Searching over 5,500,000 cases.

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

In re NutriSystem

October 26, 2009


The opinion of the court was delivered by: McLaughlin, J.

This document relates to: All Actions



This is a derivative action involving NutriSystem, Inc. ("NutriSystem"), a publicly-traded company that sells weight management products. NutriSystem's share price fell markedly on October 3, 2007, when the company announced a lowered earnings forecast as a result of competition from Alli, an over-the-counter anti-obesity drug produced by GlaxoSmithKline ("GSK") and released in June 2007. Several lawsuits were filed in this district within a month of this drop in share price, each alleging, among other claims, that NutriSystem and its management made false and misleading statements about the effect Alli was having on the company's sales.

Eight putative securities class actions were consolidated as In re NutriSystem, Inc. Securities Litigation, 07-4215. The Court granted the defendants' motion to dismiss the consolidated class complaint in that action on August 31, 2009. Two derivative actions on NutriSystem's behalf were filed in this district and consolidated in the above-captioned action. The Court now considers the defendants' motion to dismiss the consolidated derivative complaint.*fn1

In the consolidated derivative complaint, plaintiff James Fetzner, a NutriSystem shareholder, seeks to bring claims on NutriSystem's behalf against ten of its officers and directors.*fn2 The defendants are four executives of the company, Chief Executive Officer ("CEO") Michael J. Hagan, Chief Financial Officer ("CFO") James D. Brown, Chief Marketing Officer ("CMO") Thomas F. Connerty, and Chief Information Officer ("CIO") Bruce Blair, and six members of its board of directors, Ian J. Berg, Robert F. Bernstock, Michael A. DiPiano, Warren V. Musser, Brian P. Tierney, and Stephen T. Zarilli. CEO Hagan is also a member of the board of directors.

The defendants are alleged to have 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, and to be liable under Delaware law for breach of their fiduciary duties, waste, and unjust enrichment. The plaintiff has not made a demand on NutriSystem's board or its shareholders, but contends that any demand on the board would be futile and any demand on the shareholders would be impractical.

The defendants move to dismiss the consolidated derivative complaint on two grounds. They argue that the plaintiff has failed to adequately allege that making a demand on NutriSystem's board would be futile because the complaint does not contain sufficient particularized factual allegations to overcome the presumption that the board would act impartially on the demand. In the alternative, the defendants argue that the complaint fails to state a claim upon which relief can be granted.

The Court finds that the plaintiff has not carried his burden of pleading facts sufficient to show that his failure to make a demand on NutriSystem's board is excused on grounds of futility. The derivative complaint will therefore be dismissed. Because the Court has found that demand is not excused, the Court will not address whether the plaintiff's complaint should also be dismissed for failure to state a claim.

I. Allegations of the Complaint and Incorporated Documents*fn3

A. The Parties

Plaintiff James Fetzner is an individual who owned NutriSystem common stock during the events alleged in the complaint. NutriSystem is a corporation organized under the laws of Delaware that sells weight management and fitness products. Compl. ¶¶ 9-10.

Since December 2002, NutriSystem's Chairman of the board and CEO has been defendant Hagan. Hagan was also NutriSystem's President from July 2006 to September 2007. Defendant Connerty has been NutriSystem's CMO since November 2004 and its Executive Vice President for Program Development since July 2006. Defendant Brown was NutriSystem's CFO from December 1999 until he resigned in August of 2007; he was also the company's Treasurer, Secretary, and an Executive Vice President during the relevant period through August 2007. Defendant Blair has been NutriSystem's CIO and Senior Vice President, Operations since April 2005. These four defendants will be referred to collectively as the "management defendants." Compl. ¶¶ 10-14.

Defendants Berg, Tierney, and Musser and Zarilli have been members of the NutriSystem board of directors since February 2003. Defendant DiPiano has been a NutriSystem director since December 2002; defendant Musser has been a director since December 2003, and defendant Bernstock has been a director since December 2005. These six defendants will be referred to collectively as the "director defendants." Compl. ¶¶ 15-20. Another member of the board of directors, Michael F. Devine, III, was originally named as a defendant in this action, but was voluntarily dismissed by the plaintiff in April 2008.

During the relevant time period, up through April 7, 2008, the members of NutriSystem's board of directors were Hagan, the six director defendants, and non-defendant Devine. The audit committee of NutriSystem's board of directors comprised director defendants Berg, DiPiano, and Zerilli and non-defendant Devine. The audit committee was responsible for reviewing NutriSystem's press releases and earnings guidance provided to the public. Defendants DiPiano and Tierney were members of the board's compensation committee, which had the authority to review and approve the salary, bonus, and equity compensation of NutriSystem officers, including CEO Hagan. Compl. ¶¶ 15-20, 78.

After the operative complaint was filed in March 2008, NutriSystem announced on April 8, 2008, that Hagan would be replaced as CEO by Joseph Redling. Redling joined the board of directors on April 7, 2008. At least up through the briefing on the motion to dismiss, Hagan has remained on the board of directors as well, changing its membership from eight to nine members. Apr. 8, 2008, Press Release, Def. Ex. 9.

B. The Development of Alli, a NutriSystem Competitor

The drug that GSK now markets as Alli has the formulary name of Orlistat and was previously marketed as the prescription drug Xenical. The Food and Drug Administration ("FDA") approved the drug for prescription use in 1999. GSK subsequently purchased the rights to the drug and sought to have it approved for sale over-the-counter. Compl. ¶ 35.

GSK's efforts to have the drug sold over-the-counter were known to NutriSystem. In November 2006, NutriSystem sponsored a presentation at an investor conference by Dr. Gary Foster, an expert in obesity research. The presentation concerned trends in the field of obesity treatment. Dr. Foster stated at the presentation that Alli was the safest weight loss medication ever studied and that it was "certain to be approved." Dr. Foster said that he expected the public would respond with a "surge" of interest and that Alli could become a "blockbuster," although he also said that it might not. Dr. Foster said that he thought the market would be able to tell within the first six months what would happen with Alli's sales. Compl. ¶¶ 44-46.

In January 2006, an FDA advisory committee recommended that the drug be approved for over-the-counter use, a significant step toward final approval. A January 18, 2006, article in the New York Times discussed the drug and its prospects for approval for use without a prescription. In October 2006, GSK reported in forms filed with the Securities and Exchange Commission ("SEC") that it had submitted its final safety and efficacy data to the FDA and that it expected to launch the drug in the first half of 2007. On February 7, 2007, the FDA announced that it had approved Alli for over-the-counter use in the United States. In a USA Today article in May 2007, GSK was quoted as estimating that five to six million Americans a year would use the drug for sales of at least $1.5 billion a year. Compl. ¶¶ 37-40.

GSK introduced Alli to the market on June 13, 2007. The introduction was accompanied by significant media coverage. Sales of Alli were very high. In October 2007, GSK reported sales of more than two-million starter kits for Alli in the four months since its introduction. Compl. ¶¶ 40-41.

C. NutriSystem's Public Statements Before and After Alli's Introduction from February 2007 through February 2008

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 press release stated that the first quarter of 2007 had "started off strong with growth across all of our market statements" and that "key financial metrics such as customer acquisition costs have improved over the course of the quarter." 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 earnings would be between $0.88 and $0.92 per diluted share. The company estimated that full-year revenue would be between $720 million and $740 million. Compl. ¶ 47.

On April 25, 2007, NutriSystem issued a press release announcing first quarter results and providing guidance for the remainder of 2007. The company reported first-quarter revenues of $238,360,000 and net income of $37 million or $1.04 per diluted share. The company estimated that second-quarter revenues would increase 43% year-over-year to between $190 million and $200 million and that it would add at least 210,000 new Direct channel customers in that period. The company raised its estimate of 2007 full year revenues to between $790 million and $805 million.

In the April 25, 2007, press release CFO Brown is quoted as saying that the company's "economics are strong and getting stronger." CEO Hagan is quoted as saying that "2007 is shaping up to be a very good year for us" and that the company's strategy is to "focus on three areas: profitable new customer growth across all market segments -- women, men, and seniors; continue 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." Compl. ¶ 48.

On July 24, 2007, over a month after Alli's introduction to the market on June 13, 2007, NutriSystem issued a press release announcing its second quarter financial results, third quarter estimates, and full-year guidance. The company reported revenues of $213,556,000 for the second quarter and diluted earnings per share of $0.96, an increase of 61% and 81% over those figures for the second quarter of 2006. CEO Hagan was quoted as saying that "[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. In the press release, NutriSystem estimated third quarter revenues of between $200 million and $208 million, and raised its full year 2007 revenue guidance to between $810 million and $820 million. Compl. ¶ 49.

A conference call with securities analysts was held on July 24, 2007, to discuss the company's results and earning guidance. In that call, CEO Hagan noted that the company was seeing "some slight softness in demand starting in late June and carrying into early July." Id. Hagan added that the company "believe[d] the launch of a new over-the-counter weight loss pill with significant PR and media behind it has had an effect, and based on information we have this is fully reflected in our guidance for the remainder of the year." Transcript of July 24, 2007, NutriSystem Q2 2007 Earnings Call, Ex. 6 to Mot. to Dismiss. In response to a question from an analyst, Hagan stated that for the first time we did see some slight softening of demand as we entered the second half of June and not so coincidentally we believe that it might be related to the launch of a new over-the-counter drug from GSK and the big PR and media blitz surrounding it.*fn4

... we believe that --- what you often see in cases such as this, you get a lot of pent-up demand because of the huge amount of hype around this product. But if consumers either don't lose the weight or not fast enough or don't like the side effects then we believe it is just a temporary type of thing and this is what we believe.


On October 3, 2007, NutriSystem issued a press release announcing preliminary third quarter 2007 results and revising guidance for the remainder of 2007. The release stated that the company was now forecasting earnings for the third quarter of only $188 million, below the previously forecast range of $200 to $208 million. NutriSystem also stated that its number of new customers in the quarter was expected to be only 218,000, a 7% decline from the third quarter of the prior year. The press release quoted CEO Hagan as saying that, although the results for the third quarter did not meet expectations, the company continued to be "satisfied" with its performance:

We continue to be satisfied with our success in reactivating former customers, but our performance with new customers we believe was affected by shorter[-]term competitive pressures which caused our marketing dollars to become less efficient, resulting in fewer new Direct Business customers than anticipated and customer acquisition costs to be higher than anticipated.

Id. ¶ 51.

On October 24, 2007, the company issued a press release announcing financial results for the third quarter, confirming most of the guidance provided on October 3rd. The company announced third-quarter earnings of $188 million and revised its yearly earnings forecast to between $770 million to $776 million, over $30 million less than the July 24, 2007, estimate. The release stated that NutriSystem expected fourth quarter revenue to be flat on a year-to-year basis and the number of new customers in the fourth quarter to be down 20% as compared to a year earlier. CEO Hagan was quoted in the release as saying that, although the company "continue[d] to feel positive about [its] business and its long-term strength," the third-quarter results did not "meet our growth expectations." Hagan conceded in the release that "competitive pressures from new entrants in the weight loss market had a larger effect on our marketing efficiency than anticipated" and that growth in new customers was off 11% from the guidance provided in July 2007. Id. at 52.

On February 19, 2008, NutriSystem had a conference call with analysts to discuss the company's 2007 results. Participating in the call were CEO Hagan and non-defendants David Clark, who had replaced defendant Brown as CFO in August 2007, and Joseph Redling, who would replace Hagan as CEO in April 2008. CEO Hagan announced full year 2007 revenues of $777 million and fourth quarter 2007 revenues of $137 million, which increased 3% over the previous year. Hagan also announced an 18% decline in new customers in the fourth quarter. Id.; Compl. ¶ 59. CFO Clark announced that the company would be changing the metrics it used to assess its long-term profitability, moving from an emphasis on customer acquisition costs to "gross margins, marketing as a percentage of sales and adjusted EBITDA margins." Clark explained:

As you have heard and will hear our management is focusing on operating our company as a recurring revenue model that focuses not just on first-time customers but on generating maximum profitability over their time with us. Consequently, we will be directing increasing portions of our marketing and promotional spending toward extending length of stay and increasing the instance of reactivations.

Accordingly we will measure our success on adjusted EBITDA [earnings before income, taxes, depreciation, and amortization] generation and the consequent margin as compared to our revenue. And so consistent with subscriber-based businesses [sic] and we are also consistent with our peers, commencing in the first quarter we will move our focus towards gross margins, marketing as a percentage of sales, and adjusted EBITDA margins. And you will see us move away from CAC, revenue per customer and other new customer focused metrics. While continuing to use these tactical metrics to make day-today operating decisions, we will have our strategic focus on long-term profitability.

Compl. ¶ 53.

D. Alleged Insider Selling

The plaintiff alleges that six of the defendants sold NutriSystem shares in 2007. These sellers are the four management defendants --- Hagan, Brown, Connerty, and Blair -- and two of the director defendants --- Berg and Tierney. The total amount sold by these defendants was 305,179 shares for gross proceeds of $19.5 million. Compl. ¶¶ 67, 75

The vast majority of these sales occurred between April and June 2007, before the June 15, 2007 introduction of Alli. CIO Blair sold shares worth $2,581,319 on May 2, 2007. CEO Hagan sold shares worth $4,013,644 on June 1 and 4, 2007. CMO Connerty sold shares worth $7,818,657 on April 4, 5, and 26; May 1 and 25; and June 1, 2007. CFO Brown sold shares worth $2,942,380 on May 10, June 11, July 10, and September 10, 2007. Director Tierney sold $987,440 worth of shares on June 8, 2007, and director Berg sold $1,127,840 worth of shares on July 2, 2007. Compl. ¶¶ 67-68.

The complaint describes Brown's September 10, 2007, sale as particularly suspicious. Defendant Brown had retired as CFO of the company in August 2007. On September 10, 2007, he sold $687,120. A week and a half later, a Citigroup analyst, citing short-term competition from Alli, lowered his price target for the stock from $90 to $81 dollars per share. Upon this news, NutriSystem's shares dropped 12% to $50.08 per share. Compl. ¶¶ 69-70.

E. NutriSystem's Stock Buy-back

In 2006 and 2007, NutriSystem's board of directors authorized the company to buy back its own shares. Three buy-backs were authorized permitting a total of $350 million of the company's shares to be purchased, but the company ...

Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.