Businesses these days face a wide variety of headwinds – rising interest rates, economic inflation, supply chain and labor supply disruptions, war in Ukraine, even continued disruptions from COVID – that are interfering with business operations and affecting financial performance. In some instances, these macroeconomic factors are translating into securities litigation. In the latest example of this phenomenon, a plaintiff shareholder has sued video display systems company Daktronics following the company’s announcement that supply chain disruptions, labor shortages, and shutdowns in China caused a decline in the company’s sales, which led to a later announcement of a “substantial doubt” of the company’s ability to continue as a going concern. The December 21, 2022, complaint can be found here.
Background
Daktronics designs and manufactures electronic scoreboards, display systems, and video displays. On August 31, 2022 issued a press release announcing that the company had experienced “multiple material supply chain disruptions, labor shortages, and a shutdown of our facilities in Shanghai, China for a significant portion of the quarter.” These disruptions had resulted in a significant decline in gross profit, as well as an increase in operating expenses and a decline in operating margin. The company’s share price declined over 22% on this news.
Then on December 6, 2022, the company announced that it would be unable to timely file its Form 10-Q for the period ending October 29, 2022, and that there is a “substantial doubt” about the Company’s ability to continue as a going concern. The company also recorded a valuation allowance for $13 million of deferred tax assets, which created a covenant violation under the company’s line of credit. The company also stated that it “expects to conclude that its disclosure controls and procedures and internal controls over financial reporting were not effective as a result of material weaknesses.” The company’s share price declined nearly 40% on this news.
The Lawsuit
On December 21, 2022, a plaintiff shareholder filed a lawsuit in the Southern District of New York against the company and certain of its officers. The complaint purports to be filed on behalf of investors who purchased the company’s shares between March 10, 2022 and December 6, 2022.
The complaint alleges that during the class period the defendants failed to disclose: “(1) that the Company was experiencing challenges that increase costs, including supply chain disruptions, that impacted Daktronics’ ability to fund inventory levels and operations; (2) that, as a result, it was probably that some portion of the Company’s deferred tax assets would not be realized; (3) that as a result, Daktronics was reasonably likely to record a material valuation allowance to its deferred tax assets; (4) that there were material weaknesses in the Company’s internal controls over financial reporting related to income taxes; (5) that the foregoing presented liquidity concerns and there was substantial doubt as to the Company’s ability to continue as a going concern; (6) and that as a result of the foregoing, Defendant’s positive statements about the Company’s businesses, operations, and prospects were materially misleading and/or lacked a reasonable basis.”
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the class.
Discussion
In a few days, I will be publishing my annual survey of the Top Ten D&O Stories of the year. One of the stories featured in the survey will be that macroeconomic factors are an increasingly important source of securities class action lawsuits and other litigation. Supply chain disruption is one of the many factors that led to litigation during the year. In addition to the lawsuit described above filed against Daktronics, plaintiff’s lawyers have filed a number of other lawsuits during the year against companies that experienced supply chain woes, including, for example and as described here, the lawsuit filed in November 2022 against women’s apparel company Torrid, and the lawsuit filed earlier in November 2022 against the healthcare apparel company FIGS (as discussed here). I will have more to say on this topic in my forthcoming Top Ten survey, which I will publish early in the New Year.
To be sure, the Daktronics lawsuit is about more than just supply chain woes. The company’s press release cited, in addition to supply chain issues, labor supply disruption, and closures in Shanghai. The company was experiencing the fully panoply of challenging macroeconomic factors, The company also experienced changes to the valuation of its deferred tax assets and noted a going concern opinion, but those financial consequences appeared to flow directly from the macroeconomic factors – which illustrates just how disruptive the macro factors can be for some companies, and which in turn leads to the risk of securities litigation of the type filed against Daktronics.
I will say that when the time comes for the court to consider the defendants’ motion to dismiss, the court will have to conduct a diligent search to find anything in the complaint relevant to the plaintiff’s obligation to plead scienter and to show that the inference of scienter is more likely than any other likely inference.