The opinion of the court was delivered by: Claudia Wilken, United States District Judge.
ORDER GRANTING DEFENDANT'S MOTION TO DISMISS
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)
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
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
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
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