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IN RE TWINLAB CORP. SECURITIES LITIGATION

July 5, 2000

IN RE TWINLAB CORPORATION SECURITIES LITIGATION.


The opinion of the court was delivered by: Spatt, District Judge.

    MEMORANDUM OF DECISION AND ORDER

This class action securities fraud case was brought by purchasers of stock in Defendant Twinlab Corp. ("Twinlab") against the corporation, its underwriters, and its directors and officers, alleging that the company engaged in fraudulent accounting and business practices in an effort to artificially inflate its stock price. Presently before the Court are motions to dismiss the complaint by each of the Defendants.

BACKGROUND

Twinlab is a Delaware corporation with its principal place of business in Hauppauge, N.Y., and is engaged in the manufacture and wholesale distribution of various vitamins, mineral supplements, herbal remedies, and other non-prescription health and nutritional aids. Twinlab stock is traded on the NASDAQ stock exchange. The Plaintiffs, a class of purchasers of Twinlab stock from April 8, 1998 through February 24, 1999 ("the Class Period"), allege that during that time, Twinlab engaged in a fraudulent accounting practice known as "earnings management" and a deceptive business practice called "channel stuffing" to artificially inflate sales and earnings figures for the company so as to fraudulently raise the value of the stock.

A. The secondary offering prospectus

In the Spring of 1998, Twinlab, through underwriters Defendant Bear, Stearns & Co. ("Bear, Stearns") and Defendant Donaldson, Lufkin & Jenrette ("DLJ"), was preparing for a secondary offering of some 9.2 million shares of Twinlab stock. In conjunction with the secondary offering, Twinlab published a prospectus containing relevant financial information. According to the Plaintiffs, the prospectus made the following misleading statements:

(a) that in the first quarter of 1998, Twinlab received "a substantial increase in orders for its herbal supplement products";
(b) that Twinlab believes "that there has been no material decline in retail sales of its vitamin, mineral and nutritional supplements products during the first quarter of 1998;" and
(c) that "there has been adequate inventory of its products in the distribution channel."

The Plaintiffs contend that, in reality, Twinlab had suffered a decline in retail sales in the first quarter of 1998, and that it was concealing this decline by a practice known as "earnings management." In essence, Twinlab was taking accounting credit for sales of products in the first quarter of 1998, even though it had not completely shipped the products to the customers before the end of the quarter. Twinlab's prospectus included a statement of its accounting practices that indicates that "revenue from product sales is recognized at the time of shipment to the customer." In addition, the Plaintiffs allege that "growth at Twinlab was materially overstated because the Company was . . . stuffing its distribution channels with product at volumes that would not be sustained in later quarters [channel stuffing]."

The secondary offering took place on April 8, 1998. Approximately 9.2 million shares of Twinlab were sold, roughly half by Twinlab and half by Defendant Green Equity Investors II ("GEI"), who had previously held nearly a third of Twinlab's stock. On the day of the secondary offering, Twinlab's stock price was $36.50 per share, and the secondary offering yielded a total sum of roughly $335,000,000.

B. The April 28,1998 press release and first quarter 1998 10-Q form

On April 28, 1998, Twinlab issued a press release regarding its first quarter 1998 performance. Twinlab reported that its net sales for first quarter 1998 were $73.5 million, a 43.5% increase from the first quarter of 1997; that its net income for the first quarter of 1998 was $8 million, an increase of 40.9% from 1997; and that its earnings had risen to $.29 per share, 38.1% higher than the previous year. According to the Plaintiffs, those figures were falsely inflated because of Twinlab's practice of earnings management. In addition, the Plaintiffs allege that the press release contained additional misrepresentations:

(a) that Twinlab's "private label herbal product sales increased to $18.1 million" for the quarter; and
(b) that "during the first quarter of 1998, the Company received a substantial increase in the orders for its herbal supplement products . . . due to strong demand at the retail level"

According to the Plaintiffs, these statements were false as they failed to reveal the financial impropriety of Twinlab's "earnings management," and because it failed to reveal the "channel stuffing" that was taking place. As mentioned above, the Plaintiffs allege that, were it not for Twinlab's accounting improprieties, the company would report a decline in retail sales for the first quarter of 1998.

On May 15, 1998, Twinlab filed its first quarter 1998 10-Q form with the Securities and Exchange Commission. It recited the allegedly false sales figures mentioned in the press release. In actuality, as was eventually revealed in March 1999, Twinlab's sales for first quarter 1998 were $69.6 million, not $73.5 million; its net income for the quarter was $6.9 million, not $8 million; and its earnings per share was actually $.25, not $.29.

C. The purchase of PR nutrition and the second quarter 10-Q form

On June 9, 1998, Twinlab signaled its intent to purchase a competitor called PR Nutrition, in an effort to capture a share of the profitable energy bar market. Twinlab proposed a stock exchange with PR Nutrition, by which Twinlab would gain control of PR Nutrition in exchange for 1 million shares of Twinlab stock of a value of between $38.50 and $42.00 per share.

On July 28, 1998, Twinlab issued a press release regarding its second quarter 1998 financial results. The Plaintiffs claim that these statements in the press release regarding its earnings were materially false, again because of Twinlab's practices of "earnings management" and "channel stuffing." The Plaintiffs contend that Twinlab made additional false statements in the press release regarding its perceived growth opportunities in its distribution channels. Also, the Plaintiffs allege that the July 1998 press release failed to disclose problems Twinlab was having in producing its TruHerb product line.

The press release also contained semi-annual financial information, reflecting Twinlab's performance for the first half of 1998. The Plaintiffs allege that this information was false for the same reasons described above.

On August 14, 1998, Twinlab filed its second quarter 10-Q form with the SEC. The second quarter 10-Q reported net sales of $78.5 million, net income of $5.4 million, and earnings of $.27 per share. As Twinlab would eventually acknowledge in March of 1999, these figures were incorrect. In actuality, second quarter 1998 net sales were $77.6 million, not $78.5 million; net income was $5.2 million, not $5.4 million, and earnings were $.25 per share, not $.27. The Plaintiffs claim these statements were materially false because of Twinlab's "earnings management" and "channel stuffing."

D. The GNC announcement and Twinlab's August 5, 1998 press release

On August 3, 1998, GNC, a major distributor of Twinlab's products, announced that it was not going to reach its revenue targets due to increased competition, and that it was going to request that its suppliers, including Twinlab, discount their products. GNC's announcement caused stock prices in the sector to fall, and Twinlab's stock, which had been trading in and around the $40 range prior to the announcement, fell into the mid-$20 levels.

Two days after GNC's announcement, on August 5, 1998, Twinlab issued a press release regarding the GNC statement. According to the Plaintiffs, that press release contained numerous false statements, including:

(a) that all of Twinlab's distribution channels had performed as expected in the first half of 1998;
(b) that financial results for the first six months of 1998 showed increases of 40-50% over the prior year, and that sales to GNC were a decreasing percentage of overall sales;
(c) that Twinlab would soon be introducing two new product lines, including the TruHerbs line; and
(d) that pricing fundamentals for the company remained unchanged.

The Plaintiffs contend that these statements were materially false because of Twinlab's practices of "earnings management" and "channel stuffing"; because Twinlab had not yet renewed its annual distribution contract with GNC that would expire the next month; Twinlab's relationships with other retailers was straining its relationship ...


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