In re Nutrisystem, Inc. Securities Litigation

• Decision Date: 31 August 2009
• Docket Number: Civil Action No. 07-4215.
• Citation: 653 F.Supp.2d 563
• Parties: In re NUTRISYSTEM, INC. SECURITIES LITIGATION. This document relates to: All Actions.
• Court: U.S. District Court — Eastern District of Pennsylvania

Page 563

653 F.Supp.2d 563

In re NUTRISYSTEM, INC. SECURITIES LITIGATION.

This document relates to: All Actions.

Civil Action No. 07-4215.

United States District Court, E.D. Pennsylvania.

August 31, 2009.

COPYRIGHT MATERIAL OMITTED

Ann D. White, Ann D. White Law Offices, P.C., Jenkintown, PA, David A. Rosenfeld, Coughlin Stoia Geller Rudman & Robbins LLP, Melville, NY, Deborah R. Gross, Law Offices Bernard M. Gross, PC, Leon W. Silverman, Stein & Silverman PC, Philadelphia, PA, Jack I. Zwick, David C. Katz, Joseph H. Weiss, Weiss & Lurie, New York, NY, Marc M. Umeda, Robbins, Umeda & Fink, LLP, San Diego, CA, Evan J. Smith, Marc L. Ackerman, Brodsky & Smith, LLC, Bala Cynwyd, PA, for Plaintiffs.

Marc J. Sonnenfeld, Jill Baisinger, Karen Pieslak Pohlmann, Morgan, Lewis & Bockius LLP, Philadelphia, PA, for Defendants.

MEMORANDUM

McLAUGHLIN, District Judge.

In this consolidated class action, the lead plaintiff alleges that the defendants, NutriSystem Inc. ("NutriSystem" or the "company"), Chief Executive Officer Michael J. Hagan, Chief Financial Officer James D. Brown, Chief Marketing Officer Thomas F. Connerty, and Chief Information Officer Bruce Blair, committed securities fraud in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78a, and Securities and Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5. The action is brought on behalf of purchasers of NutriSystem securities between February 14, 2007 and February 19, 2008 inclusive.¹

NutriSystem is a publicly-traded company that sells weight management products. The plaintiffs allege that the defendants made false and misleading statements about the company's financial health in the face of competition from Alli, an over-the-counter anti-obesity drug produced by GlaxoSmithKline ("Glaxo") and released in June 2007. The plaintiffs allege that the statements made by the defendants artificially inflated NutriSystem's stock price and led to shareholder losses when the share price dropped following the company's disclosures on July 24, 2007, October 3, 2007, and February 19, 2008.

The defendants have moved to dismiss the amended consolidated class action complaint on several grounds. Their main arguments for dismissal of the Section 10(b) claims are: (1) that the plaintiffs have failed to satisfy the heightened pleading burden of the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4, requiring the plaintiff to identify allegedly false statements with particularity and plead facts that raise a strong inference of scienter; (2) that the plaintiffs cannot maintain claims based on NutriSystem's failure to meet earnings estimates announced on July 24, 2007; and (3) that the plaintiffs cannot maintain claims based on events occurring after October 4, the date of the lead plaintiff's final alleged stock purchase. The defendants further argue that all Section 20(a) claims fail because: (1) the underlying Section 10(b) claims fail; (2) the plaintiffs have not adequately alleged culpable participation by the individual defendants; and (c) the plaintiffs have not alleged that defendant Blair is a controlling person for purposes of Section 20.

The Court finds that the plaintiffs have not carried their burden of raising a strong inference of scienter under the PSLRA. The Court also finds that the plaintiffs do not have standing to bring claims arising out of statements made after October 4, 2007, nor have the plaintiffs met their burden of alleging false statements with the particularity required by the PSLRA with respect to most of the allegations in the complaint. The Court will grant the defendants' motion.

I. Allegations of the Complaint and Incorporated Documents²

NutriSystem sells a weight management system based on the purchase of a portion-controlled prepared meal program, typically consisting of a 28-day supply of prepared meals. Compl. at ¶ 2. During the class period, defendant Hagan was NutriSystem's Chairman and Chief Executive Officer. Id. ¶ 19(a). Defendant Brown served as the firm's Chief Financial Officer, but announced on August 10, 2007, that he planned to resign. Id. ¶¶ 19(b), 49. Defendant Connerty was the company's Chief Marketing Officer and Executive Vice President for Product Development, and defendant Blair was the company's Chief Information Officer and Senior Vice President for Operations. Id. ¶¶ 19(c), 19(d).

Because NutriSystem experiences a high rate of attrition with its dieting customers, the company has focused on attracting new customers and closely tracks a metric it calls "Customer Acquisition Costs" ("CAC"). NutriSystem has used CAC as a shorthand for the effectiveness of its marketing and advertising in presentations to investors and analysts. Id. ¶¶ 3-4.

On February 7, 2007, Glaxo announced that the U.S. Food and Drug Administration ("FDA") had approved its weight loss pill for over-the-counter sale. The drug would be known as Alli and released to the market on June 15, 2007. Glaxo invested heavily in marketing and publicity for Alli leading up to and following the drug's introduction. Id. ¶¶ 6-7. Alli was a tremendous success initially, acquiring 1,500,000 customers by July 25, 2007, and 2,000,000 customers by the end of the third quarter of 2007. Id. ¶ 9. The complaint alleges that by virtue of their positions within the company, the defendants were aware of the threat Alli posed to the company's financial health and repeatedly misrepresented that threat in communications to investors and analysts throughout the second half of 2007, ending with the company's announcement of 2007 full-year results on February 19, 2008. Id. ¶¶ 12, 20, 24. The complaint also alleges that defendants Hagan, Brown, Connerty, and Blair ("Individual Defendants"), as senior executive officers or directors of the company, were "controlling persons" within the meaning of Section 20(a) of the Exchange Act and are directly liable for securities fraud under that statute. Id. ¶ 21.

The factual allegations are discussed below in greater detail.

A. February 14, 2007, to July 23, 2007³

On February 14, 2007, one week after Glaxo announced the FDA's approval of Alli for over-the-counter sale, NutriSystem issued a press release reporting fourth quarter 2006 results and providing first quarter and full-year guidance for 2007. The company reported fourth quarter revenue of $133,569,000 and net income of $19,607,000, or $0.53 per diluted share. The company predicted that 2007 first-quarter revenue would be between $205 million and $215 million, "an increase of at least 40% year-over-year," and that full-year revenue would be between $720 million and $740 million. Id. ¶¶ 31-32. Defendant Hagan commented on the results and estimates, noting, "We are very pleased with our start in 2007. Our advertising continues to perform, our new market segments provide us additional visibility for growth, and our revenue stream from ex-customers is starting strong." Id.; Defs'. Mot. to Dismiss Complaint ("Defs'. Br.") Ex. 1 at 1. Brown referred to NutriSystem's former customers as "a growing pool of people . . . offer[ing] us rather larger opportunity over the next several years." Id. Ex. 2 at 2. On February 15, 2007, the share price of NutriSystem's common stock closed at $49.79, up $5.91. Compl. ¶ 34.

On April 25, 2007, the company issued a press release announcing first quarter results and providing guidance for the remainder of 2007. The company exceeded its first quarter guidance, reporting revenues of $238,360,000. Id. ¶ 35. In the press release, Hagan attributed part of the company's first quarter success to "ongoing expansion of our pool of ex-customers," Defs'. Br. Ex. 4 at 1, and the company raised its estimate of 2007 full year revenues to between $790 million and $805 million. Compl. ¶ 36. Hagan added:

2007 is shaping up to be a very good year for us. Our 2007 strategy is to focus on three areas: profitable new customer growth across all market segments—women, men, and seniors; continues to improve retention and reactivation efforts and invest in product areas such as our new 2008 weight loss program that advance customer health while growing the lifelong value of each customer.

Id. (internal quotation marks omitted). The company's share price rose $5.05 per share over the following two days and closed at $63.29. Id. ¶ 38.

Consistent with Glaxo's announcement in February, Alli began over-the-counter sales on June 15, 2007. Id. ¶ 39.

B. July 24, 2007, to October 4, 2007

1. The July 24, 2007, 2Q Earnings Announcement and Conference Call

On July 24, 2007, NutriSystem announced its second quarter financial results, third quarter estimates, and full-year guidance in a press release. Id. ¶ 40. The company reported revenues of $213,556,000 for the second quarter, and CEO Hagan stated, "[t]he quarter was a very good one and we were pleased with the solid growth in our core women's market and continued strength in revenue coming from our ex-customers." Id. CFO Brown noted the company's

[s]ubstantial investments in the business to improve future profitability including a new e-commerce platform, the new food program, a new call center and international expansion. To date we've used our strong cash flow to fund stock buy-backs. In the first half of 2007, we generated net cash from operations of $98 million and repurchased 2.0 million shares for $98 million.

Id. In the press release, NutriSystem estimated third quarter revenues between $200 million and $208 million, and raised its full year 2007 revenue guidance to between $810 million and $820 million. The press release quotes CEO Hagan as saying, "[t]he business performed extremely well for the first half of 2007. We continue to be excited about the new market segments we've launched in the past year and even more excited about how often our excustomers are returning to us." Id. ¶ 41.

A conference call with securities analysts...