The Corporation: INVESTIGATIONS
STATIC IN CINCINNATI
Jacques A. Robinson, president and CEO of Cincinnati Microwave Inc., knows the importance of burnishing the corporate image. Back in 1993, cash was so tight at his troubled company that employees occasionally had to bring their own toilet paper to the office. Yet on one spring day, employees watched with surprise as Robinson and his wife boarded a rented luxury bus with key customers and took off for a couple of days at the Kentucky Derby. The $10,000 to $15,000 tab was picked up by CMI. Two top-ranking company executives say Robinson told them that CMI needed to keep up appearances or the company was sunk.
Robinson denies making such a statement. But now, numerous former executives at the company allege that CMI may have gone much further to spruce up its public image. In a runup to CMI's successful $18 a share secondary offering in August, the company's stock skyrocketed from 3 to a high of 21 1/8, amid optimistic pronouncements by the company and analysts that a turnaround was under way. The company said the sharp losses it suffered in 1994 were largely the result of a one-time problem beyond its control--a worldwide shortage of a critical component for its cordless phones. But numerous former senior and midlevel CMI executives say the company used the shortage to disguise far more extensive problems in its design, procurement, and manufacturing than it was disclosing.
Robinson dismisses such allegations as "complete and utter nonsense." And he has the backing of some big investors. "We continue to believe in the long-term potential of the company," says LeRoy C. Kopp, president of Kopp Investment Advisors Inc. in Edina, Minn., CMI's largest outside shareholder.
NEW SKEPTICISM. But others appear unimpressed. The controversy--together with CMI's Oct. 13 announcement of anticipated third-quarter losses--has sent the stock below 7. On Oct. 18, two shareholder class actions were filed alleging that CMI failed to disclose problems at the time of the offering. And the only two analysts who actively follow the company--Montgomery Securities Corp.'s Matthew S. Robison and Roney & Co.'s Stephen Roberts--have suddenly grown skeptical. Both analysts dropped their buy recommendations after the Oct. 13 announcement.
CMI was once a promising company. It was founded in 1976 by James L. Jaeger, today the hands-off chairman. Jaeger declined to be interviewed. Largely on the strength of its popular Escort radar detector, CMI enjoyed strong growth until a rash of cut-price competitors hit the market. The company has been in the red since 1989, losing a total of $38.2 million.
Enter Robinson, 48, a chemical engineer and former General Electric Co. executive whom Jaeger recruited in 1991. A turnaround specialist who worked under GE CEO Jack F. Welch Jr., Robinson has shored up the balance sheet and lessened dependence on radar detectors. His goal: to use CMI's expertise in wireless technology to branch into modems and cordless phones.
But with modems yet to pick up steam, Robinson has banked CMI's future for now on a hot new cordless phone launched in 1993. CMI says its phone, retailing for around $279, promises no static, greater range than traditional cordless phones--and is eaves-drop-proof. A confident Robinson projected early last year that phone sales would help return CMI to profitability in 1994.
Midway through 1994, however, CMI ran into major production problems. In press releases, Securities & Exchange Commission filings, and meetings with investors, CMI blamed the problems on a "worldwide shortage" of a tiny 14 cents inductor, a key electronic component. The inability to get inductors, Robinson says, brought "our phone production to its knees." As a result, CMI lost phone sales worth $9.5 million in the third quarter. On 1994 sales of $64.7 million, CMI lost $10.3 million.
Today, Robinson says CMI has taken steps to "improve our materials and inventory management." And in a written statement, CMI makes clear where responsibility lies. Arguing that CMI's purchasing department "missed the boat" in 1994, the company has instigated many changes, including "replacement of ineffective personnel."
Industry sources concur that surging demand for inductors during that period did cause a temporary shortage. But numerous former CMI executives in manufacturing, marketing, and procurement allege that the lack of inductors was only one of a raft of problems CMI faced with its new phones. "The inductor issue was nothing more than a smoke screen cooked up by Jacques to hide the many other, more severe problems at the company," says a former procurement official who is among those the company has replaced.
"SCAPEGOAT." His view is seconded by numerous other top-ranking former executives who oversaw the design and manufacture of the phones--all of whom have since voluntarily left CMI. "Jacques used the inductor as a scapegoat," says one former officer. "We all had a good laugh when he pinned it on the inductor."
CMI's biggest problem, say several of those sources, was a design flaw that caused excessive static and limited the phone's range. "In August and September, approximately half of the phones built didn't work," says a high-ranking former manufacturing executive. Other sources, without knowing the precise amount, agree that large numbers of rejected phones were piling up. That in turn created huge procurement problems, say the sources, because CMI's buyers had to scramble to buy extra parts on short notice in order to make enough shippable phones. At the same time, significant difficulties with inventory controls meant other parts were frequently missing. Numerous former executives, including some who oversaw daily phone production, indicate such problems shut down production more often than missing inductors. The company declines to comment on allegations involving design flaws, procurement lead times, or inventory controls.
Still, several sources say that CMI's inability to get inductors didn't stem from a shortage but from poor relations with Toko America Inc., its main supplier. Having experienced significant difficulties getting paid by CMI, Toko considered CMI a low-priority customer. "They screwed themselves," says Thomas Kons, Toko's Midwest salesman. "If they'd been on top of scheduling, paid their bills, and had good potential, Cincinnati Microwave would have gotten all the inductors they needed." CMI declined to comment on this allegation.
As CMI continued to have problems building the phones, its cash woes worsened; in December, 1994, a Price Waterhouse auditor's report raised doubts about whether the company could survive. Price Waterhouse declined to comment. Roney & Co. agreed to a rights offering. Around the time Roney's due-diligence team arrived at CMI's headquarters, an impromptu noon meeting was held in the office of Troy Gross, the company's former treasurer. The meeting included Gross, inductor buyer Jeanne Fisher, and Chief Operating Officer John Noland.
NUMBERS GAMES. Fisher was told to bring purchase orders for the inductors to the meeting so they could be reviewed. The reason? "Gross and Noland were sweating bullets," says a CMI official who attended the meeting. "They were trying to figure out what would happen if Roney asked to see the purchase orders." That's because the purchase orders, with attached production schedules, showed that manufacturing was demanding that the procurement department order parts with inadequate lead times. That could have revealed the scramble imposed by the high rejection rate and shown that bad scheduling made the inductor problem worse. CMI declined to comment on the charges, as did Noland through a spokesman. Fisher resigned from CMI in January, 1995. Gross denies such a meeting took place.
Roney's bankers declined to comment on whether they asked to see the purchase orders. But convinced that CMI's 1994 losses stemmed only from a one-time inductor shortage, Roney went ahead with a successful rights offering in late December at roughly $3.50 a share. The deal netted $9.7 million and kept the company afloat.
In March, CMI inked a key deal to sell its cordless phones to AT&T. Soon after, Montgomery Securities and Roney agreed to underwrite a secondary offering. The sales projections given by Robinson to the investment bankers called for upwards of 250,000 phones to be sold in 1995, the bulk to AT&T. As analysts for both companies talked up the stock, CMI shares took off. On Aug. 24, the $18 a share secondary offering of 4 million shares came off as planned. Chairman Jaeger sold roughly half his holdings for $58.7 million, while the company pocketed $19.1 million.
But internal projections prepared by CMI's sales department under the direction of the former head of sales, Gary S. Oppito, called for total sales of significantly fewer phones than Robinson had projected. Several high-ranking former CMI executives said Robinson pressured Oppito and his staff to present a united front on sales. If the lower projection got out, it could have jeopardized the secondary offering.
Robinson denies putting pressure on Oppito. He says CMI's sales department had a history of making lowball projections--and that he had worked closely enough with customers to develop his own estimates. But actual phone sales in 1995's first three quarters are only about 100,000. To meet Robinson's target, an additional 150,000 will have to be sold in the fourth quarter--and as of Oct. 20, according to one insider, confirmed orders through yearend total just 85,000, while the manufacturing problems linger.
"UNCERTAINTY." In September, both investment houses said they had confidence in CMI and in the information that it supplied in connection with the offerings. "Given the company's history and last year's significant losses, we did a very deep level of due diligence and we were comfortable with what we heard," said George Vetter, managing director in Montgomery's investment banking department. Added Dainforth French Jr., senior vice-president for Roney's corporate-finance unit: "Jacques' story checked out." Both investment bankers have declined subsequent comment in the wake of the shareholder lawsuits.
Robinson continues his upbeat assessment. In an October phone call with analysts, he said that the company is on track to build and sell 150,000 phones by yearend. Roney analyst Roberts has turned skeptical. "There's a lot of uncertainty; we need to see some actual earnings," he says. Indeed, talking up a stock is one thing; delivering is another.
Is CMI's Outlook Solid-Or Were Investors Misled?
-- MAY 19, 1994 Stock hits nine-year high in wake of company's bullish forecasts.
-- DEC. 14, 1994 After Price Waterhouse questions its ability to survive, CMI raises $9.7 million in rights offering.
-- MAR. 22, 1995 Company tells investors that demand for CMI's phone "remains strong," and the stock soon soars.
-- AUG. 24, 1995 Robinson projects phone sales over 250,000 by yearend in advance of successful secondary offering.
-- SEPT. 20, 1994 CMI says shortage of a key component will slash phone sales and cause loss for 1994. But former CMI executives allege that far broader problems led to losses. CMI denies any such problems.
-- OCT. 13, 1995 In wake of poor third-quarter results and an investigation by BUSINESS WEEK, CMI's stock collapses.
DATA: BLOOMBERG FINANCIAL MARKETS, COMPANY REPORTS, BUSINESS WEEKBy Willy Stern in New York