Diego, CA 92101
Telephone: 619/231-1058
619/231-7423 (fax)
E-mail:billd@lerachlaw.com
CM/ECF LIVE, Ver 2.5 - U.S. District Court, Northern Illinois
Case 1:05-cv-00236 Document 110-1 Filed 11/09/2006
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Mitchell G Blair
Calfee, Halter & Griswold LLP
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William S Lerach
Lerach Coughlin Stoia Geller Rudman & Robbins
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11/9/2006
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
DAVID ROTH, on behalf of himself and all )
Others similarly situated,
)
No . 05-C-0236 ( Consolidated )
Plaintiff, )
CLASS ACTION
V.
Judge Joan B. Gottschall
Magistrate Judge Denlow
OFFICEMAX, INC., et al ., Defendant .
DECLARATION OF SHELDON D . ZIMMERMAN
I, Sheldon D. Zimmerman, declare as follows :
1.
I am over 18 years of age and am competent to make this Declaration . I give this
Declaration in support of the Complaint in the above-captioned action to which this
Declaration is attached (hereinafter the "Complaint") .
2.
I am a shareholder in the Atlanta, Georgia accounting and auditing firm of Tauber
& Balser, P .C ., which was founded in 1968 . Tauber & Balser, P .C. is located in Atlanta,
Georgia, a full-service C.P.A. and consulting firm with a diverse group of clientele .
Tauber & Balser, P .C . is a registered firm with the Public Company Accounting
Oversight Board ("PCAOB") . I have been a Certified Public Accountant licensed in the
State of Georgia since 1975 . Attached hereto as Exhibit 1 is my curriculum vitae .
3.
Prior to joining Tauber & Balser, P.C., I was a chief financial officer of a
specialty retailer that operated over 800 stores throughout the United States . Some of my
primary responsibilities were to manage the vendor rebate and other merchandising
programs . As part of that responsibility, I was involved in the negotiation of the various
arrangements with the more significant suppliers, billing and collecting of the monies that
were due the company and determining the amount and timing of recognition in the
financial statements of the company.
4
My career in public accounting began with Touche Ross & Co . in Atlanta,
Georgia in 1972 . During my career at Touche Ross & Co . I served as an audit partner
specializing in serving retail companies . I was a partner in the National Retail Group at
Touche Ross & Co ., and taught numerous retail seminars on internal controls . I later
joined Deloitte Haskins & Sells and was an audit partner serving primarily retail
companies and was a member of their National Retail Group . After the merger o f
Touche Ross & Co . and Deloitte Haskins & Sells, I was a partner in the combined firm of
Deloitte & Touche concentrating on retail accounts and a member of their National Retail
Group .
5.
I have been retained by Lerach Coughlin Stoia Geller Rudman & Robbins LLP to
opine as to whether or not the senior management of OfficeMax, Inc . ("OfficeMax")
should have been aware of the internal control weaknesses which did not detect the
overstatement of income recorded relating to vendor rebates and allowances .
6.
Through my education, training and experience as a Certified Public Accountant,
I am familiar with generally accepted accounting principles ("GAAP") utilized by
Certified Public Accountants in the United States under the Code of Professional Conduct
of the American Institute of Certified Public Accountants ("AICPA"), generally accepted
auditing standards ("GAAS") and other applicable ethical and professional standards and
regulations . I am particularly familiar with the accounting principles relating to the
accounting for vendor rebates and allowances by retail companies and particularly
familiar with how retailers account for vendor rebates and allowances .
7.
My knowledge of the facts of this case are based primarily upon my review of the
Consolidated Complaint for Violation of the Federal Securities Law dated August 1,
2005, Memorandum Opinion and Order, dated September 12, 2006, a draft of the First
Amended Consolidated Complaint for Violation of the Federal Securities Laws and
various financial statements included in OfficeMax's filings with the Securities and
Exchange Commission ("SEC") during the applicable time period .
8.
It is clear that senior management of OfficeMax was aware of the accounting
issues surrounding vendor allowances as the company adopted the provisions of
Emerging Issues Task Force ("EITF") Issue No . 02-16 ("Accounting by a Customer
[Including a Reseller] for Certain Consideration Received from a Vendor") effective
2
January 1, 2003 . The adoption of the provisions of EITF Issue No . 02-16 resulted in a
one time, noncash, after tax charge of $4 .7 million in the financial statements .
9.
The knowledge of senior management is indicated via disclosures in the financial
statements and the Company's correspondence with the Financial Accounting Standards
Board ("FASB") and EITF . The OfficeMax Senior Vice President, Controller, Phillip P .
DePaul wrote a letter dated April 23, 2003 to the Chairman of the EITF relating to the
transition provisions of the EITF 02-16 and the impact that the proposed transition
accounting would have on the company and other retailers . The letter indicated "our
company and our other direct competitor (whose year-end was February 1, 2003) must
adopt Issue 02-16 prospectively, based on our understanding of he March 20, 2003
decision" .
10 .
The EITF is an organization formed by the FASB to provide assistance with
timely financial reporting . The EITF holds public meetings in order to identify and
resolve accounting issues occurring in the financial world . This group consists mainly of
accountants from large public firms, but it also included the chief accountant of the SEC
as observer and participant . The main purpose of the task force is to identify emerging
issues and resolve them with a uniform set of practices before divergent methods arise
and become widespread . The fact that the senior management of OfficeMax wa s
communicating with the EITF about this issue demonstrates the importance that
OfficeMax placed on the accounting for vendor rebates .
11 .
Indeed vendor rebates were significant to OfficeMax's earnings . While the sales
volume of the OfficeMax retail locations exceeded $4 .4 billion., the operating profit was
only $22 .7 million or .5% (one-half of one percent) of revenue, as reported in Form 10-K
for the year ending December 31, 2004 .
12.
The vendor rebate and merchandising programs can have a significant effect on
the operating profit of a retail company. The amount of the restatement that OfficeMax
made during 2004 resulted in an overstatement of operating income of approximately
$4 .3 million, or 18 .9% of the operating income the company reported . While the $4 .3
million only represents the portion of the vendor rebates relating to the restatement, its
relationship to the operating income reported indicates that the total amount associated
with all the vendor rebate and merchandising programs would have been substantially
greater than the reported operating income of the company and therefore material to the
company's operations .
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13 .
Due to the significance of these types of programs to OfficeMax's operating
income it was imperative for the company to have developed internal control systems
and other reporting mechanisms to monitor and track the status of the various programs
in order to comply with the relevant accounting standards and requirements . I would
have expected no less than a fully functioning system with proper reporting under GAAP
of the financial ramifications of the vendor rebate and merchandizing programs . Because
OfficeMax has thousands of different inventory products that must be tracked,
sophisticated computer programs and systems are generally utilized in order to properly
account for these programs . In fact the OfficeMax chief executive officer and chief
financial officer signed the CEO and CFO certifications pursuant to Section 302 of the
Sarbanes Oxley Act of 2002 indicating that they were responsible for establishing and
maintaining disclosure controls and procedures and internal control over financial
reporting for the company, and such controls and procedures were designed under their
supervision to ensure that material information relating to the company would be made
known to them by others within the company, particularly during the period in which the
report they are certifying is prepared .
14 .
The PCAOB and SEC have defined internal control over financial reporting as
described in AU 320, "An Audit of Internal Control Over Financial Reporting Performed
in Conjunction with an Audit of Financial Statements ." As set forth in AU 320 .07
internal control over financial reporting is defined as "a process designed by, or under the
supervision of, the company's principal executive and principal financial officers, or
persons performing similar functions, and effected by the company's board of directors,
management, and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and includes those
policies and procedures that :
(1) Pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the
assets of the company ;
(2) Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; an d
(3) Provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use of disposition of the company's assets
that could have a material effect on the financial statements ."
4
This same definition is utilized in the CEO and CFO certifications that were contained in
the OfficeMax public filings.
15 .
It is very common for senior financial management and other members of the
senior management team to be knowledgeable of, and involved in negotiating and
monitoring the vendor rebate and merchandising programs due to the magnitude of the
dollars involved and its potential impact on the earnings of the company .
I declare under penalty of perjury under the laws of the United States that the
foregoing is true and correct . Executed this 91h day of November, 2006, at Atlanta,
Georgia .
SHELDON D . ZIMMERMAN, CPA
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CURRICULUM VITAE
SHELDON D. ZIMMERMAN
Certified Public Accountant
EDUCATION
Mr. Zimmerman obtained his BBA Accounting at the University of South Florida in 1972
and is a Certified Public Accountant licensed in Georgia.
BACKGROUND
Mr. Zimmerman has approximately 30 years experience in auditing, accounting, and
corporate restructuring/turnaround, due diligence, forensic accounting and litigation
support. In addition to his public accounting experience as a partner in one of the Big 4
accounting firms, where he served as the lead engagement partner on primarily retail
engagements, he also served as Executive Vice President & Chief Financial Officer of a
national retail chain that operated over 800 stores in 40 states with more than 7,000
employees with annual revenues in excess of $500 million. He is a Shareholder in
Tauber & Balser’s Audit & Accounting Services practice. Representative assignments on
which Mr. Zimmerman has worked include:
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Court Appointed Estate Representative for the liquidation of Wolf Camera, Inc.
Workout and Lender Negotiations
Corporate Turnaround/Restructuring
Accounting Irregularities
Accounting for Vendor Rebates and Allowances
Financial and Treasury Management Operations
Structured Finance Considerations
Negotiated and integrated more than 25 business acquisitions
Responsible for the oversight and review of financial reporting requirements to the
Securities and Exchange Commission for numerous publicly held clients, including a
number of IPO’s
Financial due diligence for numerous business acquisitions
Taught various seminars focusing on accounting and internal control topics relating
to retail companies
Sheldon D. Zimmerman
Certified Public Accountant
Page 2
PROFESSIONAL
EXPERIENCE
Tauber & Balser, P.C., Atlanta, Georgia
2002 – Present
Shareholder – Accounting & Auditing Services Team
Wolf Camera, Inc.
1990 – 2001
Executive Vice President & Chief Financial Officer, Member of Board of Directors
Deloitte & Touche
1987 - 1990
Audit Partner at Deloitte Haskins & Sells prior to merger with Touche Ross
Member of National Retail Group
The Banker’s Note
1986
Chief Financial Officer
Touche Ross & Co.
1972 - 1986
Audit Partner
Member of National Retail Group
EXPERT
TESTIMONY
EXPERIENCE
(prior4yearsonly)
Williams Die & Mold, Inc.
United States Bankruptcy Court Northern District of Georgia
Trial testimony – June 2004
Michael Vogt, Paul Beaumont and Fred Breu on their own behalf and as representative
Plaintiffs on behalf of all similarly situated employees of Outboard Marine Corporation v.
Greenmarine Holdings, LLC; Quantum Industrial Partners, LDC; and Quantum Industrial
Holdings, Ltd.
United States District Court Southern District of New York
Deposition testimony – March 2005
Herbert C. Broadfoot II, in his capacity as Chapter 7 Trustee for NWS Holdings, LLC, et.
al. v. Howard and David Belford, et. al.
United States Bankruptcy Court Northern District of Georgia
Deposition testimony – August 2005
Sheldon D. Zimmerman
Certified Public Accountant
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PUBLICATIONS
“All in the Details” - March 2004, SmartBusiness Atlanta Magazine
Article related to financial due diligence in connection with acquisitions
“Cash is King” – March 2005, SmartBusiness Atlanta Magazine
Article on how cash flow forecasts can benefit business owners
PROFESSIONAL
AFFILIATIONS
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The American Institute of Certified Public Accountants
The Georgia Society of Certified Public Accountants
Association of Insolvency & Restructuring Advisors, Associate Member
Turnaround Management Association