Malone v. Microdyne Corp.

• Decision Date: 08 June 1994
• Docket Number: No. 93-1781,93-1781
• Citation: 26 F.3d 471
• Parties: Fed. Sec. L. Rep. P 98,237, 40 Fed. R. Evid. Serv. 18 Michael F. MALONE; Seth Rosenberg, Plaintiffs-Appellants, v. MICRODYNE CORPORATION; Philip Cunningham; Christopher M. Maginniss, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 471

26 F.3d 471

Fed. Sec. L. Rep. P 98,237, 40 Fed. R. Evid. Serv. 18

Michael F. MALONE; Seth Rosenberg, Plaintiffs-Appellants, v. MICRODYNE CORPORATION; Philip Cunningham; Christopher M Maginniss, Defendants-Appellees.

No. 93-1781.

United States Court of Appeals Fourth Circuit.

Argued Feb. 8, 1994.

Decided June 8, 1994.

ARGUED: I. Stephen Rabin, Rabin & Garland, New York City, for appellants. David Allen Donohoe, Akin, Gump, Strauss, Hauer & Feld, L.L.P., Washington, DC, for appellees. ON BRIEF: Joseph P. Garland, Brian Murray, Rabin & Garland, New York City; Paul Kaplan, Michael L. Shor, David & Hagner, P.C., Washington, DC; Jeffrey Squire, Kaufman, Malchman, Kirby & Squire, New York City, for appellants. Clinton R. Batterton, C. Fairley Spillman, Judith E. Beach, Akin, Gump, Strauss, Hauer & Feld, L.L.P., Washington, DC, for appellees.

Before MURNAGHAN, Circuit Judge, BUTZNER, Senior Circuit Judge, and YOUNG, Senior United States District Judge for the District of Maryland, sitting by designation.

Reversed and remanded by published opinion. Judge MURNAGHAN wrote the opinion, in which Senior Judge BUTZNER and Senior Judge JOSEPH H. YOUNG joined.

OPINION

MURNAGHAN, Circuit Judge:

At the trial of this securities-fraud class action brought by purchasers of the common stock of Microdyne Corporation, the district court heard the plaintiffs' evidence and then granted judgment as a matter of law for the defendants, Microdyne Corporation and two of its officers. The plaintiffs have appealed, arguing that the case should have gone to the jury.

I. THE FACTS ¹

A. Microdyne Corporation

Defendant Microdyne Corporation is a computer hardware and software company headquartered in Alexandria, Virginia. The other two defendants are Philip T. Cunningham, the Chairman and President of Microdyne and the owner of about seventy percent of its total common stock, and Christopher M. Maginniss, the corporation's Chief Financial Officer.

In late 1991 Microdyne entered into an agreement with a major computer networking company for the joint development of a number of new networking products. The first two of those products were the NetWare Access Server by Microdyne ("NAS") and the NetWare Asynchronous Communications Server by Microdyne ("NACS"). Beginning in March 1992, Microdyne would sell NAS (and later NACS) units to distributors who, in turn, would attempt to sell them to dealers and end users (customers). Central to the instant appeal are seven statements that Microdyne made in 1992. The plaintiffs-appellants have alleged that the statements were materially false or misleading and caused the market price of Microdyne common stock to be artificially inflated for nearly eight months in 1992, during which time the appellants and all members of the class they represent purchased such stock.

B. The Seven Allegedly False or Misleading Statements

The appellants have claimed that the first of the seven statements was essentially forward-looking but lacked any reasonable basis and thus was false and misleading. The other six statements, they have claimed, were false or misleading because they omitted critical facts and violated generally accepted accounting principles. Specifically, Microdyne (1) booked and reported NAS transactions as final sales even though the distributors to whom NAS products were shipped had the right to return the products if they could not sell them; and (2) failed to disclose the actual return of more than forty percent of the NAS products reportedly "sold" to distributors. We briefly summarize each of the seven challenged statements.

1. The "Comfort" Statement--February 12. On February 12, 1992, ² Cunningham said in response to an inquiry from a Dow Jones reporter that he was "comfortable with the earnings estimates for fiscal 1992 and 1993 prepared by Hancock Institutional Equity Services analyst William B. Becklean." The day before, Becklean had publicly predicted that Microdyne would earn 80 cents per share in fiscal year 1992 and $1.05 the following year, an increase from the 76 cents per share that the company had earned in fiscal year 1991. Cunningham also was quoted in the Dow Jones report as saying, "The data communications market is booming and it's exciting."

2. The Second-Quarter Press Release--April 23. In a press release dated April 23, Microdyne reported its second-quarter financial performance, including $21,515,000 in total company revenues. Although the press release did not separately report revenues from NAS, that product accounted for about $2.9 million, or 13%, of the total reported revenues. The release made no mention of the fact that Microdyne had granted some distributors the right to return NAS units that they could not sell, with no obligation to purchase an equal amount of other Microdyne products. ³

3. The Second-Quarter Form 10-Q--May 15. Microdyne's Form 10-Q for the second quarter, filed with the Securities and Exchange Commission (SEC) on May 15, stated that "$2.9 million [in revenues] was associated with sales of the Company's new NetWare Access Server (NAS)." The Form 10-Q made no mention of the distributors' rights of return.

4. The "Earnings Preview" Press Release--June 15. On June 15 Microdyne issued a press release entitled "MICRODYNE SEES REVENUE, EARNINGS SHORTFALL IN THIRD QUARTER." The opening paragraph explained that the company's third-quarter revenues and earnings "would fall short of analyst expectations" and that "slower than expected initial sales of two major new products [NAS and NACS] would cause the shortfall." The release continued:

Philip T. Cunningham, Chairman and President of Microdyne, said a preliminary forecast indicated that the shortfall would result in quarterly earnings of from 8 cents to 12 cents for the third quarter versus analyst estimates [i.e., Becklean's February estimate] of 26 cents. Previously, Mr Cunningham had said he was "comfortable" with Street estimates.

The new products ... were expected to generate $7 million of Microdyne's anticipated $27 ⁺ million of revenues for the quarter. Instead, [NAS] and [NACS] are expected to have sales of less than $2 million.

"We misjudged the length of the product's selling cycle," Mr. Cunningham said. "We expected to close sales in 30 to 60 days. Instead, the product is taking 90 days or longer to sell in quantity."

"Our estimate of the product's eventual success has not changed," he said. "We have commitments to buy the product from major customers, and early users give it enthusiastic reviews. Customers with the potential to buy hundreds of these systems have evaluation units installed. On the whole, our sense is that we have deferred sales from the third quarter into subsequent quarters. Over the longer term, we believe we have a product that can generate as much as $30 million in annual revenue."

The press release made no mention of the fact that distributors had told Microdyne that they were planning to return substantial quantities of NAS that had been shipped in March and for which revenue had been booked in the second quarter.

5. The Third-Quarter Press Release--July 21. In a July 21 press release, Microdyne announced its third quarter results. The press release stated that net income was down 47% from the third quarter of the prior fiscal year and net income per share had fallen 58%. Microdyne attributed the earnings decline to "lower than expected sales of new products, coupled with higher marketing, sales, and related expense." Cunningham's June 15 statement was largely repeated: " 'As we reported in our mid-June earnings preview, we misjudged the length of the selling cycle of our NetWare Access Server by Microdyne. Volume sales that we expected to begin closing immediately instead will take 90 days or longer to sell in quantity.' " The release cited Cunningham's statement that

the company's management had examined the causes of the new products sales shortfall, and had not changed their opinion of the eventual acceptance of the lines. "It is a question of timing," he said. "Users are giving enthusiastic reviews to our NetWare Access Server by Microdyne and its companion product, the NetWare Asynchronous Communications Server by Microdyne. Customers with the potential to buy hundreds of these systems have evaluation units installed and sales in the first three weeks of this quarter have accelerated markedly. Therefore, over the longer term we believe we have a product that will generate as much as $30 million in annual revenue."

Once again, the release did not mention distributors' returns of NAS, which Microdyne's internal figures then estimated at more than one million dollars.

6. The Third-Quarter Form 10-Q--August 12. Microdyne's Form 10-Q for the third quarter, filed with the SEC on August 12, reiterated that "lower than expected sales of new products, coupled with higher levels of marketing, sales, and related expense, were responsible for an earnings decline. Specifically, initial sales of NetWare Access Server (NAS) and NetWare Asynchronous Communications Server (NACS) were slower than expected." Nevertheless, the quarterly report stated, "NAS and NACS are well placed to succeed. The market reaction to these products has been very positive. Although there is no certainty that this expectation will be met, management remains optimistic of the market acceptance of NAS and NACS." The report did not explain that only three percent of the company's total third-quarter revenues ($583,000 out of $18 million) represented NAS and NACS sales. It also made no mention of the $1.2 million in NAS returns that Microdyne booked in July.

7. The Third-Quarter Shareholders' Report--August 14. Microdyne's August 14 report to shareholders for the third quarter largely mimicked its July 21 press release, sometimes verbatim. Cunningham wrote in the August 14 report that "[c]ustomers with the potential to buy hundreds of these systems [NAS and NACS] have evaluation...