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August 14, 2002


The opinion of the court was delivered by: Claudia Wilken, United States District Judge.


Defendants U.S. Aggregates, Inc. (U.S. Aggregates or Company), its former Chief Executive Officer James Harris and its former Chief Financial Officer Michael Stone move to dismiss lead Plaintiff Eugene L. Loper's complaint alleging securities fraud in violation of sections 10(b) and 20(a) of the Securities and Exchange Act of 1934. Plaintiff opposes the motion. The matter was heard on August 9, 2002. Having considered all of the papers filed by the parties, and oral argument on the motion, the Court grants Defendants' motion to dismiss, and grants leave to amend (Docket # 49)


The following facts are taken from Plaintiff's Consolidated Class Action Complaint filed on October 12, 2001 and assumed to be true for purposes of this motion. In re Silicon Graphics Sec. Litig., 183 F.3d 970, 983 (9th Cir. 1999).

U.S. Aggregates is a producer of aggregates, i.e. crushed stone, sand and gravel. The Company's products are used primarily for the construction and maintenance of highways and other infrastructure projects and for residential construction. U.S. Aggregates operates through two wholly owned subsidiaries, SRM Holdings Corp. (SRMH) and Western Aggregates Holding Corp. (WAHC). WAHC, in turn, holds two additional subsidiaries, Monroc and Valley Asphalt.

Between 1994 and 1998, U.S. Aggregates completed twenty-eight business and asset acquisitions. The Company pursued this growth by acquisition strategy in order to place itself in a position to benefit from the Transportation Equity Act for the 21st Century (TEA-21), a federal program that promised a significant infusion of federal funding into highway construction and maintenance projects. U.S. Aggregates' acquisition strategy resulted in a rapid increase in its total assets, from $54 million at the end of 1994 to $374 million in June, 1999. It also resulted in a commensurate increase in debt, from $22.3 million to $225 million over the same time period. The Company's debt was financed, principally, by a credit agreement with Bank of America (BofA Credit Agreement) and a separate Warrant Purchase Agreement with Prudential Insurance Company of America (Prudential Agreement) collectively referred to throughout this Order as the Loan Agreements. The Loan Agreements included covenants that required U.S. Aggregates to maintain certain financial ratios. Plaintiff alleges that noncompliance with the financial ratio covenants constituted an event of default and could result in the loans becoming immediately due and payable. In August, 1999, U.S. Aggregates completed an IPO which raised approximately $68 million. This infusion of capital was used to pay down the Company's debt from $225 million to $157 million. By January, 2000, however, the Company's debt had once again increased to more than $200 million. Plaintiff alleges that in order to avoid violating the financial covenants in the Loan Agreements, U.S. Aggregates engaged in various forms of accounting fraud that falsely overstated its earnings for the first three quarters of calendar year 2000.*fn1

The details of Plaintiff's allegations of fraud are provided by ten confidential witnesses (CW). Six of these confidential witnesses are former employees of Monroc. They include individuals who formerly held the positions of Chief Operating Officer (CW 1), controller (CW 10), assistant controller (CW 5), credit manager (CW 7), assistant credit manager (CW 8), and Vice President of Sales (CW 9) for Monroc. Three of the confidential witnesses are former employees of Valley Asphalt. These witnesses formerly held the positions of controller (CW 2) and assistant controller (CW 3 and CW 4) for Valley Asphalt. The final confidential witness is the former Director of Finance for Western Aggregates (CW 6).

In the complaint, the confidential witnesses describe five areas where U.S. Aggregates' subsidiaries provided false information in their monthly financial reports in order to inflate earnings and maintain compliance with the debt/earnings ratios in the Loan Agreement covenants. First, CW 1, CW 5, CW 7 and CW 8 contend that Monroc regularly overbilled customers by sending invoices to customers for amounts greater than the agreed upon price and recorded the overbilled amount as revenue even though Monroc did not believe these billed amounts to be collectible. Second, CW 5, CW 7, and CW 8 state that up to $1 million in uncollectible accounts receivable remained on the books during the class period because the CFO of WAHC, Bart Smith, refused to write them off.

Third, in August or September, 2000, Monroc received $189,000 from a railroad as payment for a right-of-way. CW 1, CW 5, and CW 7 state that this payment was improperly recorded as payment on an unrelated customer's account receivable. The CWs allege that CFO Smith ordered the improper accounting. CW 7 states that he sent a letter to Defendant Stone informing him of this improper accounting, but received no reply.

Fourth, CW 2 alleges that U.S. Aggregates reported an inflated percentage of completion revenues by falsely reporting that particular construction projects were closer to completion than they actually were.

Fifth, CW 1, CW 4, and CW 5 contend that Monroc improperly capitalized labor costs and routine maintenance to quarry development in order to reduce expenses and increase margins, earnings and capital.*fn2

The improper capitalization of costs and the improper recognition of revenues detailed by the confidential witnesses violated various Generally Accepted Accounting Principles (GAAP). CW 7, CW 4, and CW 5 all state that the reason the subsidiaries improperly recognized revenue and improperly capitalized costs was so that the Company could maintain compliance with the loan covenants.

For example, one of the loan covenants required the Company to maintain a specific "leverage ratio." The leverage ratio is the amount of debt divided by earnings before extraordinary items, minority interests, taxes interest, depreciation, depletion, and amortization expenses (EBITA). For the first two quarters of 2000, the leverage ratio required by the Loan Agreements was four to one. U.S. Aggregates reported a leverage ratio of 3.8 to one for those two quarters. Plaintiffs allege that if U.S. Aggregates' revenues and expenses had been reported accurately, the leverage ratio would have exceeded that required by the loan covenants for both quarters. On the day before the end of the third quarter of 2000, Defendant Stone negotiated a loosening of the leverage ratio to 4.25 to one. U.S. Aggregates reported a leverage ratio of 4.2 to one for that quarter. Plaintiffs allege that the actual ratio was 5.8 to one and the improper accounting measures detailed by the CWs permitted Defendants to report inaccurate numbers which hid the fact that the Company was not in compliance with the Loan Agreements.

In its press releases, SEC Form 10-Qs and in conversations with analysts that were subsequently relayed to the market, Defendants did not reveal any of these alleged financial improprieties. On April 24, 2000, U.S. Aggregates issued a press release summarizing its first quarter results. On April 25, Defendants participated in a conference call with capital market analysts wherein they discussed U.S. Aggregates' first quarter results. On May 9, 2000, U.S. Aggregates filed a Form 10-Q for the quarter ending March 31, 2000.

The press release and Form 10-Q stated that U.S. Aggregates net loss for that quarter was $2.6 million. The Form 10-Q also stated that the financial statements contained therein were prepared in accordance with GAAP. Plaintiff contends that these statements were false and misleading because the Company's actual net loss for the first quarter of 2000 was $5.1 million and the financial statements were not prepared in accordance with GAAP. Similarly, Plaintiff contends that the information provided to analysts was false and misleading because Defendants gave false earnings results and did not disclose the accounting improprieties detailed above.

Defendants made similar disclosures describing the Company's second and third quarter results. Plaintiff allege that these press releases and Form 10-Q disclosures were also false and misleading for the reasons already discussed. Namely, Defendants overstated earnings, understated costs, and violated GAAP in their financial statements.

On February 26, 2001, Defendant Stone was terminated as CFO after the Company's auditors raised concerns about the financial and accounting procedures for the Company's western operations. Stone's termination was not publicly disclosed until April 18, 2001.

On April 3, 2001, U.S. Aggregates restated its earnings for the first three quarters of 2000. Previously reported net income of $9.7 million was restated as a $300,000 net loss. Earnings per share (EPS) for all three quarters was also restated. Simultaneously, the Company announced that it was in default of the Loan Agreements, that its senior secured lenders had waived all defaults under the credit facility through April 13, 2001, and that the Company was discussing with its lenders and subordinated debt holder a longer term solution.

On April 18, 2001, the Company announced the results of those negotiations. The lenders agreed to waive defaults in exchange for increases in interest rates and fees. U.S. Aggregates' lenders also required the Company to hire a Chief Restructuring Officer by May 31, 2001. On May 11, 2001, Defendant Harris was replaced by Stanford Springel, an individual with experience in crisis management and financial turnarounds.

After the restatement of earnings, U.S. Aggregates entered into a loan agreement with its largest shareholder and also attempted to sell its assets in Northern Utah.

In short, Plaintiff alleges that the restatement of the Company's earnings and the consequent default on the Loan Agreements required U.S. Aggregates to 1) restructure its existing debt; 2) take on new debt; 3) change its management team; and 4) sell a large portion of its assets. Despite these actions, U.S. Aggregates' financial results have continued to decline since the end of the class period.*fn3 U.S. Aggregates filed for bankruptcy protection on March 11, 2002.*fn4


A. Rule ...

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