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Wayne C. Conlee v. Wms Industries

July 25, 2012

WAYNE C. CONLEE, PLAINTIFF,
v.
WMS INDUSTRIES, INC., BRIAN R. GAMACHE, SCOTT D. SCHWEINFURTH, AND ORRIN J. EDIDIN, DEFENDANTS.



The opinion of the court was delivered by: Judge James B. Zagel

MEMORANDUM OPINION AND ORDER

Kenneth Zeitlin ("Zeitlin" or "Lead Plaintiff") is the lead plaintiff in a securities fraud class action brought against Defendants WMS Industries, Inc. ("WMS"), WMS Chief Executive Officer and Chairman Brian R. Gamache, WMS Chief Financial Officer Scott D. Schweinfurth, and President Orrin J. Edidin. The amended complaint has two substantive counts. Count I alleges violations of § 10b of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Count II alleges control person liability for the individual Defendants under § 20(a) of the Securities Exchange Act.

I determine that the pleading is an impermissible "puzzle pleading" and therefore grant Defendants' motion to dismiss. Because the dismissal is due to the form of the pleading, rather than its substance, the dismissal is without prejudice to Lead Plaintiff filing an additional amended complaint.

GENERAL BACKGROUND

The facts, as alleged by Lead Plaintiff, are as follows.

WMS manufactures and distributes video and gaming machines, such as electronic slot machines, to casinos worldwide. WMS earns revenue through sales and leases of those machines. According to the Amended Complaint, at the start of the Class Period, the gaming industry was still in the midst of a slow replacement cycle. The replacement cycle is the process by which casinos swap out old gaming machines for new ones to refresh and modernize the gaming floors. The clear implication is that a faster replacement cycle essentially equates to greater demand for WMS's products, all other factors being equal.

Despite the comparatively slow replacement cycle, Defendants issued guidance showing robust growth in earnings and margins in FY11 over FY10. The forecasts, respectively, were $830-$850 million in revenues compared to $765 million and operating margins of 22.5-23% compared to 21.9%). Analysts were skeptical because the market was not expecting improvement in the replacement cycle in FY11. Despite this skepticism, Defendants assured investors that WMS would improve its financial performance over FY10 despite the slow replacement cycle. Defendants did so on the basis that they had two principal "levers" available to them to drive revenues and margins in FY11 above FY10.

The first lever Defendants touted was the launch of new products in FY11. One such product was "WAGENET," a purported "golden goose" that would be available for "full commercial launch" in second quarter of FY11 ("2Q11"). Defendants also touted the imminent launch of other theme-based gaming machines such as "The Price is Right" and "Attack from Mars." Defendants claimed to have "accelerated" the new product launches, with Defendant Gamache highlighting the quantity and scale of FY11 new product launches. Gamache allegedly told investors during a January 25, 2011 conference call that WMS "never had a back half of the year loaded with this kind of product launch, ever in the history of our company." Defendants further assured investors that WMS was "on track" to meet their lofty guidance due in part to the fact that they would be "having literally a theme every month in the back half of the year come out."

Defendants claimed that the FY11 new products were "higher-margin" products, defendants' margin guidance showed considerable improvement, for example, margins of approximately 29% in 4Q11, much higher than FY10 (21.9%) and the first half of FY11 (17%), as a result of the favorable mix of the FY11 new, high margin products on total sales.

Defendants' statements are alleged to be false and misleading because WMS was experiencing development and process failures that were delaying regulatory submissions and commercialization of its FY11 new products. The new products that Defendants claimed would be launched in FY11 were more technologically complex to develop and, since the technology linked across products, these complexities caused development delays across multiple products. For example, the "Price is Right" game allegedly suffered from a programming error which miscalculated its incremental rate and required multiple fixes. Additionally, the "Attack from Mars" game failed in field trials (an important step in regulatory approval) because players were not winning. The touted "golden goose," WAGE-NET, had its initial regulatory approval delayed from October 2010 to April 2011, and even then only very limited approval was obtained.

The end result of the delays was that Defendants did not reach the final stage of regulatory approval, field trials, in critical jurisdictions like Nevada until 4Q11. This allegedly derailed the full commercial launch of new products. Rather than launching the most products "ever in the history of the company," defendants launched fewer new products in FY11 than in FY10, and only one of their usual four annual "tent pole" new products.

The amended complaint alleges that Defendants knew or recklessly disregarded facts that the FY11 new products were not on track to launch in sufficient time and quantity to drive FY11 revenues and margins in the manner they had forecast. Lead Plaintiff claims that Defendants closely monitored new products throughout the research and development process ("R&D") process, up to and including commercial launch.

These purported product and process failures left WMS with little to sell other than apparently low margin used gaming machines. Therefore, rather than increase, forecasted 29% guidance, margins came in at a "disappointing" 4.7% in 4Q11. Additionally, though WMS had slightly higher total sales in FY11, sales fell far short of the $830-$850 million FY11 guidance. Moreover, the higher sales came with lower profitability as margins dropped to 14.1% from 21.9%.

The second "lever" used to justify improved performance was an operational improvement to fix a phenomenon called "quarter-end compression." WMS routinely discounted product at the end of quarters to boost sales, which led to a bulk of orders coming in at the ends of quarters. This both increased costs of production, for example extra overtime and shipping costs, and created difficulties sourcing product to fill orders on time. Defendants touted their "vigilance" and "intense focus" implementing these operational improvements to combat the inefficiencies of quarter-end compression. The goal of the process improvements was to achieve better monitoring of new product introductions and be able to replenish inventory "within two hours." However, allegedly unbeknownst to investors, Defendants had not undertaken the touted operational improvements. This was allegedly revealed when the Company disclosed that it failed to fill orders on time in 3Q11 because they could not timely ...


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