Read Scott Schultz, et al. v. Applica Incorporated, et al. 06-CV-60149-Consolidated Class Action Complaint For Violations Of Federal Securities Laws text version

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UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF FLORIDA

SCOTT SCHULTZ and JOSEPH ROTHMAN, ) ) Individually and On Behalf of All Others ) Similarly Situated, ) Plaintiffs, ) ) vs. ) ) APPLICA INCORPORATED, HARRY D. ) SCHULMAN and TERRY L. POLISTINA, ) ) Defendants. )

CASE NO.: 06-60149-CIV-DIMITROULEAS Magistrate Judge Torres

JURY TRIAL DEMANDED

CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS Plaintiffs Scott Schultz and Joseph Rothman (hereinafter "Plaintiffs") have alleged the following based upon the investigation of Plaintiffs' counsel, which included a review of United States Securities and Exchange Commission ("SEC") filings by Applica Incorporated ("Applica" or the "Company"), as well as regulatory filings and reports, securities analysts' reports and advisories about the Company, press releases and other public statements issued by the Company, media reports about the Company and interviews with former employees of the Company, and Plaintiffs believe that substantial additional evidentiary support will exist for the allegations set forth herein after a reasonable opportunity for discovery.

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NATURE OF THE ACTION 1. This is a securities class action on behalf of purchasers of the common stock of

Applica between November 4, 2004 and April 28, 2005, inclusive (the "Class Period"), seeking to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange Act"). JURISDICTION AND VENUE 2. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) of the

Exchange Act [15 U.S.C. §§78j(b) and 78t(a)] and Rule 10b-5 promulgated thereunder by the SEC [17 C.F.R. §240.10b-5]. 3. This Court has jurisdiction over the subject matter of this action pursuant to 28

U.S.C. §1331 and Section 27 of the Exchange Act [15 U.S.C. §78aa]. 4. Venue is proper in this District pursuant to Section 21 of the Exchange Act, and 28

U.S.C. §1391(b), as and many of the acts and practices complained of herein occurred in substantial part in this District. 5. In connection with the acts alleged in this complaint, defendants, directly or

indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to, the mails, interstate telephone communications and the facilities of the national securities markets. PARTIES 6. Plaintiff Scott Schultz, as set forth in his certification, previously filed in this

litigation and incorporated by reference herein, purchased the common stock of Applica during the Class Period and has been damaged thereby.

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7.

Plaintiff Joseph Rothman, as set forth in his certification, previously filed in this

litigation and incorporated by reference herein, purchased the common stock of Applica during the Class Period and has been damaged thereby. 8. Defendant Applica engages in the manufacture, marketing, and distribution of small

household appliances. The Company markets and distributes kitchen products, home products, pest control products, pet care products, and personal care products. Applica is incorporated in Florida and maintains its principal place of business at 3633 Flamingo Road, Miramar, FL 33027. 9. (a) Defendant Harry D. Schulman ("Schulman"), at all times relevant, served as

the Company's President and Chief Executive Officer ("CEO"). (a) Defendant Terry L. Polistina ("Polistina"), at all times relevant, served as the

Company's Senior Vice President and Chief Financial Officer ("CFO"). (b) Defendant Michael Michienzi ("Michienzi"), at all times relevant, served as

President of the Household Products Division. (c) Defendants Schulman, Polistina and Michienzi are collectively referred to

herein as the "Individual Defendants." 10. Each of the defendants is liable as a participant in a fraudulent scheme and course of

business that operated as a fraud or deceit on purchasers of Applica common stock by disseminating materially false and misleading statements and/or concealing material adverse facts. The scheme: (i) deceived the investing public regarding Applica's business, operations, management and the intrinsic value of Applica common stock; (ii) enabled the Company to receive advances under its credit facilities by materially overstating its inventory which had become obsolete; and (iii) caused

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Plaintiffs and other members of the Class to purchase Applica common stock at artificially inflated prices. PLAINTIFFS' CLASS ACTION ALLEGATIONS 11. Plaintiffs bring this action as a class action pursuant to Federal Rule of Civil

Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or otherwise acquired the common stock of Applica during the Class Period and who were damaged thereby. Excluded from the Class are defendants, the officers and directors of the Company, at all relevant times, members of their immediate families and their legal representatives, heirs, successors or assigns and any entity in which defendants have or had a controlling interest. 12. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, Applica common shares were actively traded on the NYSE. While the exact number of Class members is unknown to Plaintiffs at this time and can only be ascertained through appropriate discovery, Plaintiffs believe that there are hundreds or thousands of members in the proposed Class. Record owners and other members of the Class may be identified from records maintained by Applica or its transfer agent and may be notified of the pendency of this action by mail, using the form of notice similar to that customarily used in securities class actions. 13. Plaintiffs' claims are typical of the claims of the members of the Class as all members

of the Class are similarly affected by defendants' wrongful conduct in violation of federal law that is complained of herein. 14. Plaintiffs will fairly and adequately protect the interests of the members of the Class

and has retained counsel competent and experienced in class and securities litigation.

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15.

Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are: (a) alleged herein; (b) whether statements made by Defendants to the investing public during the whether the federal securities laws were violated by Defendants' acts as

Class Period misrepresented material facts about the business, operations and products of Applica; (c) (d) whether Defendants acted with scienter in making those false statements; and to what extent the members of the Class have sustained damages and the

proper measure of damages. 16. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it impossible for members of the Class to individually redress the wrongs done to them. There will be no difficulty in the management of this action as a class action. CONFIDENTIAL SOURCES 17. The allegations made herein are made on information and belief and are supported by

the first-hand knowledge of five (5) confidential informants (CI). These informants are former Applica employees, each of whom was employed during the Class Period and provided facts from various departments of the Company. As detailed below, the CIs each served in positions at Applica which provided them with access to the information they are alleged to possess.

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18.

CI 1 worked at Applica from June 2002 to July 2005 as its Senior Quality Systems

Engineer. CI 1's duties involved gathering data regarding the quality of Applica's various products such as return rates and defects, analyzing and reporting quality related data with a goal towards identifying corrective actions. 19. CI 2 worked at Applica from 2002 to early June 2005 as its Engineering Program

Manager and Senior Reliability Test Engineer. 20. Engineering. 21. CI 4 worked at Applica from December 2003 to April 2005 as Business Development CI 3 worked at Applica from April 2002 to October 2005 as Vice President of

Manager For Beverage and Kitchen Product Categories. CI 4 was responsible for developing products for Applica's various sales channels. 22. CI 5 worked at Applica from 1998 to June 2005 as its Pricing Program Manager. CI 5

was personally responsible for issuing return authorizations to national retail accounts when the reasons for the return were not quality related. SUBSTANTIVE ALLEGATIONS 23. Defendant Applica describes itself as a "marketer[ ] and distributor[ ] of a broad

range of branded small household appliances. Applica markets and distributes kitchen products, home products, pest control products, pet care products and personal care products. " 24. In 2004, Applica launched two products that it was co-marketing with Proctor &

Gamble ("P&G") ­ the TideTM BuzzTM Ultrasonic Stain Remover and Home CaféTM single cup coffee maker. The products were launched in May 2004 and figured prominently in the Company's prospects. For example, on May 6, 2004, Applica issued a press release announcing its financial

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results for the first quarter of 2004, the period ending March 31, 2004. In the press release, Defendant Schulman highlighted the introduction of the TideTM BuzzTM Ultrasonic Stain Remover and Home CaféTM stating in pertinent part as follows: Business is off to an excellent start as we are excited about our top line growth in the quarter. We are confident that our business plan will gain momentum throughout the year. Two new products launched this week, the Home Café single-cup brewing system and the Tide Buzz ultrasonic stain removal system, both co-developed with The Proctor & Gamble Company, should contribute to exceptional growth. [Emphasis added.] In a conference call following the earnings release, Defendants projected that Buzz and Home Café would make a material contribution to the Company's fiscal year 2004 earnings. 25. By the start of the Class Period, however, the TideTM BuzzTM Ultrasonic Stain

Remover and Home CaféTM were not performing according to the Company's internal projections and were beset by a host of problems. During the Class Period, Defendants did not disclose the full extent of the problems with the products and made numerous materially false and misleading statements which misrepresented material facts about the products and the "sales" of the products. 26. The TideTM BuzzTM Ultrasonic Stain Remover: By the start of the Class Period,

Defendants knew or recklessly disregarded that the TideTM BuzzTM Ultrasonic Stain Remover was not selling according to internal expectations and was causing the Company to incur additional expenses. According to CI 1, Applica's Senior Quality Systems Engineer, Applica's internal projections provided that the Company would sell 900,000 to 1 million units in 2004. Furthermore, according to CI 1, by the end of October 2004, Applica had only sold approximately one-third of those units. Moreover, according to CI 1, in November 2004, Applica started selling the TideTM BuzzTM Ultrasonic Stain Remover at "fire sale" prices which approximated a "liquidation" of the

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product. CI 1 knew of the actual sales of the TideTM BuzzTM Ultrasonic Stain Remover because CI 1 used the sales data to prepare projected cost of quality reports. 27. The TideTM BuzzTM Ultrasonic Stain Remover did not sell well for several reasons.

First, according to CI 1, the TideTM BuzzTM Ultrasonic Stain Remover was vastly overpriced at approximately $69.00 and was in direct competition with a P&G product the Tide StainBrush which sold for $5.99 and was more effective than the TideTM BuzzTM Ultrasonic Stain Remover. During meetings attended by CI 3, Applica's Vice President of Engineering, in April/May 2004, it was discussed that the TideTM BuzzTM Ultrasonic Stain Remover was very expensive. 28. Second, the TideTM BuzzTM Ultrasonic Stain Remover suffered from quality issues According to CI 1, the TideTM BuzzTM Ultrasonic Stain Remover

which hampered sales.

encountered numerous defect issues as the initial run of product had 30% defect rate. According to CI 2, Applica's Engineering Program Manager and Senior Reliability Test Engineer, the TideTM BuzzTM Ultrasonic Stain Remover was manufactured in Mexico and there were significant variances in the performance and quality of the product and especially significant when it came to the frequency of the ultrasonic vibrations "for very ten units that worked, there were 10 that did not." 29. The unrealized sales of the TideTM BuzzTM Ultrasonic Stain Remover placed further

strains on the Company as, during the Class Period, it was forced to incur increased warehouse costs in order to store unsold units. According to CI 3, in anticipation of the launch of the product, Applica had manufactured approximately 1 million units and, during the Class Period, as product sales failed to materialize Applica was experiencing increased warehouse fees to store the unsold units of the TideTM BuzzTM Ultrasonic Stain Remover.

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30.

As detailed further herein, by the start of the Class Period, Applica was slashing the

price of the TideTM BuzzTM Ultrasonic Stain Remover. but failed to disclose that it was cutting the price close to its manufacturing costs. Indeed, according to CI 3, it cost Applica $39 to manufacture each unit. 31. The Home CaféTM: By the start of the Class Period, Defendants knew or recklessly

disregarded that the The Home CaféTM was plagued with unresolved quality and design defect issues and that the vast majority of the "sales" made by the Company prior to and during the Class Period would soon be returned to the Company. 32. Unbeknownst to investors, the Home CaféTM was launched by Applica with known

quality and design problems which rendered the units unsafe and ineffective. As detailed herein, the Home CaféTM was poorly designed and manufactured. The unit was supposed to brew a single cup of coffee through a "pod" of coffee that was placed inside the machine's pod-holder. The Home CaféTM, however, was manufactured out of a plastic that was unable to withstand the heat generated by brewing coffee and, accordingly, would start to smoke and leak during use. Moreover, the podholder was easily opened during brewing which presented serious safety issues. 33. According to CI 1, Applica's Senior Quality Systems Engineer, The Home CaféTM

was plagued with safety problems as the pod holder to insert the coffee pods could easily open during brewing which caused safety issue. Furthermore, according to CI 1, the heat and brew cycle were controlled by "firmware" software for controlling the temperature but the "firmware" was never finalized before sale and the plastic used to make the pod-holders was "apparently never tested with high-temperature coffee" and it was belatedly determined that it would crack and break when exposed to the heat of brewing coffee.

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34.

According to CI 1, Applica produced and sold its first units to Wal-Mart and Target

in May 2004. By July/August 2004, according to CI 1, CI 1 had received "serious data" regarding quality problems, which led to a large number of returns. 35. According to CI 2, Applica's Engineering Program Manager and Senior Reliability

Test Engineer, the The Home CaféTM was so flawed that it was literally "blowing up and catching fire". 36. According to CI 4, Applica's Business Development Manager For Beverage and

Kitchen Product Categories, The Home CaféTM had significant defect issues as the product had a rubber housing which could not withstand heat and caused the product to generate smoke and hot water would seep from the unit and users risked getting burned. Furthermore, according to CI 4, many consumers that purchased the product called their local fire department because of the smoke that arose from the heat that the systems generated. The problems with the unit were discussed regularly at meetings with the Engineering, Business Development and Marketing Personnel, according to CI 4. 37. According to CI 4, Applica had generated strong customer demand for the product

because Applica's sales people had told customers of that P&G would be extensively advertising for the coffee pods. According to CI 4, the demand exceeded the Company's ability to produce the product so a "timeline" was created that set forth when particular customers would receive the product. 38. The Home CaféTM's quality and design defects were known by Defendants, or

recklessly disregarded by them, prior to the launch of the product. According to CI 2, The Home CaféTM's quality and design defects were known prior to the launch of the product as the product had

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such poor testing results that Applica's technical chief, Les Campbell, went to Defendant Schulman to ask for the product launch to be postponed. According to CI 2, Defendant Schulman rejected the request and the product was launched and sold. According to CI 1, Applica's Senior Quality Systems Engineer, the The Home CaféTM's concept and quality problems were known prior to the Company's sales to Wal-Mart and Target because the in first quarter of 2004, Applica delivered some of the initial units to P&G for use in test marketing in the Boise Idaho area and the units landed leaking all over the place. 39. According to CI 3, Applica's Vice President of Engineering, Applica released The

Home CaféTM despite the quality and design issues because Defendant Schulman had projected revenues based on sales of the product and needed the product released in order to realize those projections. Based on CI 4's participation at meetings, the decision to rollout the product with the problems was "very much driven by Michienzi and Schulman". 40. According to CI 2, after the launch of the product, Applica began shipping the

product to its major retail accounts including Wal-Mart ­ two weeks after it was shipped Wal-Mart returned approximately 50% of everything they had purchased and demanded that the product problems be fixed. At this time, according to CI 2, Applica had about 250,00 units at its Little Rock warehouse that had not been shipped to customers and Applica management sent employees to the warehouse in an attempt to fix the problem. According to CI 2, Applica determined that the "solution" was to change the software to have the system "cut off" if a certain temperature was reached. According to CI 2, however, this "fix" was not adequate as the real problem was that Applica used cheaper raw materials to manufacture the products in an effort to reduce costs and the materials melted once the temperature in the device reached a certain point.

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41.

According to CI 2, after supposedly fixing the product by changing the software,

Applica shipped 250,000 units to customers. At this time, according to CI 2, a government agency contacted Applica concerning the safety of the product and in response a decision was made to no longer ship any more products. By the time of this decision, according to CI 2, Applica's Little Rock warehouse had accumulated 500,000 units. Finally, according to CI 2, of the 250,000 units shipped after the "software" fix, 50% were returned to the Company. 42. Ultimately, the vast majority of The Home CaféTM units sold by Applica were

returned to the Company during the first quarter of 2005. According to CI 5, Applica's Pricing Program Manager, returns started to escalate in January 2005 and continued thereafter and Wal-Mart returned "hundreds of thousands of products." Moreover, according to CI 4, based on the quality and design problems with The Home CaféTM, "management knew that there was a good chance there would be warranty issues" and returns of the products. APPLICA'S FALSE AND MISLEADING FINANCIAL STATEMENTS AND FINANCIAL DISCLOSURES 43. As noted herein, Defendants were intent on creating the appearance that Applica was

successfully transforming its business and that it was experiencing strong demand for its two key products. Unbeknownst to investors, however, Applica recorded product shipments during the Class Period in violation of Generally Accepted Accounting Principles ("GAAP"), the SEC's accounting and disclosure rules and regulations and the Company's publicly stated policy of revenue recognition. In addition, Defendants violated GAAP and inflated Applica's Class Period financial

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results by failing to timely record an impairment in the value of its obsolete and unsaleable inventory.1 Applica's Improper Overstatement Of Revenue 44. GAAP provides that revenue should not be recognized until it is realized or realizable

and earned. Financial Accounting Standards Board ("FASB") Statements of Concepts ("Concepts Statement") No. 5, ¶ 83. The conditions for revenue recognition ordinarily are met when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price is fixed or determinable, collectibility of the sales price is reasonably assured and when the entity has substantially performed the obligations which entitle it to the benefits represented by the revenue. Generally, revenue should not be recognized until an exchange has occurred and the earnings process is complete. A transfer of risk has to occur in order to effect an "exchange" for the purposes of revenue recognition. SEC Staff Accounting Bulletin ("SAB") No. 104; FASB Concept Statement Nos. 2 and 5; FASB Statement of Financial Accounting Standards ("SFAS") No. 48; Accounting Research Bulletin No. 43; Accounting Principles Board Opinion No. 10; and American Institute of Certified Public Accountants Statement of Position 97-2. 45. During the Class Period, Applica falsely represented that it complied with these

accounting rules and its publicly disclosed policy of revenue recognition. In its financial statements for the year ended December 31, 2004 with the SEC on Form 10-K, the Company disclosed the following with respect to its policy of accounting for the recognition of revenue:

1

Regulation S-X [17 C.F.R. 210.4-01(a)(1)] states that financial statements filed with the SEC that are not prepared in conformity with GAAP are presumed to be misleading and inaccurate.

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Applica recognizes revenue when title, risks and rewards of ownership of its products transfer to its customers, all contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. Generally, this is at the time products are shipped for delivery to customers. Net sales are comprised of gross sales less provisions for estimated customer returns, discounts, vendor payments and volume rebates. Amounts billed to a customer for shipping and handling are included in net sales and the associated costs are included in cost of goods sold in the period when the sale occurs. 46. As Defendants knew or recklessly ignored, the above representations were materially

false and misleading because prior to and during the Class Period Applica recognized millions of dollars in revenue on defective products. In so doing, Applica recognized revenue in direct contravention of its publicly stated revenue recognition policies and GAAP so that it could meet earning targets previously announced to investors. Ultimately, at the end of the Class Period, Applica announced that is was taking $3.3 million in charges related to higher product warranty returns and related expenses. 47. According to CI 1, Applica's Senior Quality Engineer, the quality of the Company's

HomeCafe product was "an unmitigated disaster." Among other fundamental concept and design issues, CI 1 stated that the software used to operate the product was never "firmed up" before production of the Home Cafes began. Nonetheless, Applica knowingly or recklessly shipped and improperly recognized revenue on the defective product. In fact, CW 1 stated that the defects with the Home CaféTM were known by the highest members of management and named an Applica Senior Vice President who "knew all the details" about the problems with the product. representations were confirmed by numerous former Applica employees as follows: · CW 2 characterized the development of the Home CaféTM "chaos." CW 2 stated that the product was so flawed that it was literally "blowing up and catching on fire." In fact, the Home CaféTM had such poor testing results that Applica's "technical chief" arranged a meeting with Defendant Schulman to strongly advocate that the product launch date be postponed until the problems could be resolved. CW 2 stated that - 14

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following such meeting, the technical chief told various members of the engineering staff, including CW 2, that Defendant Schulman had advised him that he would need to "watch his neck" if the Home CaféTM product was not released by the predesignated launch date. After the meeting with Defendant Schulman, the technical chief went to Applica's manufacturing facility in Mexico to "speed up" the production process so that the release date could be met. Upon his return from Mexico, the technical chief declared that "everything was fine" so far as the HomeCafe product was concerned and that the product was "ready to ship." CW 2 stated "we knew it was not fine because it was catching fire in the lab." Although these problems were clearly identified and the engineering staff communicated their concerns about these issues to Applica's management, Applica's managers ordered that the Home CaféTM product be shipped to Applica's customers regardless. In fact, CW 2 explained that at a late 2004/early 2005 meeting, Defendant Schulman said that if any employees did not like the Company's plans for the Home CaféTM product release, they should leave the Company. CW 2 explained that the Company attempted a software solution to have the system "cut off" when a certain temperature was reached. CW 2 stated, however, that the problem with the product could not really be fixed; rather the software solution was an attempt to "fix a symptom" and not a true cure for the problem because of the materials that had been used to manufacture the products. · CW 3 stated that if the Home CaféTM was used too many times in a row, the temperature of the unit would get so hot that plastic parts would become "brittle." In other instances the units were "dead out of the box," meaning that they just did not work. CW 3 attributed these quality problems to Applica's manufacturing facility in Mexico. CW 4 stated that the Home CaféTM had a variety of quality and design problems that were widely known amongst employees of the Company prior to and after the product's release. For example, the "rubber housing" on the top of the device that "couldn't withstand heat" and caused the product to begin generating smoke. In fact, CW 4 explained that that the Home CaféTM was used in the Company's offices and that such units would "smoke" because it was unable to handle the heat that the device generated. In other instances, the device would arbitrarily shut off. In fact, CW 4 stated that when the device would shut off during product demonstrations, retail store accounts were told that the unit had been accidentally unplugged. CW 4 said it got to the point that "you were scared to demo the product" to prospective customers. CW 4 explained that the employees were admonished to keep their observations and concerns about the Home CaféTM quiet and that the product was shipped with quality and design defects. After the Home CaféTM was launched, consumers experienced the same problems that were observed by Applica employees. In fact, CW 4 stated that many consumers who purchased the product actually called their local fire department when it began to smoke.

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· 48.

CW 5 stated that he/she witnessed a defect with the Home CaféTM when a pod-like element "just flew out of the coffee maker" during a product demonstration. As Defendants knew or recklessly ignored, Applica's recognition of revenue on the

shipment of defective product violated GAAP in that the revenues were not earned since Applica had not substantially performed the obligations which entitled it to the benefits represented by the revenue. 49. Moreover, GAAP, in SAB No 104 and FASB's SFAS No. 48, mandates that when

customers are granted a right to return product, the amount of future returns must be reasonably estimable in order for revenue to be recognized prior to the expiration of the product return rights. 50. As Defendants knew or recklessly ignored, during the Class Period, Applica

improperly recognized revenue on transactions when it was unable to reasonably estimate product returns on the Home Cafe product. 51. SFAS No. 48 provides that:

The ability to make a reasonable estimate of the amount of future returns depends on many factors and circumstances that will vary from one case to the next. However, the following factors may impair the ability to make a reasonable estimate: (a) The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand; (b) Relatively long periods in which a particular product may be returned;

(c) Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise's marketing policies or relationships with its customers; and (d) Absence of a large volume of relatively homogeneous transactions.

The existence of one or more of the above factors, in light of the significance of other factors, may not be sufficient to prevent making a reasonable estimate; likewise, other factors may preclude a reasonable estimate. [Emphasis Added]

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52.

Expanding on this guidance, GAAP, in the SEC's SAB No. 104, list the following

additional factors affecting or precluding an entity from making reasonable and reliable estimates of product returns: (1) significant increases in or excess levels of inventory in a distribution channel (sometimes referred to as "channel stuffing"); (2) lack of "visibility" into or the inability to determine or observe the levels of inventory in a distribution channel and the current level of sales to end users; (3) expected introductions of new products that may result in the technological obsolescence of and larger than expected returns of current products; (4) the significance of a particular distributor to the registrant's (or a reporting segment's) business, sales and marketing; (5) the newness of a product; (6) the introduction of competitors' products with superior technology or greater expected market acceptance; and (7) other factors that affect market demand and changing trends in that demand for the registrant's products. 53. In addition, SAB No. 104 provides:

Question 7 of SAB 101 states that the staff would expect a two-year history of selling a new service in order to be able to make reliable estimates of cancellations. How long a history does the staff believe is necessary to estimate returns in a product sale transaction that is within the scope of SFAS No. 48? A: The staff does not believe there is any specific length of time necessary in a product transaction. However, SFAS No. 48 states that returns must be subject to reasonable estimation. Preparers and auditors should be skeptical of estimates of product returns when little history with a particular product line exists, when there is inadequate verifiable evidence of historical experience, or when there are inadequate internal controls that ensure the reliability and timeliness of the reporting of the appropriate historical information. Start-up companies and companies selling new or significantly modified products are frequently unable to develop the requisite historical data on which to base estimates of returns. [Emphasis Added] 54. Given that the Home Cafe was a new product without historical data upon which

Applica could reasonably estimate product returns and that the product was "sold" with serious

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manufacturing defects, Applica was unable to reasonably estimate Home Cafe product returns during the Class Period. As a result, GAAP required that Applica otherwise defer the recognition of revenue until such time as the HomeCafe return provisions expired. 55. Applica has now publicly admitted that it was not able to reasonably estimate its

Home Cafe product returns during the Class Period. 56. Defendants knew or recklessly ignored that the Company's estimates of product

returns during the Class Period was inherently unreliable and nothing more than a guess. For example, the first 20,000 Home Cafe units, which CI 1 stated were likely produced in April 2004 and shipped to Target and Wal-Mart a month or so later, were defective. Thereafter, CI 1 stated that CI 1 began receiving "serious data" regarding the products quality problems. This data included monthly "return reports" that were sent to CI 1 from the Applica Distribution Center that received the returned products. CI 1 stated that despite such known problems, the Company continued to manufacture and ship defective Home Cafes even after the initial defective 20,000 units were sent to Target and Wal-Mart. As a result, during the Class Period, Applica continued to experience a 30% 35% return rate for the Home Cafes. 57. employees: · CW 2 stated that about two weeks after receiving the initial product shipments, WalMart returned approximately 50% of the product they had received. CW 2 also stated that after Applica instituted a software change for the Home CaféTM, it produced another 250,000 units and shipped those to customers, including Wal-Mart. CW 2 said of those 250,000 supposedly fixed units, at least 50% were also returned. CW 3 stated that Applica considered "re-working" 100,000 Home CaféTM units that had been returned by installing new software, but that such alternative were not viable. The representations by CW 1 have been confirmed by numerous former Applica

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CW 4 stated that a significant number of the initial shipments of the Home CaféTM went to Wal-Mart, with Target, Kohls and K-Mart being the other major customers. CW 4 stated that it was necessary for the product to ship during the summer months so that the retailers would have them on the shelves ahead of the busy Holiday Season. However, two to three months after the retail stores received the product, its problems became known and returns started to occur. In fact, Wal-Mart identified a particular batch number that was prone to smoke and/or catch fire. CW 5 stated that Home CaféTM returns ensued shortly after the product was shipped to various large national retail customer accounts, including Wal-Mart, Sears, KMart, Kohls, Ace Hardware and TrueValue Hardware. CW 5 stated that Wal-Mart "returned an obscene amount" of product, and estimated that 20% of what was shipped during the third and fourth quarter of 2004 was returned to Applica. As a result, Applica was unable to reasonably estimate future product returns and

·

58.

price concessions during the Class Period which rendered the Company's policy of recording revenue upon shipment of product in violation of GAAP because, as noted in various GAAP pronouncements [i]f a reasonable estimate of future returns cannot be made, revenue can not be recognized until the return period lapses. 59. As a result of the revenue recognition manipulations noted above, and its failure to

comply with GAAP, Applica falsely inflated its reported sales and earnings during the Class Period. Nonetheless, in furtherance of Defendant's deceptive financial reporting, Applica has failed to correct its improper recognition of revenue by restating its previously issued false and misleading financial statements, as specifically required by GAAP in APB Opinion No. 20. Rather, Defendants have masked and managed their improper revenue recognition practices by lowering Applica's reported revenue and revenue guidance after the end of the Class Period. 60. To the detriment of unsuspecting investors, these improperly recorded transactions

added credibility that the Home Cafes was being well received in the marketplace and materially overstated Applica's revenues and earnings during the Class Period. These improper accounting

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practices, which violated GAAP and Applica's publicly disclosed policy of revenue recognition, were employed by the Company to enable it to meet the revenue and earnings expectations of Wall Street analysts, inflate the true demand for Applica's products and create a false impression about the value of Applica's business. Applica's Improper Failure To Record An Impairment In The Value Of Its Inventory 61. that: A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as its cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference should be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. The term market means the current replacement cost except that: a) Market should not exceed the . . . estimated selling price in the ordinary course of business less reasonably predictable costs of . . . disposal; and b) Market should not be less than the . . . estimated selling price in the ordinary course of business less reasonably predictable costs of . . . disposal reduced by a . . . normal profit margin. 62. Accordingly, for financial reporting purposes, the issue is not whether a product is not GAAP, as stated in Accounting Research Bulletin No. 43, Chapter 4, ¶¶7-8, provides

usable or obsolete, but, rather, whether obsolescence, physical deterioration, changes in price levels, or other factors cause inventory to be worth less than its stated cost. 63. During the Class Period, Applica falsely represented that it complied with these

accounting rules and its publicly disclosed policy of accounting for inventory. Applica's 2004 financial statements filed with the SEC on Form 10-K disclosed its policy of accounting for inventory as follows: - 20

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Inventory. Applica values inventory at the lower of cost or market, using the first-in, first-out (FIFO) method, and regularly reviews the book value of discontinued product lines and stock keeping units (SKUs) to determine if these items are properly valued. If market value is less than cost, Applica writes down the related inventory to the estimated net realizable value. Applica regularly evaluates the composition of inventory to identify slow-moving and obsolete inventories to determine if additional write-downs are required. This valuation requires significant judgment from management as to the saleability of its inventory based on forecasted sales. It is particularly difficult to judge the potential sales of new products. Should the forecasted sales not materialize, it would have a significant impact on Applica's result of operations and the valuation of its inventory, resulting in a charge to income in the period such determination is made. 64. In violation of GAAP and the above-stated accounting policy, Applica's financial

statements in its periodic reports filed with the SEC, and the press releases issued by the Company during the Class Period which included financial statements, materially overstated the Company's inventories as a result of its improper failure to timely record an impairment in the value of its outmoded inventory. In so doing, Applica also materially overstated its gross margins and earnings during the Class Period. 65. During the Class Period, Defendants knew, or recklessly ignored that Applica failed

to timely record an impairment in the value of its inventory. 66. For example, CW 1 stated that by mid-2004 it was common knowledge that Applica

was "not going to get the demand" that had originally been forecasted for the TideTM BuzzTM Ultrasonic Stain Remover. As a result, during the Class Period Applica's warehouses were loaded with inventory they could not sell. These representations are confirmed by other former Applica employees as follows: · CW 2 stated the sales of the TideTM BuzzTM Ultrasonic Stain Remover were so poor that Wal-Mart, in essence, told Applica to "come and get your product" out of our stores. - 21

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·

CW 3 stated that the TideTM BuzzTM Ultrasonic Stain Remover failed to meet its sales expectations from virtually the moment the product was officially launched. In fact, CW 3 said that there were "side-bets" among Applica employees about how many sales of the product would actually materialize. Ultimately, according to CW 1, the Company's sales personnel began selling the

67.

TideTM BuzzTM Ultrasonic Stain Remover at 50% to 60% below their normal selling price in November 2004. The above factors required the Defendants to timely evaluate whether the value of Applica's inventory was impaired pursuant to GAAP. Nonetheless, Applica failed to timely record an impairment in the value of its inventory, as the Defendants knew, or recklessly disregarded. Applica's False and Misleading Reporting and Certifications of Disclosure and Internal Controls 68. During the Class Period, Defendants had the obligation to assure that the financial

information disseminated by Applica, including the financial statements contained in filings made with the SEC and press releases, was fairly stated in compliance with GAAP and Applica's stated accounting policies. The Company's financial disclosures during the Class Period were not fairly stated because: (a) Applica lacked adequate internal controls and was therefore unable to

ascertain the true financial results of the Company; (b) policies and GAAP; (c) and (d) Applica failed to restate its false and misleading Class Period financial Applica delayed the recognition of an impairment in the value of its inventory; Applica recognized revenue in violation of its stated revenue recognition

statements in accordance with GAAP.

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69.

As a result of the foregoing, the financial statements and information issued by

Applica during the Class Period was materially false and misleading. 70. In 2002, Congress enacted the Sarbanes-Oxley Act ("SOX"), in part, to heighten the

responsibility of public company directors and senior managers associated with the quality of financial reporting and disclosures made by their companies. Section 906 of SOX requires that the CEO and CFO certify the financial statements of public companies filed with the SEC. As a result, during the Class Period Defendants Schulman and Polistina signed the following certifications on which were filed as an exhibit to Applica's September 30, 2004 Form 10-Q: I, . . . , certify that: 1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 of Applica Incorporated; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and - 23

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c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. 71. The certifications above were materially false and misleading when made for the

reasons alleged herein. 72. Defendants also had the responsibility to design, implement, and maintain a system of

internal accounting controls that would provide accounting records to appropriately reflect the transactions of Applica. As Section 13 of the Securities Exchange Act of 1934 provides: Every issuer which has a class of securities registered pursuant to Section 12 of this title and every issuer which is required to file reports pursuant to Section 15(d) of this title shall - 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 accounting controls sufficient to provide reasonable assurances that - i. transactions are executed in accordance with management's general or specific authorization;

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ii. transactions are recorded as necessary (a) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (b) to maintain accountability for assets; iii. access to assets is permitted only in accordance with management's general or specific authorization; and iv. the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. 73. As a result of the wrongful accounting practices alleged herein, Defendants

disseminated financial statements of Applica that were materially false and misleading. In addition to the accounting improprieties stated above, Applica presented its financial statements during the Class Period in a manner which also violated at least the following provisions of GAAP: (e) The concept 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 (Concepts Statement No.1, ¶34); (f) The concept that financial reporting should provide information about the

economic resources of an enterprise, the claims to those resources, and the effects of transactions, events and circumstances that change resources and claims to those resources (Concepts Statement No. 1, ¶40); (g) The concept 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. 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 (Concepts Statement No. 1, ¶50);

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(h)

The concept that financial reporting should provide information about an

enterprise's financial performance during a period. 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 (Concepts Statement No. 1, ¶42); (i) The concept that financial reporting should be reliable in that it represents

what it purports to represent. That information should be reliable as well as relevant is a notion that is central to accounting (Concepts Statement No. 2, ¶¶58-59); (j) The concept of completeness, which means that nothing is left out of the

information that may be necessary to ensure that it validly represents underlying events and conditions (Concepts Statement No. 2, ¶79); and (k) The concept 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. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (Concepts Statement No. 2, ¶¶95, 97). 74. The foregoing accounting improprieties caused Applica to issue financial statements

which violated numerous provisions of GAAP and the SEC's accounting rules and regulations. Applica's undisclosed adverse financial reporting materially falsified its financial performance to the detriment of unsuspecting investors 75. In failing to file financial statements with the SEC which conformed to the

requirements of GAAP, Applica repeatedly disseminated financial statements that were

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presumptively misleading and inaccurate. Indeed, the numerous accounting machinations detailed herein evidences the defendant's intent to deceive investors during the Class Period and misrepresent the truth about the Company and its business, operations and financial performance to the detriment of those who relied on them. 76. The Company's Class Period Forms 10-K and 10-Q filed with the SEC were also

materially false and misleading in that they failed to disclose known trends, demands, commitments, events, and uncertainties that were reasonably likely to have a materially adverse effect on the Company's liquidity, net sales, revenues and income from continuing operations, as required by Item 303 of Regulation S-K. MATERIALLY FALSE AND MISLEADING STATEMENTS MADE DURING THE CLASS PERIOD 77. The Class Period begins on November 4, 2004. On that date, Applica issued a press

release announcing its financial results for its third quarter, the period ended September 30, 2004. For the quarter, the Company reported sales of $187.8 million and a net loss of $9.9 million, or $0.41 per share, including expenses of $9.2 million related to termination benefits and a loss of $0.8 million on the sale of Applica's Chinese manufacturing operations. The Company represented that the sales for the quarter were an increase of "8.2% from the same period the prior year" and attributed the increase in sales to "sales of new products," among other things. Defendant Schulman, commenting on the results, stated, in pertinent part, as follows: We have gone through significant changes over the last few months, including the sale of our Chinese manufacturing operations, the renewal of the Black & Decker(R) license, the move of our executive offices and other matters. Additionally, this past week, we sold our Jerdon division. We believe that these are profound changes that will have a lasting positive effect on the company, and we intend to continue to transform Applica to create long--term shareholder value.

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78.

The statement referenced above in ¶ 77 that the Company had experienced "an

increase in sales" that was attributable to sales of "new products" was materially false and misleading because it failed to disclose that the Company was improperly recognizing revenue in connection with "sales" of the Home Café. In addition, the statements above in ¶ 77 reporting the financial performance of the Company were materially false and misleading because they overstated the financial performance of the Company as the Company had improperly recognized revenue in connection with the "sales" of the Home Café and failed to timely record an impairment in the value of its inventory of the Tide Buzz Ultrasonic Stain Removal, as detailed above in ¶¶ 43-76. Finally, the positive statements about the Company and its prospects created a duty upon Defendants to disclose the true condition of the Company and the problems that it was experiencing with the Home Café and The Tide Buzz Ultrasonic Stain Remover, as detailed herein. 79. Following the earnings release, on November 4, 2004, Applica held a conference call

with analysts to discuss its financial results (the "November 4th Call"). During the November 4th Call, Defendant Michienzi represented that the Home Café was performing well for the Company and that the The Tide Buzz Ultrasonic Stain Remover was receiving "support" from customers stating in pertinent part as follows: In the third quarter we have gained significant market share in pot coffeemakers as a result of our combined Home Cafe marketing plan with Procter & Gamble. We have gained distribution in close to 40,000 retail doors in North America and we are well on our way to selling in and moving through all the units we are producing. Despite the slow start in the second quarter we have now achieved the No. 1 Market Share position at most retailers on a weekly point-of-sale basis and look to continue to grow as the Home Cafe promotional plan gets into full swing. Home Cafe was featured on the hit TV show "Survivor" last week as the winning team got to visit an island version of the Home Cafe featuring the Black & Decker coffeemaker. We saw an immediate uptick in point-of-sale the very next day. This type of unique exposure, along with great in-store execution should solidify a great Christmas selling season.

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. . . Buzz continues to be a product that tests and researches very well. We are committed to the concept and we are working on future products using this technology and the great association with Tide. Point-of-sales has been slow, but we have repositioned the price point to 39.99 and we will launch the next wave of our TV campaign November the 15th as consumers are in the store with the intent to purchase. Customers continue to give Buzz the support they committed to for the fourth quarter are enthused with the product extensions that we have for 2005. [Emphasis added.] 80. The statements referenced above in ¶ 79 about the Home Café product and the

purported positive sales it was experiencing were materially false and misleading because they failed to disclose the true facts concerning the product. Specifically, the Home Café was plagued by known quality and design defects, as detailed herein, and customers were returning and preparing to return the units to the Company. The statement above in ¶ 79 that "Buzz continues to be a product that tests and researches very well" was materially false and misleading because The Tide Buzz Ultrasonic Stain Remover was not performing to internal expectations and the Company was forced to slash prices in an attempt to sell the products. Finally, the statement referenced above in ¶79 that "Point-of-sales has been slow, but we have repositioned the price point to 39.99" was materially false and misleading because it failed to disclose the true extent of the slowdown in sales ­ the Company had only sold one-third of the units projected ­ and that the "price point" of "$39.99" represented a fire sale of the product as it cost Applica approximately $39 to manufacture the units. 81. During the November 4th Call, Defendant Polistina represented that sales of The Tide

Ultrasonic Stain Remover and The Home Café would "still remain at about $40 million for the year." This statement was materially false and misleading because it failed to disclose the known adverse facts about the products as detailed herein and that the Company was improperly recognizing revenues in connection with its "sales" of the Home Café and failing to timely record an impairment in the value of its inventory of the Tide Buzz Ultrasonic Stain Removal.

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82.

During the November 4th Call, with respect to sales of Home Café and Buzz, the

following question and answer took place: RON PHILLIS, ANALYST, BANC OF AMERICA SECURITIES: I was wondering if you could tell us where you are right new in the sell-in process for Buzz? And I think you are already fully sold into Home Cafe, but I could be wrong. MICHAEL MICHIENZI: We are basically in the same position, Buzz versus Home Cafe. There is product in each of the main retailers right now. We have plans for in-store promotions in most major retailers and by the end of October, middle of November, right about now, we will have 100% distribution in all targeted accounts. RON PHILLIS: Could you talk to us about how Home Cafe is doing versus your plan versus how Buzz is doing versus your plan? MICHAEL MICHIENZI: Yes, Home Cafe is right on plan. As I mentioned we had a production planned commensurate with what research told us we would move through and we are dead nuts on that plan. Buzz, POS on Buzz is close to plan. The POS Buzz is a little bit slow right now, and thus we repositioned the price point that I talked about, the 39.99, but we have got all the promotions in place that the customers have promised us. TV starts 11/15 and runs right through Christmas day. So we are still bullish on the product. [Emphasis added.] 83. The statement referenced above in ¶ 82 that "Home Café is right on plan" was

materially false and misleading because it failed to disclose that Home Café was plagued by known quality and design defects, as detailed herein, and customers were returning and preparing to return the units to the Company. The statements referenced above in ¶ 82 concerning The Tide Buzz Ultrasonic Stain Remover were materially false and misleading because it was not true that "Buzz is close to plan" as the Company had only sold one-third of what it had internally projected and, accordingly, the statement that "we are still bullish on the product" was lacking in a reasonable basis and materially false and misleading. 84. On November 8, 2004, Applica filed its Form 10-Q for the quarter ended September

30, 2004, with the SEC which was signed by Defendants Schulman and Polistina and confirmed the

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previously released financial results (the "Third Quarter 10-Q"). In the Third Quarter 10-Q, Applica represented that the financial statements contained therein had "all adjustments (consisting of normal recurring accruals), which, in the opinion of management are necessary for a fair presentation of the financial statements, have been included." The Third Quarter 10-Q also represented that Applica "expects sales of Black & Decker branded products to continue to increase for the remainder of the 2004 as the result of sales of several new products, including the Home Café single-cup brewing system and the Tide Buzz ultrasonic stain removal system, both of which were co-developed with The Procter & Gamble Company. . . ." 85. The Third Quarter 10-Q was materially false and misleading because it reported

artificially inflated financial results for the Company as detailed herein at ¶¶ 43-76. In addition, the financial statements contained in the Third Quarter 10-Q were not prepared in accordance with GAAP, as detailed above in ¶¶ 43-76, and , therefore, it was not true that those financial statements contained "all adjustments" necessary for a "fair presentation" of the financial statements. Finally, given the true facts about the Home Café and Tide Buzz Ultrasonic Stain Removal System, the statement that Applica "expects sales . .. to continue to increase for the remainder of 2004" was lacking in a reasonable basis and, therefore, materially false and misleading. 86. On March 14, 2005, Applica issued a press release announcing its financial results

for its fourth quarter and year end of 2004, the period ended December 31, 2004. For the quarter, the Company reported sales of $247.5 million and net income of $5.3 million, or $0.22 per diluted share. Defendant Schulman, commenting on the results, stated, in pertinent part, as follows: We are pleased by our strong performance in the fourth quarter. We remain financially stable despite a difficult year. Management will continue to focus aggressively on improving profitability and the balance sheet. We will increase customer and product contribution margins, maximize supply chain efficiencies and - 31

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deliver quality products. We expect that our efforts will position us to be profitable in 2005. [Emphasis added.] 87. The statement referenced above in ¶ 86 that "we are pleased by our strong

performance in the fourth quarter" was materially false and misleading because the Company had not truly had a "strong performance' rather it had improperly recognized revenue on the sale of the Home Café, it was failing to timely record an impairment in the value of its inventory of the Tide Buzz Ultrasonic Stain Removal and its two new products were beset by a host of problems. Similarly, the statement referenced above in ¶ 86 that "We expect that our efforts will position us to be profitable in 2005" was lacking in a reasonable basis and, therefore, materially false and misleading as it failed to disclose the true condition of the Company and the host of problems plaguing its two new products. The statement referenced above in ¶ 86 that Applica had sales of $247.5 million and net income of $5.3 million, or $0.22 per diluted share for the fourth quarter of 2004, was materially false and misleading as the Company had materially overstated its financial performance by improperly recognizing revenue on "sales" of the Home Café and failed to timely record an impairment in the value of its inventory of the Tide Buzz Ultrasonic Stain Removal, as detailed above in ¶¶ 43-76. 88. Following its earnings announcement, on March 14, 2005, Applica held a conference

call with analysts to discuss its earnings announcement. With regard to the Company's outlook, Defendant Polistina stated, in pertinent part, as follows: As for the first quarter, we should have sales in the $120 to $125 million range with a loss of $0.20 to $0.25 per share. We should see a big improvement in operating income but we won't record a tax benefit like we did last year. Last year's loss of $0.19 included a tax benefit of $0.12 per share. As far as the balance sheet this year, our focus will be on working capital management. Inventory and debt will come down on average compared to 2004. And we expect to end the year $20 to $30 million better in both compared to 2004. Capital expenditure is estimated at $13 - 32

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million for year. We expect cash taxes to be less than $5 million for the year. So by year end we're looking for total debt to be below $135 million. Our plans are to build around -- -- are built around making a profit and meeting or hopefully beating our guidance. [Emphasis added.] 89. The statements in ¶ 88 that "we should have sales in the $120 to $125 million range

with a loss of $0.20 to $0.25 per share" and "Our plans are to build around -- -- are built around making a profit and meeting or hopefully beating our guidance" were lacking in a reasonable basis and, therefore, materially false and misleading given the true condition of the Company and the problems with the Home Café and The Tide Buzz Ultrasonic Stain Removal System. Defendant Polistina knew of the mounting returns of the Home Café and of the failure of The Tide Buzz Ultrasonic Stain Removal System which factors undermined the projections that he represented to the market. 90. On March 11, 2005, Applica filed its Form 10-K for the year end of 2004, the period

ended December 31, 2004, with the SEC which was which was signed by defendants Schulman and Polistina, among others (the "2004 10-K"). The 2004 10-K was materially false and misleading because it contained materially false and misleading financial results for the Company as detailed herein. THE TRUTH BEGINS TO EMERGE 91. On April 20, 2005, Applica issued a press release updating its financial guidance it

provided on March 14, 2005. The press release stated, in pertinent part, as follows: Applica Incorporated (NYSE:APN) today announced that it anticipates it will record a net loss in the first quarter of between $22 million and $23 million. The larger than estimated loss is primarily the result of: * a write-down of inventory related to lower-than-anticipated consumer demand; * increased product warranty returns and related expenses; and - 33

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* additional losses in the Mexico manufacturing operations. 92. Upon this shocking news, shares of Applica common stock closed at $3.00 per share,

a decline of $1.57 per share, or over 30%, from the previous trading day's close, on heavy trading volume. 93. On April 28, 2005, Applica issued a press release announcing its financial results for

the first quarter of 2005, the period ending March 31, 2005. The Company reported sales of $112.5 million. The press release continued, in pertinent part, as follows: As previously announced, Applica initiated a product and customer profitability review that resulted in an expected decrease in sales in the first quarter. Additionally, the sales of both the Hong Kong--based manufacturing operations in July 2004 and the Jerdon division in October 2004 contributed to lower sales. Applica's gross profit margin decreased to 16.7% in the three--month period ended March 31, 2005 as compared to 26.1% for the same period in 2004. Gross margins in the first quarter were negatively impacted by: - inventory write-downs of $9.4 million related to lower-than-anticipated consumer demand of certain products, primarily related to our ultrasonic stain removal appliance; - higher product warranty returns and related expenses of $3.3 million; and - a loss of $2.1 million in the Mexico manufacturing operations. These were partially offset by an improving product mix. Applica reported a net loss for the first quarter of 2005 of $23.0 million, or $0.95 per diluted share, compared to a net loss of $4.5 million, or $0.19 per diluted share, for the 2004 first quarter. Applica also announced that it has made a policy change with regard to providing future earnings guidance. Starting this quarter and in the future, Applica will no longer provide quarterly or annual earnings guidance. Further, Applica will not update its outlook for full--year earnings expectations for 2005 as the year progresses. Defendant Schulman, commenting on the results, stated, in pertinent part, as follows: We previously announced that we would report a larger net loss than anticipated in the first quarter. The loss was primarily the result of inventory write--downs, the majority of which were related to our ultrasonic stain removal appliance. The - 34

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decisions we made in the first quarter will allow our product managers to focus on, and accelerate the introduction of, the next generation of this product. Despite the loss in the quarter, to date, we have paid down approximately $26 million of debt since year--end and we currently have availability under our bank revolver of approximately $38 million. Due to the difficulty in predicting the impact of transition and other issues on our Company, we will no longer be providing guidance. In our quarterly calls, we will continue to provide investors with our perspective on trends in the industry and our operations, our strategic initiatives and those factors critical to understanding our business and operating environment. 94. per share. 95. Applica's financial results for the first quarter of 2005, the period ended March 31, Upon this news, shares of Applica common stock declined further, falling to $2.51

2005, were repeated in the Company's Report on Form 10-Q filed with the SEC on or about April 29, 2005, which was signed by defendants Schulman and Polistina. The 10-Q stated, in pertinent part, as follows: COST OF GOODS SOLD Included in cost of sales for the first quarter of 2005 are inventory write-downs of approximately $9.4 million related to lower-than-anticipated consumer demand for two of our products. Also, included in cost of sales for the three months ended March 31, 2005 are restructuring charges of $0.9 million related to our decision to move the production of Home Café single cup coffee maker from Mexico to third party manufacturers in China. The restructuring charges consist of $0.3 million in severance charges and $0.6 million in the acceleration of the depreciation of machinery and equipment used in the manufacturing process. Included in cost of sales for the three months ended March 31, 2004 are restructuring charges of $0.9 million primarily related to the downsizing of our Hong-Kong based manufacturing facilities. The Hong Kong based manufacturing operations were sold in July 2004. The inventory write-downs relate to the Household Products reportable segment. All restructuring charges relate to the Manufacturing reportable segment. * SHORT-TERM DEBT - 35

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*

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Revolving Credit Facility Applica has a revolving credit facility with a syndicate of banks that provides for borrowings on a revolving basis of up to $175 million with a $10 million sublimit for letters of credit (the "credit facility"). The credit facility has a maturity date of November 2009. Advances under the credit facility are governed by Applica's collateral value, which is based upon percentages of eligible accounts receivable and inventories. * * *

We continuously have to balance the cost of our products, without compromising quality, with the price constraints from our customers. The prices of raw materials such as copper, steel and plastics have significantly increased in recent years and are expected to continue to be high in the foreseeable future. This has negatively impacted our gross margins by increasing the price we pay for our products and is expected to continue to negatively impact our margins during the remainder of 2005. We have been focused on making changes to combat the margin pressures resulting from the combination of the inflation of raw materials prices and the deflationary pressures from the retail environment. Steps we have taken include: · the downsizing and ultimate sale of our Hong Kong-based manufacturing operations; · the downsizing of our manufacturing operations in Mexico; and · the establishment of strategic sourcing partners and joint product development relationships. We are also continuing to focus on innovative products with proprietary technologies, design and higher margins. As part of our focus on new products introductions and brand development, we search for other growth opportunities within and beyond our existing businesses. We believe that the markets and industry in which we compete may provide growth opportunities through strategic acquisitions or mergers. We review these prospects for strategic transactions as they become available. We continue to rationalize our Mexican manufacturing operations. In 2004, we shifted a significant amount of production from Mexico to third parties in China. As part of the rationalization, we also plan to sell the building housing our factory in Mexico. In 2004, we began to reduce our Mexican manufacturing capacity to reflect only the volume needed for the Mexican marketplace, which will continue throughout 2005.

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Additionally, in late 2004, we initiated an annual product and customer profitability review. Through this process, management identifies products sold to customers that do not meet Applica's product profitability threshold. Once those products are identified, management either requests a price increase from the applicable customer or cost reductions from the applicable supplier. If the combination of price increases and cost reductions does not increase the product's profitability to meet the threshold, Applica will not offer such product to the customer. This initiative will significantly reduce the number of products we offer. As a result, we expect our sales volume to continue to decrease in 2005; however, this process is expected to result in higher gross margin percentages. * * *

Gross Profit. Applica's gross profit margin decreased to 16.7% for the three months ended March 31, 2005 as compared to 26.1% for the same period in 2004. The gross profit margin decrease was primarily attributed to: · inventory write-downs of $9.4 million related to lower-than-anticipated consumer demand for two of our products; · higher product warranty returns and related expenses of $3.3 million; and · higher unabsorbed overhead and inefficiencies of $2.1 million at our Mexican manufacturing operations as the result of reduced production associated with our downsizing activities during 2004 and the first quarter of 2005. The majority of the inventory write-downs related to the TideTM BuzzTM Ultrasonic Stain Remover. Sales of the first generation of this product were lower than we had anticipated. The size of the product and the price were the main reasons given by consumers for not purchasing the product. Based on this information, we decided to close out the first generation of the TideTM BuzzTM and accelerate the introduction of the next generation. We believe that we have addressed both those factors in the next generation of the TideTM BuzzTM Ultrasonic Stain Remover. Additionally, the inventory write-down included the Home CaféTM single cup coffee maker. Our Home CaféTM sales plan for 2005 was based on promotional campaigns by our alliance partner that did not fully materialize. This resulted in lower-than-anticipated consumer demand for the Home CaféTM coffee maker, which resulted in excess inventory. We expect to sell the first generation units in the second half of 2005. The next generation of Home CaféTM is scheduled to be launched in the fourth quarter of 2005. The TideTM BuzzTM and the Home CaféTM represented approximately 3.7% of consolidated net sales in 2004. We have recently experienced an increase in our warranty returns and related expenses. We believe that we have taken appropriate measures to combat these - 37

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trends in a timely and effective manner. These measures include the contracting of an independent third party quality consultant to oversee the production process at our major suppliers in China and our manufacturing facility in Mexico. We expect unabsorbed overhead and inefficiencies to continue at our Mexican manufacturing operations for the remainder of 2005. We also anticipate additional severance and asset write-downs as we continue to downsize our manufacturing operations. Additionally, we continue to experience increases in prices for raw materials, including plastic, steel, aluminum and copper in our Mexican manufacturing operations, as well as fuel surcharges and increased freight costs in the first quarter of 2005. We expect these trends to continue for the remainder of 2005, adversely impacting gross profit margins. LOSS CAUSATION/ECONOMIC LOSS 96. During the Class Period, as detailed herein, Defendants engaged in a scheme to

deceive the market, and a course of conduct that artificially inflated Applica's stock price and operated as a fraud or deceit on Class Period purchasers of Applica's stock by misrepresenting the Company's expected financial results. When Defendants' prior misrepresentations and fraudulent conduct came to be revealed and was apparent to investors, shares of Applica declined precipitously - evidence that the prior artificial inflation in the price of Applica's shares was eradicated. As a result of their purchases of Applica stock during the Class Period, Plaintiff and other members of the Class suffered economic losses, i.e., damages under the federal securities laws. 97. By misrepresenting the Company's prospects, Defendants presented a misleading

image of Applica's business and future growth prospects. During the Class Period, Defendants repeatedly emphasized the financial strength and well-being of the Company. These claims caused and maintained the artificial inflation in Applica's stock price throughout the Class Period and until the truth about the Company was ultimately revealed to investors.

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98.

Defendants' false and materially misleading statements had the intended effect of

causing Applica's shares to trade at artificially inflated levels throughout the Class Period - reaching a Class Period high of over $6.00 per share on December 31, 2004. 99. On April 20, 2005, however, Defendants revealed that the Company would not come

near achieving the guidance previously sponsored and/or endorsed by Defendants, that the Company's business was suffering from numerous adverse factors and was marking down inventory and experiencing increased warranty expenses. Then, on April 28, 2005, Defendants further detailed the impact of these adverse factors on Applica's business. These belated disclosures had an immediate, adverse impact on the price of Applica shares. 100. As a direct result of Defendants' statements on April 20, 2005 and April 28, 2005,

which indicated that: (i) the Company would take an inventory write-down of $9.4 million related to lower-than-anticipated consumer demand for the Home Café and the Tide Buzz Ultrasonic Stain Removal System; and (ii) the Company was experiencing higher product warranty returns and related expenses of $3.3 million, among other things, Applica's stock price collapsed to $2.51 per share ­ a decline of more than 50% from its Class Period high. This dramatic share price decline eradicated much of the artificial inflation from Applica's share price, causing real economic loss to investors who purchased this stock during the Class Period. 101. The decline in Applica stock price at the end of the Class Period was a direct result of

the nature and extent of defendants' fraud being revealed to investors and to the market. The timing and magnitude of Applica stock price decline negates any inference that the losses suffered by plaintiff and the other members of the Class was caused by changed market conditions, macroeconomic or industry factors or even Company-specific facts unrelated to defendants'

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fraudulent conduct. The economic loss, i.e., damages suffered by Plaintiffs and other members of the Class, was a direct result of defendants' fraudulent scheme to artificially inflate the price of Applica's stock and the subsequent significant decline in the value of the Company's shares when defendants' prior misstatements and other fraudulent conduct was revealed. Additional Scienter Allegations 102. As alleged herein, Defendants acted with scienter in that defendants knew that the

public documents and statements issued or disseminated in the name of the Company were materially false and misleading; knew that such statements or documents would be issued or disseminated to the investing public; and knowingly and substantially participated or acquiesced in the issuance or dissemination of such statements or documents as primary violations of the federal securities laws. As set forth elsewhere herein in detail, defendants, by virtue of their receipt of information reflecting the true facts regarding Applica, their control over, and/or receipt and/or modification of Applica allegedly materially misleading misstatements and/or their associations with the Company which made them privy to confidential proprietary information concerning Applica, participated in the fraudulent scheme alleged herein. 103. Defendants were further motivated to engage in this course of conduct in order to

enable the Company to receive advances under its credit facilities by materially overstating its inventory which had become obsolete. Applicability of Presumption of Reliance: Fraud on the Market Doctrine 104. At all relevant times, the market for Applica's common stock was an efficient market

for the following reasons, among others:

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(a)

Applica stock met the requirements for listing, and was listed and actively

traded on the NYSE, a highly efficient and automated market; (b) the NYSE; (c) Applica regularly communicated with public investors via established market As a regulated issuer, Applica filed periodic public reports with the SEC and

communication mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and (d) Applica was followed by several securities analysts employed by major

brokerage firms who wrote reports which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace. 105. As a result of the foregoing, the market for Applica common stock promptly digested

current information regarding Applica from all publicly available sources and reflected such information in Applica stock price. Under these circumstances, all purchasers of Applica common stock during the Class Period suffered similar injury through their purchase of Applica common stock at artificially inflated prices and a presumption of reliance applies. No Safe Harbor 106. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pleaded in this complaint. Many of the specific statements pleaded herein were not identified as "forward-looking statements" when made. To the extent there were any forward-looking statements, there were no meaningful

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cautionary statements identifying important factors that could cause actual results to differ materially from those in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe harbor does apply to any forward-looking statements pleaded herein, defendants are liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker knew that the particular forward-looking statement was false, and/or the forward-looking statement was authorized and/or approved by an executive officer of Applica who knew that those statements were false when made. COUNT I Violation of Section 10(b) of the Exchange Act and Rule 10b-5 Promulgated Thereunder Against All Defendants 107. 108. Plaintiffs incorporate ¶¶ 1-106 by reference. 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 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. 109. Defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 in that they: (a) (b) Employed devices, schemes, and artifices to defraud; 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

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(c)

Engaged in acts, practices, and a course of business that operated as a fraud or

deceit upon plaintiff and others similarly situated in connection with their purchases of Applica publicly traded securities during the Class Period. 110. Plaintiffs and the Class have suffered damages in that, in reliance on the integrity of

the market, they paid artificially inflated prices for Applica stock. Plaintiffs and the Class would not have purchased Applica stock 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. 111. As a direct and proximate result of these Defendants' wrongful conduct, Plaintiffs and

the other members of the Class suffered damages in connection with their purchases of Applica common stock during the Class Period. COUNT II Violation of Section 20(a) of the Exchange Act Against the Individual Defendants 112. 113. Plaintiffs incorporate ¶¶ 1-111 by reference. The Individual Defendants acted as controlling persons of Applica within the

meaning of Section 20(a) of the Exchange Act. By reason of their positions as officers and/or directors of Applica, and their ownership of Applica stock, the Individual Defendants had the power and authority to cause Applica to engage in the wrongful conduct complained of herein. Applica controlled each of the Individual Defendants and all of its employees. By reason of such conduct, the Individual Defendants and Applica are liable pursuant to Section 20(a) of the Exchange Act. WHEREFORE, Plaintiffs pray for relief and judgment, as follows:

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(a)

Determining that this action is a proper class action, certifying Plaintiffs as

class representatives under Rule 23 of the Federal Rules of Civil Procedure and Plaintiff's counsel as Class Counsel; (b) Awarding compensatory damages in favor of Plaintiffs and the other Class

members against all defendants, jointly and severally, for all damages sustained as a result of defendants' wrongdoing, in an amount to be proven at trial, including interest thereon; (c) Awarding Plaintiffs and the Class their reasonable costs and expenses incurred

in this action, including counsel fees and expert fees; and (d) Such other and further relief as the Court may deem just and proper. JURY TRIAL DEMANDED Plaintiffs hereby demand a trial by jury. DATED: July 10, 2006 LERACH COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP 197 South Federal Highway, Suite 200 Boca Raton, FL 33432 Telephone: (561) 750-3000 (561) 750-3364 (fax)

/s/ David J. George DAVID J. GEORGE PAUL J. GELLER FLORIDA BAR NO. 984795 [email protected] DAVID J. GEORGE FLORIDA BAR NO. 0898570 [email protected]

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LERACH COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP SAMUEL H. RUDMAN DAVID A. ROSENFELD MARIO ALBA JR. 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631.367.7100 631.367.1173 (fax) ABRAHAM FRUCHTER & TWERSKY JACK FRUCHTER One Penn Plaza New York, NY 11019 Telephone: 212.279.5050 Attorneys for Plaintiffs CERTIFICATE OF SERVICE I HEREBY CERTIFY that a true and correct copy of the foregoing has been furnished by facsimile and U.S. Mail this 10th day of July, 2006, to the following: David Coulson, Esq. Glenn Harris, Esq. Eliot Pedrosa, Esq. Alex M. Nemiroff, Esq. GREENBERG TRAURIG, P.A. 1221 Brickell Avenue Miami, FL 33131 (305) 579-0500 Phone (305) 579-0717 Facsimile Attorneys for Defendants

/s/ David J. George David J. George

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Information

Scott Schultz, et al. v. Applica Incorporated, et al. 06-CV-60149-Consolidated Class Action Complaint For Violations Of Federal Securities Laws

45 pages

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