in re: organogenesis, inc. securities litigation 04-cv...
TRANSCRIPT
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 1 of 39
Exhibit A
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 2 of 39
UNITED STATES DISTRICT COURT DISTRICT OF MASSACHUSETTS
MASTER FILE NO. 04-10027 JLT
IN RE ORGANOGENESIS SECURITIES LITIGATION CORRECTED CONSOLIDATED
AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS
JURY TRIAL DEMANDED
Plaintiffs, through their attorneys, bring this action on behalf of themselves and all others
similarly situated, on personal knowledge as to themselves and their activities, and on all other
matters based upon the investigation of counsel, including, inter alia, a review of United States
Securities and Exchange Commission ("SEC") filings by Organogenesis, Inc. ("Organogenesis"
or the "Company"), securities analysts' reports and advisories about the Company, press releases
and other public statements issued by the Company, newspaper articles and media reports about
the Company, and interviews with former employees of the Company and other companies who
are knowledgeable about the businesses of those companies. Plaintiffs believe that substantial
additional evidentiary support will exist for the allegations set forth herein after a reasonable
opportunity for discovery.
SUMMARY OF THE COMPLAINT
1. This is a federal class action on behalf of purchasers of the securities of
Organogenesis between November 15, 1999 and February 7, 2002, inclusive (the "Class
Period"), seeking to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange
Act")
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 3 of 39
2. Throughout the Class Period, Organogenesis was a Company with only one
commercially available product - Apligraf, a unique skin replacement therapy used for severe
skin wounds. Thus, most if not all of the Company's revenues were generated from the sale of
Apligraf. Organogenesis describes Apligraf as having a structure similar to human skin and as
being a "skin construct," composed of living cells. The product's human skin-like properties
allow this product to be used by doctors to aid in the healing of certain types of skin ulcers, and
other epidermal injuries.
3. At all times throughout the Class Period, defendants were well aware that the
Company's business model was entirely dependent upon their ability to mass-produce Apligraf
and market it to physicians as an "off-the-shelf," cost-effective product that doctors could use on
patients absent hospitalization. While the Company encountered some difficulties in
manufacturing and marketing Apligraf during the first half of 1999, by the inception of the Class
Period, defendants assured investors:
(a) that Organogenesis maintained the expertise and ability to manufacture
sufficient quantities of Apligraf so that it was foreseeable that the Company could achieve
economies of scale and achieve profitability through the sales of only this product;
(b) that the Company maintained marketing agreements with experienced
partners such as defendant Novartis Pharma AG ("Novartis"), which would allow Organogenesis
to obtain the marketing support necessary to sell sufficient quantities of Apligraf, while at the
same time retaining enough of the revenue split in these deals to fund operations and achieve
profitability; and
2
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 4 of 39
(c) that between the Company's marketing agreements with Novartis and
others, and through other foreseeable sources of available debt and equity, Organogenesis could
foreseeably achieve profitability and commercial self-sufficiency.
4. Thus, by the inception of the Class Period, while it was fully disclosed that the
Company would need to raise additional funding at some point in the future to increase
production and distribution, throughout the Class Period, defendants consistently reported that
Organogenesis had the necessary funding in place to allow it to achieve the Company's stated,
foreseeable near-term objectives. In fact, according to the Company's 1999 Form 10-K, filed
with the SEC on or about March 29, 2000, Organogenesis stated that, "future capital comprised
of product sales, research and development support payments and debt and equity financings
will be sufficient tofundfuture operations into 2001..."
5. Accordingly, throughout the Class Period, plaintiffs and other members of the
Class were led to believe that Organogenesis was able to manufacture Apligraf in sufficient
quantities and that other sources of funding were available such that the Company would be able
to achieve profitability in the foreseeable near-term. Defendants repeatedly stated that
Organogenesis' results were "consistent with the transition in progress from a research focused
company to a research based operating company with a novel medical product in introduction
phase," and that the Company was operating according to defendants' plan for sufficiency.
Central to defendants' plan was a key agreement with Novartis, Organogenesis' Apligraf
marketing partner, which purportedly allowed Organogenesis to access at least $20 million from
Novartis through the exercise of a "put" option.' Defendants represented to investors that this
'A "put" option is an option contract that gives the holder (here, Organogenesis) the right to sell a certain quantity of an underlying security to the writer of the option (here, Novartis), at a specified price up to a specified date.
3
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 5 of 39
agreement allowed the Company to raise this money at "any time" during the Class Period, "at
[the Company's] discretion and at [the Company's] option," and thereby maintain a large mega-
million dollar "safety net" for the Company. The Novartis put option agreement was, therefore,
during the Class Period, a critical part of the Individual Defendants' announced plan to achieve
profitability and to avoid bankruptcy.
6. At all times during the Class Period, therefore, Organogenesis represented that it
was able to make Apligraf commercially available in a cost-effective manner which - even if
the Company were forced to incur losses at the early stages of development - would allow
Organogenesis to ramp up production and soon be able to fund operations from sales. Both prior
to and during the Class Period, defendants consistently represented that the Company was
sufficiently well funded, or had access to sufficient funding to carry out defendants' business
plan.
7. Unbeknownst to investors, however, the reality was far different than defendants'
representations. In the words of one former employee who worked at Organogenesis during the
Class Period, "it was always a series of smoke and mirrors." According to a confidential
document created in October 2001 by defendant Arcari, then the Company's Chief Financial
Officer (the "Confidential Arcari Document") - which has since been obtained by Plaintiffs'
counsel in the course of their investigation of this action - the Company was informed by stock
brokers in 2001 that defendant Erani, then Chairman of the Company's board of directors, sought
to have them "manipulate the market for the Company's stock." According to the Confidential
Arcari Document, defendant Erani also "encouraged the Company to prepare overly optimistic
financial projections to existing and potential service providers." Neither defendant Arcari, the
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 6 of 39
other defendants, nor the Company ever disclosed this scheme to manipulate the Company's
stock to the public and overstate the Company's financial projections.
8. In furtherance of this scheme defendants withheld from investors the true facts
about the Company's dismal and ever-deteriorating financial condition and business prospects.
Throughout the Class Period, the Company was suffering from a host of undisclosed adverse
factors that were negatively impacting its business and that would cause it to report declining
financial results - materially less than the market expectations defendants had caused and
cultivated - and eventually to file for bankruptcy. In particular:
• At all times during the Class Period, it was not true that defendants could achieve profitability through the sale of Apligraf under the terms, or even the revised terms, of the Novartis marketing agreement, which did not provide Organogenesis with enough of the revenues or profits provided through such Apligraf sales to offset the extremely high cost of production or to offset other undisclosed manufacturing problems such as defective products and recalls. Indeed, as defendants were well aware but did not publicly disclose, throughout the Class Period the Company was actually losing money on every unit ofApligraf sold due to the adverse terms of the marketing agreement with Novartis.
• Throughout the Class Period, undisclosed problems related to the manufacture and marketing of Apligraf were leading to even higher costs and further reducing profitability. Manufacturing problems and delays were retarding production scale, and marketing issues were reducing sales and damaging future sales development prospects. As plaintiffs would only learn following the Class Period, Novartis' inexperienced and inadequately trained sales force was encountering resistance throughout that time concerning the cost and complexity of its products and the actual and/or perceived difficulties in physician reimbursement for Apligraf.
• Throughout the Class Period, Organogenesis was underfunded and there was no reasonable basis to report that the Company could foreseeably fund operations throughout the Class Period, based on product sales, available sources of loans, debt and/or equity sales. Indeed, defendants knew but did not disclose that, as reported by defendant Arcari in the Confidential Arcari Document, the Company's own auditors - defendant PricewaterhouseCoopers LLP ("PricewaterhouseCoopers") - had in 2001 "refused to grant any consents or additional comfort letters" for future financing initiatives and that the Company had lost credibility in the eyes of PricewaterhouseCoopers. Moreover, as defendants were well aware but failed to disclose to investors, it was not true that the Company could access the full complement of funding from Novartis as defendants consistently represented, given that certain undisclosed conditions precedent existed. Organogenesis could not meet conditions
5
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 7 of 39
precedent to Novartis' requirement to provide at least $10 million of its purported commitment to Organogenesis. It also was not true that other sources of funding remained available so that the Company could preserve corporate viability.
• Throughout the Class Period, defendants failed to disclose that high management turn-over at the Company and in-fighting among its senior officers and directors was having, and would continue to have a disruptive effect on the operations and oversight of Organogenesis, such that it was also not foreseeable at any time during the Class Period that Organogenesis would be able to achieve profitability in the near-term or to attain the guidance sponsored and/or endorsed by defendants.
Isclose, As a result of the aforementioned adverse conditions that defendants failed to
throughout the Class Period, defendants lacked any reasonable basis to claim that Organogenesis was operating according to plan, that sufficient sources of funding were achieved and/or available to Organogenesis or that the Company could maintain profitability or even remain a viable entity in the foreseeable near-term.
9. Defendants were motivated to and did embark on this scheme to "manipulate the
market for the Company's stock," to conceal the true operational and financial condition of
Organogenesis, and to materially misrepresent and fail to disclose the conditions that were
adversely affecting Organogenesis throughout the Class Period, because it enabled the Company
and Company insiders, including certain defendants, to register for sale and/or sell over 6
million shares of Company stock and/or securities valued at over $68 million, prior to any
proper disclosure to the market.
10. Defendants' scheme also, ultimately, allowed defendants Erani and Ades and their
family members to improperly acquire the remaining assets of Organogenesis through a
leveraged buyout during bankruptcy - after defendants' actions drove the Company into
bankruptcy and after they sufficiently interfered with these proceedings so as to guarantee that
Erani and Ades and their family members acquired total domination and control over what was
left of Organogenesis.
11. Thus, through their illegal and improper actions which ultimately forced the
Company into bankruptcy, defendants not only were able to wipe out the equity interest of all of
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 8 of 39
the Company's outside shareholders, but they were also able to renegotiate their agreement with
Novartis - which, as defendants knew, throughout the Class Period was causing the
Company to lose money on every unit ofApligraf.
12. During the Class Period, defendant PricewaterhouseCoopers, the Company's
purported independent auditors, participated in this scheme in the following ways:
(a) PricewaterhouseCoopers recklessly disregarded suspicious behavior by the
Company's Chairman, which impugned his integrity and caused PricewaterhouseCoopers to lose
faith in the credibility of the Company's officers and directors and failed to disclose the truth
about PricewaterhouseCoopers' true opinion of the Company's officers and directors.
According to the Confidential Arcari Document, by March 2001 PricewaterhouseCoopers'
"confidence in managements [sic] and the Boards [sic] representations" had been "erodeiL"
Further, other actions by Erani caused a "loss of the Company's credibility" with
PricewaterhouseCoopers. At no time during the Class Period did PricewaterhouseCoopers ever
disclose this erosion of its confidence in the Company's management and Board or the loss of
the Company's credibility in the eyes of PricewaterhouseCoopers.
(b) Despite this lack of confidence in the integrity of the Company's
representations, PricewaterhouseCoopers continued to certify the Company's year-end financial
statements and its cash position;
(c) PricewaterhouseCoopers failed to disclose that, as a result of Company's
violation of a commitment to PricewaterhouseCoopers in connection with the exercise of the first
tranche of the Novartis put option in May 2001, PricewaterhouseCoopers informed defendants
that it refused to support any future financing initiatives by the Company. According to the
Confidential Arcari Document, defendant Erani "[h]indered the process for gaining approval to
7
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 9 of 39
exercise the Novartis put option by May 31, 2001, a commitment, which was made to
PricewaterhouseCoopers (PWC), our independent auditors." The Company had made this
commitment to exercise the put option to PricewaterhouseCoopers in order to "gain [sic]
necessary comfort letter from PWC to allow us to sell common shares" under an equity offering
with UBS Warburg. The Confidential Arcari Document states that "fsJince then PWC has
refused to grant any consents or comfort letters because we violated our commitment. ,2
PricewaterhouseCoopers, however, never publicly disclosed the Company's "hindering" of the
process for obtaining critical funding or its own refusal to support the Company's future
financing initiatives; and
(d) PricewaterhouseCoopers consistently failed to alert investors to the fact
that, throughout the Class Period, the Company lacked the ability to fund operations through
product sales, or that Organogenesis was actually losing money on each sale of Apligraf due to
the disadvantageous terms, or revised terms, of the Novartis marketing agreement.
13. It was only after the end of the Class Period, after the Company had finally
disclosed that it was impossible to fund operations with product sales that
PricewaterhouseCoopers belatedly issued a "going concern opinion" on the Company - an
opinion that should have been in place at least since the inception of the Class Period.
14. It was only beginning on January 30, 2002 that the truth about Organogenesis
began to emerge. On that day, defendants announced that the Company was running out of
money and would be forced into insolvency unless it could raise at least $15 million in the
immediate near term. At the same time, the Company also disclosed that it would not be able to
2 A "comfort letter" is an auditor's statement provided to a company preparing for a public offering, confirming that unaudited financial data in the prospectus follows Generally Accepted Accounting Principles.
ro]
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 10 of 39
access the $10 million funding commitment from Novartis that they had previously touted as a
"safety net" because of significant conditions precedent to that funding - conditions that
defendants had never before disclosed. Defendants also revealed that, contrary to their previous
representations that the Company could remain properly funded and could achieve profitability,
the "extent offuture losses and the time required to achieve profitability are highly uncertain,
and we may never achieve a profitable level of operations or, even if we achieve profitability,
we may not be able to sustain it on an ongoing basis." Defendants also announced that because
of the Company's inability to raise necessary funds it might be forced to "curtail or discontinue
our activities."
15. In the wake of these disclosures, shares of Organogenesis fell to as low as $1.32
on February 7, 2002 - a decline of almost 95% compared to the Class Period high of over
$22.00 per share reached on March 7, 2000.
16. In September 2002, the Company filed for bankruptcy protection - from which it
later emerged under a plan that allowed defendants Erani and Ades to buy the Company at a
steep bargain while liquidating the Company's stock - thus leaving the Company's
shareholders with nothing.
JURISDICTION AND VENUE
17. The claims asserted herein arise under, and pursuant to Sections 10(b) and 20(a)
of the Exchange Act [15 U.S.C. §§ 78j(b) and 78t(a)] and Rule lOb-5 promulgated thereunder by
the SEC [17 C.F.R. § 240.1Ob-5].
18. This Court has jurisdiction over the subject matter of this action pursuant to 28
U.S.C. §§ 1331 and 1337, and Section 27 of the Exchange Act [15 U.S.C. § 78aa].
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 11 of 39
19. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and
28 U.S.C. § 1391(b). Organogenesis maintains its principal place of business in this District and
many of the acts and practices complained of herein occurred in substantial part in this District.
20. In connection with the acts alleged in this complaint, defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not
limited to, the mails, interstate telephone communications and the facilities of the national
securities markets.
PARTIES
21. Court-appointed lead plaintiffs Bruno Hofmann, John Bowie, Richard Madigan
and Richard Conen purchased the common stock of Organogenesis at artificially inflated prices
during the Class Period and have been damaged thereby. The certifications of the lead plaintiffs
in this action previously have been filed with the Court.
22. Non-party Organogenesis is a Delaware corporation with its principal place of
business at 150 Dan Road, Canton, MA 02021. Organogenesis designs, manufactures and sells
medical products containing living cells and/or natural connective tissue, including living tissue
replacements, cell-based organ asset devices and other tissue-engineered products. The
Company's lead product, Apligraf living skin construct, is promoted as being the only product
containing living human cells to gain Food and Drug Administration ("FDA") marketing
approval in the United States.
23. Non-party Novartis Pharma Ag is a Swiss-based pharmaceutical and drug
company with substantial operations in the United States, which throughout the Class Period was
the purported marketing partner of the Company and a principal shareholder in Organogenesis,
10
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 12 of 39
holding as many as 2.88 million shares, or more than 6% of the Company's shares issued and
outstanding during that time.
24. Defendant PRICEWATERHOUSECOOPERS LLP was, throughout the Class
Period, the purported independent auditor of the Company.
25. Defendant PHILIP LAUGHLIN ("Laughlin") was during the relevant period,
President and a Director and member of the Company's Executive Committee of Organogenesis.
Defendant Laughlin assumed these positions immediately prior to the inception of the Class
Period, on or about, October 5, 1999 and later, on or about January 1, 2000, also assumed the
role of Chief Executive Officer. Defendant Laughlin retained these positions of power and
control over the Company until his sudden and unexpected departure, which was announced on
or about May 16, 2001. During the Class Period, defendant Laughlin, inter alia, signed the
Company's materially false and misleading SEC filings, as set forth herein.
26. Defendant MICHAEL SABOLINSKI ("Sabolinski") was during the Class
Period, President, Chief Executive Officer and a member of the Board of the Company, having
assumed those positions on or about May 16, 2001, upon the resignation of defendant Laughlin.
Prior to assuming the aforementioned positions and also during the Class Period, defendant
Sabolinski also served as the Company's Senior Vice President, Medical and Regulatory Affairs.
Defendant Sabolinski abandoned his position at the Company on or about April 5, 2002, less
than one year after assuming the leadership of Organogenesis. During the Class Period,
defendant Sabolinski, inter alia, signed the Company's materially false and misleading SEC
filings, as set forth herein.
27. Defendant ALBERT ERANI ("Erani") was during the relevant period, a member
of the Board of the Company and on or about January 1, 2000 assumed the role of Chairman of
11
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 13 of 39
the Board of Organogenesis. Defendant Erani served as Chairman of the Board of the Company
until his sudden and unexpected departure on or about January 4, 2002. During the Class
Period, defendant Erani, inter a/ia, signed the Company's materially false and misleading SEC
filings, as set forth herein.
28. Defendant ALAN ADES ("Ades") was nominated and appointed Chairman,
President and Chie Executive Officer of the Company following the end of the Class Period on
or about October 2002. Defendant Ades is the cousin of defendant Erani, and was also a
member of the group of investors who took the Company private through a leveraged acquisition
in bankruptcy. Defendant Ades was an active participant in the fraud alleged herein. It has been
reported that defendant Ades, with the aid and complicity of other defendants named herein,
acted to assure that other interested parties were not able to successfully participate in the
ultimate sale of the Company and that defendant Ades, with the aid and complicity of other
insiders, was then able to acquire the Company for a lower price, further depriving investors of a
return on their investment in Organogenesis.
29. Defendant DONNA ABELLI LOPOLITO ("Lopolito") was during the relevant
period, Chief Financial Officer and Vice President, Finance and Administration of
Organogenesis. During the Class Period, defendant Lopolito, inter a/ia, signed the Company's
materially false and misleading SEC filings, as set forth herein.
30. Defendant JOHN J. ARCARI ("Arcari") was during the relevant period, Chief
Financial Officer and Vice President - Finance and Administration of Organogenesis, having
replaced defendant Lopolito on or about April 30, 2000. Defendant Arcari served in the
aforementioned positions until his sudden and unexpected departure on or about May 14, 2002.
12
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 14 of 39
During the Class Period, defendant Arcari, inter a/ia, signed the Company's materially false and
misleading SEC filings, as set forth herein.
31. Defendant HERBERT M. STEIN ("Stein") was at the inception of the Class
Period, Chairman of the Board and Chief Executive Officer, until his resignation on or about
January 1, 2000. Upon his retirement from the aforementioned positions, defendant Stein
remained at the Company as a member of the Board and Chairman Emeritus until March 2000.
During the Class Period defendant Stein made materially false and misleading statements about
the Company and/or failed to disclose material information necessary to make such statements
not false. During the Class Period, defendant Stein also signed the Company's SEC filings,
including, but not limited to, Organogenesis' Form 10-Q for the third quarter of 1999 and the
materially false and misleading Registration Statements (including the Company's Registration
Statements filed on December 27, 1999, the amended Registration Statement filed on February 3,
2000, and the second amended Registration Statement, filed on February 14, 2000) issued in
connection with the sale and offering of stock by the Company.
32. Defendant ALAN W. TUCK ("Tuck") was during the Class Period, Chief
Strategic Officer of the Company. During the Class Period, defendant Tuck also made
materially false and misleading statements during the Class Period, as set forth herein.
33. The defendants referenced above in paragraphs 25-32 are referred to herein as the
"Individual Defendants."
34. Because of the Individual Defendants' positions with the Company, or relations
with Company insiders, they had access to the adverse undisclosed information about its
business, operations, products, operational trends, financial statements, markets and present and
future business prospects via access to internal corporate documents (including the Company's
13
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 15 of 39
operating plans, budgets and forecasts and reports of actual operations compared thereto),
conversations and connections with other corporate officers and employees, attendance at
management and Board of Directors meetings and committees thereof and via reports and other
information provided to them in connection therewith and/or otherwise actively participated in
the fraudulent scheme alleged herein.
35. It is appropriate to treat the Individual Defendants as a group for pleading
purposes and to presume that the false, misleading and incomplete information conveyed in the
Company's public filings, press releases and other publications as alleged herein are the
collective actions of the narrowly defined group of defendants identified above. Each of these
defendants, by virtue of their high-level positions with the Company and/or relations with
company insiders, directly participated in the management of the Company, was directly
involved in the day-to-day operations of the Company at the highest levels and was privy to
confidential proprietary information concerning the Company and its business, operations,
products, growth, financial statements, and financial condition, as alleged herein and/or
otherwise actively participated in the fraudulent scheme alleged herein. These defendants were
involved in drafting, producing, reviewing and/or disseminating the false and misleading
statements and information alleged herein, were aware, or recklessly disregarded, that the false
and misleading statements were being issued regarding the Company, and approved or ratified
these statements, in violation of the federal securities laws.
36. As officers and controlling persons of a publicly-held company whose common
stock was registered with the SEC pursuant to the Exchange Act, traded on the American Stock
Exchange (the "AMEX"), and governed by the provisions of the federal securities laws, the
Individual Defendants each had a duty to disseminate promptly accurate and truthful information
14
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 16 of 39
with respect to the Company's financial condition and performance, growth, operations, financial
statements, business, products, markets, management, earnings and present and future business
prospects, and to correct any previously-issued statements that had become materially misleading
or untrue, so that the market price of the Company's publicly-traded securities would be based
upon truthful and accurate information. The Individual Defendants' misrepresentations and
omissions during the Class Period violated these specific requirements and obligations.
37. The Individual Defendants participated in the drafting, preparation, and/or
approval of the various public and shareholder and investor reports and other communications
complained of herein and were aware of, or recklessly disregarded, the misstatements contained
therein and omissions therefrom, and were aware of their materially false and misleading nature
and/or otherwise actively participated in the fraudulent scheme alleged herein. Because of their
Board membership and/or executive and managerial positions with Organogenesis, each of the
Individual Defendants had access to the adverse undisclosed information about Organogenesis'
business prospects and financial condition and performance as particularized herein and knew (or
recklessly disregarded) that these adverse facts rendered the positive representations made by or
about Organogenesis and its business, or adopted by the Company, materially false and
misleading and/or otherwise actively participated in the fraudulent scheme alleged herein.
38. The Individual Defendants, because of their positions of control and authority as
officers and/or directors of the Company, or relations with officers and/or directors, were able to
and did control the content of the various SEC filings, press releases and other public statements
pertaining to the Company during the Class Period. Each Individual Defendant was provided
with copies of the documents alleged herein to be misleading prior to or shortly after their
issuance and/or had the ability and/or opportunity to prevent their issuance or cause them to be
15
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 17 of 39
corrected. Accordingly, each of the Individual Defendants is responsible for the accuracy of the
public reports and releases detailed herein and is therefore primarily liable for the representations
contained therein and/or otherwise actively participated in the fraudulent scheme alleged herein.
39. Each of the defendants is liable as a participant in a fraudulent scheme and course
of business that operated as a fraud or deceit on purchasers of Organogenesis common stock by
disseminating materially false and misleading statements and/or concealing material adverse
facts. The scheme: (i) deceived the investing public concerning defendants' attempt to
manipulate the market for the Company's stock; (ii) deceived the investing public regarding
Organogenesis' business, operations, management and the intrinsic value of Organogenesis
common stock; and (iii) enabled the defendants and Company insiders to sell and/or register for
sale over $68 million worth of Company stock to investors during the Class Period - of this
amount defendants sold over 5 million shares of the Company's securities in a series of public
stock offerings, private equity offerings and other debt and/or equity sales of Organogenesis
stock; and (iv) caused plaintiffs and other members of the Class to purchase Organogenesis
securities at artificially inflated prices.
PLAINTIFF'S CLASS ACTION ALLEGATIONS
40. Plaintiffs bring this action as a class action pursuant to Federal Rule of Civil
Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or
otherwise acquired the securities of Organogenesis between November 15, 1999 and February 7,
2002 inclusive (the "Class") and who were damaged thereby. Excluded from the Class are
defendants, the officers and directors of the Company at all relevant times, members of their
immediate families and their legal representatives, heirs, successors or assigns and any entity in
which defendants have or had a controlling interest.
16
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 18 of 39
41. The members of the Class are so numerous that joinder of all members is
impracticable. Throughout the Class Period, Organogenesis common shares were actively traded
on the American Stock Exchange. As of November 2, 2001, the Company had over 37.0 million
shares issued and outstanding. While the exact number of Class members is unknown to
plaintiffs at this time and can only be ascertained through appropriate discovery, plaintiffs
believe that there are hundreds or thousands of members in the proposed Class. Record owners
and other members of the Class may be identified from records maintained by Organogenesis or
its transfer agent and may be notified of the pendency of this action by mail, using the form of
notice similar to that customarily used in securities class actions.
42. Plaintiffs' claims are typical of the claims of the members of the Class as all
members of the Class are similarly affected by defendants' wrongful conduct in violation of
federal law that is complained of herein.
43. Plaintiffs will fairly and adequately protect the interests of the members of the
Class and have retained counsel competent and experienced in class and securities litigation.
44. Common questions of law and fact exist as to all members of the Class and
predominate over any questions solely affecting individual members of the Class. Among the
questions of law and fact common to the Class are:
(a) whether the federal securities laws were violated by defendants' acts as
alleged herein;
(b) whether statements made by defendants to the investing public during the
Class Period misrepresented material facts about the business, operations and management of
Organogenesis; and
17
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 19 of 39
(c) to what extent the members of the Class have sustained damages and the
proper measure of damages.
45. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy because joinder of all members is impracticable. Furthermore,
as the damages suffered by individual Class members may be relatively small, the expense and
burden of individual litigation make it impossible for members of the Class to individually
redress the wrongs done to them. There will be no difficulty in the management of this action as
a class action.
SUBSTANTIVE ALLEGATIONS
46. The Company. Organogenesis was organized as a Delaware corporation in 1985.
Throughout the Class Period, Organogenesis described itself as a "tissue engineering firm" that
designs, develops and manufactures medical products containing living cells and/or natural
connective tissue. For Organogenesis, tissue engineering involves developing and
manufacturing medical products containing actual living human cells.
47. Operations. Prior to the inception of the Class Period, Organogenesis appeared
to be a Company with a very unique product, but a Company that was research-centric and
which had little product manufacturing experience. Complicating matters, the Company's main
product, Apligraf a "tissue replacement" therapy, discussed in more detail below, was difficult to
manufacture and required very specialized manufacturing procedures and techniques. As
evidence of the difficulties associated with Apligraf production during mid-1999, the Company
was even forced to recall several lots of Apligraf - accounting for more than 10% of monthly
production at that time - for contamination reasons. In addition to manufacturing issues, the
marketing of Apligraf was also difficult because, until early in the Class Period, Apligraf had not
18
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 20 of 39
been approved for Medicare or Medicaid reimbursement - leaving doctors with a vast array of
red tape to get reimbursed for the product.
48. The manufacture and marketing of Apligraf proved so difficult that in the year
prior to the inception of the Class Period, sales of Apligraf were well below expectations. In
fact, when the Company reported fiscal year 1998 results in March 1999, Organogenesis
reported Apligraf sales of only $335,000 - well below product sales of $1.3 million that
defendants had guided the market to expect. The result of these lower-than-expected sales was
larger losses, and by the end of the fourth quarter of 1998 the Company had posted a loss of
$0.19 per share.
49. Although during 1999 defendants reported less than consistent sales of Apligraf,
the trend overall, bolstered by defendants' guidance, appeared bullish. For example, in April
1999, the Boston Business Journal reported the view of an investment analyst for Moors &
Cabot, Inc. that Apligraf was a "revolutionary" product and a "major medical breakthrough" for
which "it's simply a matter of time before it wins wide acceptance."
50. The manufacturing and marketing problems which limited the sale of Apligraf
also raised issues concerning the funding of the Company and its ability to remain in operation
long enough to achieve profitability. In this regard, while the Company initially had issued very
aggressive predictions, forecasting operational break-even by the fourth quarter of 1999 and full
funding by that time, by the inception of the Class Period, defendants had already revised these
expectations and had taken a relatively longer-term view towards profitability. By the inception
of the Class Period, and at all times thereafter, however, defendants consistently reported that
sufficient sources of funding were available, that Organogenesis received or would receive
19
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 21 of 39
sufficient profits from sales of Apligraf and that the Company still expected to achieve
profitability in the foreseeable near-term.
51. Funding Representations. Thus, by the inception of the Class Period, while it
was fully disclosed that the Company would need to raise additional funding at some point in the
future to increase production and distribution, by this time and consistently thereafter, defendants
reported that Organogenesis had the necessary funding in place to allow it to achieve the
Company's stated, foreseeable near-term objectives. In fact, according to the Company's 1999
Form 10-K, filed with the SEC on or about March 29, 2000, Organogenesis stated that, 'future
capital comprised of product sales, research and development support payments and debt and
equity financings will be sufficient tofundfuture operations into 2001," and additional sources
could be relied on to fund operations thereafter.
52. Moreover, according to statements made by defendants and filed with the SEC,
while there could be "no assurance" that additional funding might not be required,
Organogenesis' funding already was in place and sufficient. According to defendants, by the
inception of the Class Period, the Company was sufficiently funded barring only unforeseen
circumstances, unplanned contingencies, "delays," or unexpected "changes," such as the
following:
Delays in obtaining regulatory approvals of products, and timing of product launches;
• Delays in commercial acceptance and reimbursement when product launches occur;
• Changes in the progress of research and development programs; and
• Changes in the resources devoted to outside research collaborations or projects, self-funded projects, proprietary manufacturing methods and advanced technologies.
20
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 22 of 39
53. Thus, throughout the Class Period, defendants led investors to believe that
Organogenesis was able to manufacture Apligraf in sufficient quantities and that other sources of
funding were available such that the Company would be able to achieve profitability in the
foreseeable near-term. Defendants consistently reported that the Company had necessary and
available funding sources, from foreseeable sales of debt and equity to both private and public
investors, which would allow Organogenesis to achieve defendants' plan for sufficiency. Central
to this plan was a key agreement with Novartis, Organogenesis' Apligraf marketing partner,
which purportedly allowed defendants to access at least $20 million through the exercise of a
"put" option. This agreement purportedly would allow defendants to raise this money at any
time, and thereby maintain a mega-million dollar "safety net" for the Company.
54. Apligraf. As stated above, throughout the Class Period, Apligraf was the
Company's only commercially available product and was described by defendants as its "lead
product." Defendants touted Apligraf as a unique product - according to a November 15, 1999
press release issued by the Company, it was the first and only product to containing living human
cells to gain FDA PMA approval. Most if not all of the Company's revenues were at all times
generated from the sale of Apligraf. Apligraf has a structure similar to human skin - consisting
of living cells - and is described as a "skin construct." The product's human skin-like
properties allow this product to be used by doctors to aid in the healing of certain types of skin
ulcers, and other epidermal injuries. 3 At all times throughout the Class Period, defendants were
well aware that the Company's business model was entirely dependent upon its ability to
According to Organogenesis, Apligraf has an organized, two-layered structure, much like skin, and features the key components of skin - the lower dermal cells (fibroblasts), the upper epidermal cells (keratinocytes) and its keystructural protein (collagen). Unlike human skin, however, Apligraf does not contain structures such as blood vessels, hair follicles and sweat glands or other cell types.
21
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 23 of 39
mass-produce Apligraf and market it to physicians as an "off-the-shelf," cost-effective product
that doctors could use on patients absent hospitalization.
55. By the inception of the Class Period, Apligraf was approved by the FDA for
marketing in the United States for the treatment of venous leg ulcers and was pending approval
for diabetic leg ulcers. At that time and during the Class Period, Apligraf was a registered
trademark of Novartis, the Company's Apligraf marketing partner. At all times during the Class
Period, the Company's marketing agreement with Novartis was consistently touted by
defendants as a key to the Company's profitability. According to defendants' representations,
the marketing agreement with Novartis (both prior to and following the time of its amendment)
provided Organogenesis with enough of the revenue split generated through Apligraf sales to
allow the Company to grow operations and achieve profitable growth in the foreseeable near-
term. That impression was substantially reinforced when the Novartis marketing agreement was
allegedly amended during the Class Period to provide even more revenues to the Company.
56. In addition to simply marketing Apligraf, Novartis was also a significant owner of
Organogenesis shares, and during the Class Period owned as many as 2.8 million Company
shares - or over 6% of the Organogenesis shares issued and outstanding. Novartis had acquired
its shares in the Company through several private equity investments, as well as through certain
funding agreements which purportedly allowed Organogenesis to sell stock to Novartis at prices
predetermined and at the election of the Company.
57. The supposed ability of the Company to be able to sell stock to Novartis was also
purportedly a critical part of Organogenesis' financing, because it should have allowed
defendants to raise money whenever necessary - up to $20 million in equity financing in
addition to any other sources of debt or equity financing available to the Company. Again, this
22
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 24 of 39
financing was also very important to investors, because it provided a purported "safety net" for
Organogenesis - a reserve of cash which defendants could allegedly access as a last resort. The
Novartis put option agreement was, therefore, during the Class Period, a critical part of
defendants' announced plan to achieve profitability.
58. At all times during the Class Period, therefore, Organogenesis represented that it
was able to make Apligraf commercially available in a cost-effective manner which, even if the
Company was forced to incur losses at the early stages of development, would allow
Organogenesis to ramp up production and soon be able to fund operations from sales.
Defendants consistently represented both prior to and during the Class Period that the Company
was sufficiently well-funded to carry out defendants' business plan.
59. Unbeknownst to investors, however, the reality was far different from defendants'
representations. According to the Confidential Arcari Document - created by defendant Arcari,
then the Company's Chief Financial Officer - defendant Erani, then the Company's Chairman
of the Board, sought during the Class period to have stock brokers "manipulate the market for
the Company's stock." According to the Confidential Arcari Document, Erani also "encouraged
the Company to prepare overly optimistic financial projections to existing and potential service
providers." Neither defendant Arcari, the other defendants, nor the Company ever disclosed this
scheme to manipulate the Company's stock to the public or this attempt to have the Company
overstate its financial projections.
60. In furtherance of this scheme, defendants withheld from investors the true facts
about the Company's dismal and ever-deteriorating financial condition and business prospects.
In the words of one former employee of Organogenesis during the Class Period, "it was always a
series of smoke and mirrors." Throughout the Class Period, the Company was suffering from a
23
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 25 of 39
host of undisclosed adverse factors which were negatively impacting its business and which
would cause it to report declining financial results, materially less than the market expectations
defendants had caused and cultivated. In particular:
• At all times during the Class Period, it was not true that defendants could achieve profitability through the sale of Apligraf under the terms, or even the revised terms, of the Novartis marketing agreement, which did not provide Organogenesis with enough of the revenues or profits provided through such Apligraf sales to offset the extremely high cost of production or to offset other undisclosed manufacturing problems such as defective products and recalls. Indeed, as defendants were well aware but did not publicly disclose, throughout the Class Period the Company was actually losing money on every unit ofApligraf sold due to the adverse terms of the marketing agreement with Novartis.
• Throughout the Class Period, undisclosed problems related to the manufacture and marketing of Apligraf were leading to even higher costs and further reducing profitability. Manufacturing problems and delays were retarding production scale, and marketing issues were reducing sales and damaging future sales development prospects. As plaintiffs would only learn following the Class Period, Novartis' inexperienced and inadequately trained sales force was encountering resistance throughout that time concerning the cost and complexity of its products and the actual and/or perceived difficulties in physician reimbursement for Apligraf.
• Throughout the Class Period, Organogenesis was underfunded and there was no reasonable basis to report that the Company could foreseeably fund operations based on product sales, available sources of loans, debt and/or equity sales. Indeed, defendants knew but did not disclose that, as reported by defendant Arcari in the Confidential Arcari Document, the Company's own auditors - defendant PricewaterhouseCoopers - had in 2001 "refused to grant any consents or additional comfort letters" for future financing initiatives and that the Company had lost credibility in the eyes of PricewaterhouseCoopers. Moreover, as defendants were well aware but failed to disclose to investors, it was not true that the Company could access the full complement of funding from Novartis as defendants consistently represented, given that certain undisclosed conditions precedent existed. Organogenesis could not meet conditions precedent to Novartis' requirement to provide at least $10 million of its purported commitment to Organogenesis. It also was not true that other sources of funding remained available so that the Company could preserve corporate viability.
;1m Throughout the Class Period, defendants failed to disclose that high management
-over and in-fighting among the senior officers and directors of the Company was having, and would continue to have a disruptive effect on the operations and oversight of Organogenesis, such that it was also not foreseeable at any time during the Class Period that Organogenesis would be able to achieve profitability in the near-term or to attain the guidance sponsored and/or endorsed by defendants.
24
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 26 of 39
• As a result of the aforementioned adverse conditions that defendants failed to disclose, throughout the Class Period, defendants lacked any reasonable basis to claim that Organogenesis was operating according to plan, that sufficient sources of funding were achieved and/or available to Organogenesis or that the Company could maintain profitability or even remain a viable entity in the foreseeable near-term.
61. Contrary to defendants' public statements that they expected commercial sales to
increase and that they had laid the foundations for future sales development, several former
employees of Organogenesis and Novartis with knowledge of the relevant facts were privy to the
aforementioned problems with the marketing of Apligraf, which damaged the reputation of
Apligraf and Organogenesis among purchasers and severely limited the Company's sales
prospects. Although defendants were aware of these problems, they did not disclose them to
investors. For example:
(a) Contrary to defendants' representations that Novartis had a "a marketing
and sales force[] with technical expertise and distribution capability" to effectively market
Apligraf, a former Tissue Engineering and Immunology Specialist with knowledge of the
relevant facts who worked for Novartis Pharmaceutical Corporation, a U.S.-based business unit
of Novartis, stated that although Novartis had expertise in marketing pharmaceuticals in pill
form, Novartis "had no idea what they were doing" when it came to marketing a living-tissue
product like Apligraf. According to this employee, Novartis' marketing team "had no idea about
the condition, no idea how to influence a physician to change their practice to use the product
because it wasn't a pill."
(b) A former director (non-Board level) on the senior management team of
Organogenesis during the Class Period who attended senior management meetings and who has
knowledge of the relevant facts, confirmed that Novartis' marketing team did not have the
proper training, experience or expertise in marketing a living product, such as Apligraf, as
opposed to a drug - which hindered Novartis' ability to sell Apligraf. According to this former
25
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 27 of 39
Director, Novartis' efforts to market Apligraf suffered significantly, with the result that the
Company was required to pay for the high cost of manufacturing many more units of Apligraf
than Novartis could sell. The Company thus took a "huge loss" every time that Novartis was
unable to sell units of the product that Organogenesis had manufactured.
(c) According to a former Associate Director of Clinical Trials/Affairs for
Organogenesis during the Class Period with knowledge of the relevant facts, the Novartis
marketing team had "no experience with a living product that had afive day shelf ljfe," such as
Apligraf.
62. Contrary to defendants' representations to investors that the Company expected to
increase production volume and that it could achieve the mass production of Apligraf that was
purportedly necessary to increase the Company's margins on sales, several former
Organogenesis employees with knowledge of the relevant facts were privy to undisclosed
manufacturing- and distribution-related problems with Apligraf that led to limited and delayed
production, poor quality control - including at times shipping batches of Apligraf to physicians
without first reviewing vital laboratory results - and, in some cases, contamination and recall of
the product. As a result of these undisclosed manufacturing and distribution problems, the
Company was not able to feasibly mass-produce Apligraf and the purchasers of the Company's
product were steadily becoming less and less willing to order, or re-order Apligraf, thus
damaging future sales prospects and adversely impacting the Company's purported attempt to
achieve profitability. For example:
(a) According to a former Senior Manager of Quality Systems Compliance for
Organogenesis during the Class Period with knowledge of the relevant facts, there was "no way"
that the Company could commercially mass-produce Apligraf given the Company's inadequate
OR
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 28 of 39
production infrastructure and processes. According to this Senior Manager of Quality Systems
Compliance at Organogenesis, at the direction of defendant Sabolinski, the Company often
shipped units of Apligraf for distribution to purchasers before obtaining the results of vital
laboratory testing on those units. In fact, according to this former employee, in some cases,
Sabolinski himself signed the paperwork authorizing the release of units of Apligraf before
obtaining laboratory results because Quality Assurance employees refused to sign the paperwork
without first viewing the laboratory results.
(b) Another former employee of the Company - a Maintenance Supervisor
during the Class Period with knowledge of the relevant facts - confirmed that several times the
Company "would ship the product before they had the results back from the QC lab."
According to this former employee, on more than one occasion, the laboratory results received
after the product had already been shipped to doctors - an in some cases, after patients had
already been treated with it - indicated that the shipped units had failed chemistry testing,
requiring the Company to recall the shipped units. According to a former Organogenesis
employee who was employed during the Class Period as a Quality Assurance Documentation
Specialist and who has knowledge of the relevant facts, the Company experienced substantial
problems growing the cells that were necessary for the production of Apligraf.
(c) According to a former employee of Novartis who was employed during
the Class Period as a Tissue Engineering Specialist, and who was involved in the marketing of
Apligraf, physicians who had ordered Apligraf grew frustrated and disappointed with the product
because contamination of the product frequently resulted in physicians not receiving the product
when necessary.
27
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 29 of 39
(d) According to an individual who was employed during the Class Period as
a Vice President of Information Technologies for Theracom, and who worked with Novartis to
set up a hotline that could be used by health care providers who used Apligraf, physicians grew
reluctant to re-order Apligraf because they "couldn't rely on it - they couldn't rely on it coming
through."
63. Several former employees during the Class Period at various levels of the
Company witnessed how high management turnover and infighting among the Company's senior
officers disrupted the operations and oversight of the Company. For example, according to the
former director (non-Board level) on the senior management team of Organogenesis mentioned
above, the Company suffered from, inter alia, "too many presidents, and too many going in
different directions - a lack of leadership."
64. According to a former Project Engineer with Organogenesis with knowledge of
the relevant facts, Novartis' sales forecasts were "always inflated" - a fact of which upper
management at Organogenesis was well aware, but which defendants did not publicly disclose.
65. Contrary to defendants' representations, it was not true that costs exceeded sales
due to start-up costs and the high costs of low volume production, and that the Company's
margins would improve as production volume increased. According to a former Project
Engineer for Organogenesis during the Class Period with knowledge of the relevant facts, it was
well known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Indeed, according
to a former Maintenance Supervisor for Organogenesis during the Class Period with knowledge
28
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 30 of 39
of the relevant facts, this fact was known by "the whole company." Given the terms, and the
revised terms, of the Novartis marketing agreement - which caused Organogenesis to lose
money on every unit of Apligraf that it produced - far from lowering costs, the more units of
Apligraf that Organogenesis produced, the greater its losses would be.
66. Further, according to several former employees of Organogenesis during the
Class Period with knowledge of the relevant facts - a Senior Director (non-Board level), a
Project Engineer and a former Materials Handler - Organogenesis would not be reimbursed by
Novartis for any units of Apligraf that were manufactured by Organogenesis pursuant to
Novartis' sales forecasts, but that ultimately were not sold by Novartis. Thus, as alleged above,
the Company took a "huge loss" every time that Novartis was unable to sell units of the product
that Organogenesis had manufactured. The damage to the Company's bottom line caused by this
failure to receive compensation for Apligraf units manufactured but not sold was compounded
by the fact that, as alleged above, Novartis' sales forecasts were "always inflated." Defendants
were motivated to and did conceal the true operational and financial condition of Organogenesis,
and materially misrepresented and failed to disclose the adverse conditions that were adversely
affecting Organogenesis throughout the Class Period, because it enabled the Company,
defendants and Company insiders to register for sale and/or sell over 6 million shares of
Company stock and/or securities valued at over $68 million, prior to any disclosure to the
market.
67. Indeed, according to the former director (non-Board level) on the senior
management team of Organogenesis during the Class Period, several members of the senior
management of the Company were more concerned with recouping their own personal
investments in the Company than in pursuing the interests of shareholders. According to this
29
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 31 of 39
former director, a culture of "corporate greed" prevailed among the senior management of the
Company, who were primarily interested in "taking care of themselves at the top." This former
director personally attended a meeting of the members of the Company's board of directors that
occurred after Defendant Stein had left the Company, at which defendants Erani as well as other
members of the Board, said that "they needed to get back. their investments" and that, in the
words of these board members, they "were not going to have been taken by Herb Stein."
Defendants' Materially False and Misleading Statements Made During the Class Period
68. The Class Period begins on November 15, 1999. On that day, Organogenesis
published a release on Business Wire announcing financial results for the third quarter of 1999,
the period ending September 30, 1999. For the third quarter of 1999, Organogenesis reported
total revenues of $946,000, equal to a net loss of $0.21 per share, compared to a net loss of $0.25
per share the prior quarter. According to the release, total expenses for the third quarter of 1999
were $7.426 million, including one-time technology acquisition charges of $900,000, compared
to a sequential loss of $8.527 million. This release also quoted defendant Stein, as follows:
Apligraf is a revolutionary technology development to provide significant advantages in wound healing. Alpigraf is FDA approved, well-received by physicians and can be a highly cost-effective therapy for many patients. The key remaining piece of the puzzle is gaining broad, standardized reimbursement. Achieving standardized reimbursement for Apligraf is a top priority at both Novartis and Organogenesis and is being addressed aggressively by both companies.
69. A subsequent release, dated December 2, 1999, reported that Apligraf sales
reached a "record number" in November 1999 - 755 units. In that release, defendant Tuck -
the Company's Chief Strategic Officer, touted the marketing and sales efforts of Novartis, stating
that "[ti/se growth now being seen is due to new Apligraf marketing and sales initiatives by
30
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 32 of 39
Novartis and is independent of the efforts underway to gain standardized reimbursement for the
product."
70. 3Q:99 Form 10-Q. On or about November 15, 1999, the Company filed with the
SEC the Company's financial results for the third quarter of 1999, the period ended September
30, 1999, pursuant to its Form 10-Q signed by defendants Stein and Lopolito. The Company's
Form 10-Q for the third quarter of 1999 stated that "[wJe expect Apligraf commercial sales to
increase." [Emphasis added.] The Form 1 0-Q also stated that:
Production costs exceeded product sales due to the start-up costs of new product introduction and the high costs associated with low volume production. We expect production volume to increase and our margins to improve. We expect to continue to expand manufacturing operations and advance the product pipeline during the remainder of 1999 and into 2000. [Emphasis added.]
71. Following the publication of the Company's earnings announcement, the price of
Organogenesis rallied - trading from a low of $6.81 per share on November 15, 1999, to above
$12.30 per share on December 2, 1999.
72. $50 Million Shelf-Registration. Taking full advantage of the artificial inflation
in the price of Organogenesis stock caused by the publication of defendants' false and materially
misleading statements, on or about December 27, 1999, defendants raced to the market to
register for sale at least $50 million in mixed securities in a "shelf registration." The shelf
registration would allow the Company to sell up to 3 million shares of common stock either
directly or through convertible securities at the sole discretion of the Company. In connection
with this shelf registration, the Company filed with the SEC a Registration Statement on
December 27, 1999, and two amended Registration Statements, filed on February 3, 2000 and
31
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 33 of 39
February 14, 2000, respectively, all of which incorporated by reference the Company's Form 10-
Q for the third quarter of 1999.
73. On January 13, 2000, defendant Laughlin presented at the Hambrecht & Quist
Annual Healthcare Conference held in San Francisco, California, where he reiterated former
guidance and where he further conditioned investors to believe that the Company was operating
according to plan. The following day, January 14, 2000, defendant Laughlin also provided a
widely circulated interview, with The Wall Street Transcript, during which he also represented,
in part, that "we're not concerned that we won't ultimately be successful," despite the fact that
the adoption of Alpigraf had, to that point, "gone slower than we'd like." (Emphasis added)
74. Amended 3Q:99 Form 10-Q. On or about February 14, 2000, defendants filed
with the SEC the Company's amended financial results for the third quarter of 1999, the period
ended September 30, 1999, pursuant to its amended Form 10-Q signed by defendants Laughlin
and Lopolito. The Company's amended Form 10-Q for the third quarter of 1999 contained the
same materially false and misleading information as had previously been announced on
November 15, 1999, in addition to the following:
Basis of Presentation:
The accompanying unaudited consolidated financial statements of Organogenesis Inc., have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation.... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented .... [Emphasis added].
75. In addition to the foregoing, Organogenesis' Form 10-Q for the third quarter of
1999 also characterized rising costs during the third quarter as one-time events and predicted that
costs would foreseeably remain in line with guidance, as follows:
32
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 34 of 39
Production costs exceeded product sales due to the start-up costs of new product introduction and the high costs associated with low volume production. We expect production volume to increase and our margins to improve. We expect to continue to expand manufacturing operations and advance the product pipeline during the remainder of 1999 and into 2000. [Emphasis added.]
Regarding the $6.2 million payment for the conversion of the Series C convertible preferred
shares, the Form 10-Q reported the existence of this payment, but it did not identify the
recipients.
76. The statements contained in Organogenesis' November 15, 1999 release, its SEC
filings and those statements made by defendants to analysts, investors and the press during the
period November 15, 1999 through February 14, 2000 referenced above, were each materially
false and misleading when made, and were known by defendants to be false or were recklessly
disregarded as such thereby, for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
33
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 35 of 39
sales that was below the product's manufacturing cost to Organogenesis. Given the terms, and
the revised terms, of the Novartis marketing agreement - which caused Organogenesis to lose
money on every unit of Apligraf that it produced —far from lowering costs, the more units of
Apligraf that Organogenesis produced, the greater its losses would be.
(c) Contrary to defendants' representations that Apligraf was "well-received
by physicians" and that achieving standardized reimbursement for Apligraf was being
aggressively addressed by the Company, manufacturing and distribution problems,
contamination issues, inadequate marketing support, and difficulties in obtaining reimbursement
for Apligraf were causing increasing frustration among physicians, who were becoming less
willing to order or re-order Apligraf for their patients. Continuing difficulties in obtaining
reimbursement for Apligraf were not being adequately addressed by either Organogenesis or
Novartis, which adversely affected Apligraf's future sales prospects.
(d) Defendants' public statements touting the "record number" of sales in
November 1999 and Novartis' "new Apligraf marketing and sales initiatives" were materially
misleading and incomplete given that, as confirmed by several former employees of
Organogenesis, the Company was experiencing serious manufacturing and marketing problems
that were inhibiting sales and damaging future sales development prospects. Further, as
defendants knew but did not disclose, Novartis' marketing team did not have the proper training
experience or expertise in selling a product like Apligraf, with the result that Novartis' efforts to
market Apligraf suffered significantly.
(e) Defendants' representations that they expected Apligraf "commercial sales
to increase" was untrue given the marketing problems that Novartis was experiencing because of
inadequate marketing support and the problems with the manufacturing and distribution of
34
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 36 of 39
Apligraf that were causing frustration among purchasers, leading to reluctance among physicians
to order or re-order Apligraf.
(f) Contrary to defendants' representations that they were "not concerned that
we won't ultimately be successful," defendants knew that the Company's ultimate prospects for
achieving profitability were severely compromised by the fundamental problems alleged in
paragraphs 59-67, supra, including the Company's serious manufacturing and marketing
problems, its inability to access as necessary adequate funding to keep the Company viable, the
difficulties in achieving reimbursement for Apligraf, and the disruptive effect on operations that
high turnover and infighting among the Company's senior management was having and would
continue to have for the foreseeable future.
(g) Contrary to defendants' representations, the Company's amended Form
l0-Q for the third quarter of 1999 did not reflect the true financial condition of the Company
because it failed to disclose the adverse factors affecting the Company's operations and future
viability alleged in subparagraphs (a) through (f) above and in paragraphs 59-67, supra.
77. $9.4 Million Equity Sale. One month later, on February 24, 2000, with
Organogenesis stock trading at almost $15.50 per share, defendants issued a release announcing
that Organogenesis had completed the sale of over 688,000 shares of common stock for gross
proceeds of $9.4 million. According to defendants, this was a remarkable accomplishment given
that it allowed them to raise more money than defendants had originally planned - and
presumably placed Organogenesis in a position of having more money than needed to fulfill
defendants' near-term objectives. According to the Company's release, defendants' purported
"goal" had been to raise $6.2 million but the offering priced at $14 per share was over-
35
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 37 of 39
subscribed due to the "strong interest in our Company." This placement raised the total number
of Organogenesis shares outstanding to 31.3 million from 30.6 million.
78. At the time of this offering, the Company stated that proceeds from the sale of
these shares would enable, among other things, the retirement of $6.2 million in preferred stock.
Defendants created the impression that the redemption of Organogenesis' preferred stock was
necessary to bolster the Company's debt and equity ratings. The Company's February 24, 2000
release quoted defendant Tuck, who exhibited a complete knowledge of Organogenesis'
financial and operational performance, stating that, "The completion of this initial shelf-offering
removes any concern among the investment community about the retirement of our $6.2
million of preferred stock." No disclosure was made as to the identity of the owners of these
retired preferred shares.
79. Moreover, the following day, February 25, 2000, the Company also issued a
release announcing that defendants had raised an additional $1.4 million through the sale of an
additional 100,000 shares to satisfy an additional over-subscription commitment. This sale
brought the total February 2000 Offering proceeds to over $10.8 million, and the total number of
shares issued and outstanding to 31.4 million.
80. $16 Million In Equity Sales. Taking further advantage of the artificial inflation
in the price of Organogenesis stock defendants' misrepresentations and omissions had caused, on
March 9, 2000, defendants sold another 300,000 shares of Organogenesis common stock at
approximately $17.60 per share in a private-placement, thereby realizing another $5.27 million.
Including this latest offering, the Company had issued a total of 1.088 million shares in less than
20 days in combined placements valued at over $16 million.
trel
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 38 of 39
81. On March 7, 2000, shares of the Company rallied to a Class Period high of over
$22.37 per share on substantial volume of over 1.5 million shares, driven by management's
optimistic guidance, and the false and misleading assurances that the Company was operating
according to plan - capable of achieving profitability in the near-term - and that the Company
had raised enough money to fund operations. Within days, however, on March 13, 2000,
defendant Stein suddenly and unexpectedly announced that he was resigning from the Board of
the Company. Stein had only accepted the position of Chairman Emeritus of the Board in
January 2000, after resigning as Chairman and Chief Executive Officer effective January 1,
2000. At the time of his resignation, no disclosure was made regarding the Company's inability
to generate sufficient funds from operations or sources of debt or equity to allow Organogenesis
to achieve profitability, or to foreseeably remain as a viable business.
82. On or about March 21, 2000, as President and CEO of Organogenesis, defendant
Laughlin showcased a presentation of the Company at the New York Society of Securities
Analysts 4th Annual Health Care Conference, held in New York City.
83. $6.2 Million Series C Redemption. Consistent with defendants' earlier
announcement, on March 27, 2000, Organogenesis issued a release which reported that
defendants had opted to use at least $6.2 million of its recently raised cash to pay for the
redemption of the Company's outstanding Series C convertible preferred stock. According to the
Company's release, the Series C convertible stock had a mandatory conversion date of March 26,
2000, but these shares were redeemable in either common stock or cash, at the option of
Organogenesis. The Company's release did not reveal why the cash election was chosen by
Organogenesis or who received the cash payments as a result of this redemption.
37
Case 1:04-cv-10027-JLT Document 58-2 Filed 12/22/04 Page 39 of 39
84. 4Q and FY:99 Results. On March 31, 2000, Organogenesis issued a release
published on Business Wire which purported to announce financial results for the fourth quarter
and year end 1999. According to the Company, results for the fourth quarter and full year 1999
were "consistent with the transition in progress from a research focused company to a
research based operating company with a novel medical product in introduction phase," in
addition to stating the following:
For the year ended December 31, 1999, revenue from product sales to related party and others was $1.8 million, compared with $1.1 million in 1998. Total revenues were $3.6 million for 1999, compared with $9.0 million in 1998, which included $6.8 million in milestone payments from Novartis Pharma AG. Total expenses (including manufacturing, research and development, and general and administrative costs) were $31.9 million in 1999, compared with $23.0 million in 1998. Net loss was $0.93 per share (or $28.4 million) for 1999 compared with a net loss of $0.48 per share (or $14.0 million) for 1998.
The increase in expenses was primarily due to: strengthening our employee base through additions to our production, research and support teams; costs to support publication studies and other sponsored programs, as well as increased activities in our corporate communications and business development functions; interest expense on the convertible debt issued last March; expanding our production and warehouse capacity while consolidating our administrative space; and the acquisition of intellectual property and assets from Baxter Healthcare Corporation. [Emphasis added.]
In addition to the foregoing, defendant Laughlin also used this release to condition investors to
believe that the Company was operating according to plan and was actually taking steps to
reduce operating costs, as follows:
Prior to the US commercialization of Apligraf, our corporate focus needed to be on supporting the validity of the product concept through solid research, clinical trials and manufacturing consistency.... Now, as sales of Apligraf begin to develop, our focus must include driving down per unit manufacturing costs through the development and implementation of more efficient methods ofproduction. At the same time, we are continuing to support other programs in our pipeline - the VITRTX(TM) living soft tissue replacement product, the vascular graft, the liver assist device - important to our longer term growth. [Emphasis added.]
38
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 1 of 39
85. FY:99 Form 10-K. The same day, March 31, 2000, Organogenesis also filed
with the SEC its financial results for full year 1999, pursuant to a Form 10-K signed by
defendants Laughlin, Erani and Lopolito, among others. In addition to repeating many of the
same misrepresentations made in the Company's release, the 1999 Form 10-K also stated that,
Organogenesis "believefsJ that future capital comprised of product sales, research and
development support payments and debt equity financings will be sufficient to fund future
operations into 2001. . . ." The Form 10-K also represented that its marketing partner, Novartis,
had "a marketing and sales force[J with technical expertise and distribution capability" and
that "[wJe expect Apligraf commercial sales to continue to increase." The Form 10-K further
stated that:
Cost of product sales exceeded product sales due to the start-up costs of new product introduction and the high costs associated with low volume production. We expect production volume to increase and our margins to improve. We expect to continue to expand production operations during the next 12 months.
* * *
We expect production costs to exceed product sales for the near term due to start-up expenses and the high costs associated with low volume production. However, we expect production volume to increase.
86. Following the filing of Organogenesis' 2000 Form 10-K, shares of the Company
traded as high as $12.60 per share on March 31, 2000.
87. The statements made by defendants and contained in the Company's March 31,
2000 release and 1999 Form 10-K, reproduced herein supra, were each materially false and
misleading and were known by defendants to be false at that time, or were recklessly disregarded
as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
I
39
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 2 of 39
(b) Contrary to defendants' representation that Novartis had "a marketing
and sales force[J with technical expertise and distribution capability," Novartis' marketing
team did not have the proper training, experience or expertise in selling a product like Apligraf,
with the result that Novartis' efforts to market Apligraf suffered significantly. In fact, as alleged
above, according to former employees of Novartis and Organogenesis, Novartis "had no idea
what they were doing" when it came to marketing a living-tissue product like Apligraf.
(c) Contrary to defendants' suggestion, the Company's planned focus on
"driving down per unit manufacturing costs" and implementing "more efficient methods of
production" would not achieve profitability for the Company. As defendants were well aware at
the time but failed to disclose, and as confirmed by former employees of Organogenesis,
Organogenesis was losing money on every unit of Apligraf that it produced because of the terms
of the disadvantageous terms of the Novartis marketing agreement - under which Novartis
shared revenue from Apligraf sales that was well below the product's manufacturing cost to
Organogenesis and reimbursed Organogenesis for production costs in connection with unsold
units at only a fraction of the actual costs of production.
(d) Defendants' representation that they expected Apligraf "commercial sales
to increase" was untrue given the marketing problems that Novartis was experiencing because of
inadequate marketing support and the significant problems with the manufacturing and
distribution of Apligraf that were causing frustration among purchasers, leading to reluctance
among physicians to order or re-order Apligraf and damaging Apligraf's future sales
development prospects.
(e) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
EUI
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 3 of 39
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Given the terms,
and the revised terms, of the Novartis marketing agreement - which caused Organogenesis to
lose money on every unit of Apligraf that it produced —far from lowering costs, the more units
ofApligraf that Organogenesis produced, the greater its losses would be.
(f) Defendants' representations touting the oversubscription of the
Company's stock offering as a result of investors' "strong interest in the Company" were
materially misleading and incomplete given that defendants failed to disclose the obstacles that
existed in accessing essential future funding. Defendants' representations misleadingly
conditioned investors to believe that the Company would be able to raise the additional equity
and debt financing necessary to keep the Company operational and achieve profitability. As
later revealed, the Company in fact did not have access to such funding.
(g) Contrary to defendants' representations that they expected to "continue to
expand production operations," according to former employees of the Company, Organogenesis
was experiencing serious problems in manufacturing Apligraf and there was "no way" the
41
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 4 of 39
Company could feasibly mass-produce Apligraf given the Company's inadequate production
infrastructure and processes.
88. Stein Stock Registration. Taking further advantage of the artificial inflation in
the price of Organogenesis that defendants' false statements had caused, on or about April 21,
2000, defendant Stein caused the Company to file with the SEC a Registration Statement
allowing him to register for sale over 732,000 shares of his personally held Organogenesis stock.
The Registration Statement, signed by defendants Laughlin, Lopolito and Erani, among others,
stated in part the following:
CALCULATION OF REGISTRATION FEE
Proposed
Proposed Title of
maximum maximum securities to be
Amount to be offering price aggregate Amount of registered
registered(1) per share(2)
offering price(2)
registration fee
Common Stock, $.01 par value (3) 732,423 $9.4375 $6,912,242.10 $1,824.83
* * *
This Prospectus is part of a Registration Statement we filed with the Securities and Exchange Commission for registration of up to 732,423 shares of Common Stock for sale by the selling stockholder listed on page 12 of this prospectus.
Each of the shares to be sold either were issued upon the exercise of options held by the selling stockholder. The selling stockholder may offer his common stock through transactions on the American Stock Exchange; in private transactions at current market prices; or at negotiated prices.
We will not receive any of the proceeds from the selling stockholder's sale of his common stock.
* * *
USE OF PROCEEDS
We will receive no net proceeds from the sale of the common stock. All proceeds will be realized by the selling stockholder.
42
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 5 of 39
SELLING STOCKHOLDER
The selling stockholder, Herbert M. Stein, is offering shares which have been acquired by him upon the exercise of options granted under a stock option grant. Mr. Stein previously served as Chairman and Chief Executive Officer of the Company until his retirement on December 31, 1999 and as a member of the Board of Directors of the Company until March 17, 2000. The following table lists the selling stockholder and other information regarding beneficial ownership of the common stock by the selling stockholder as of March 29, 2000:
of Percentage of Class to be Beneficially
Name
Herbert M. Stein
Number of Shares Beneficially Owned Prior to the Offering
2,086,597
Number of Shares Being Offered
723,423
Number Shares Beneficially Owned After Offering
1,363,174
Owned After Offering
4.0%
This registration represented almost half of defendant Stein's personal holdings (excluding
approximately 1.1 million shares of common stock held by H.M. Stein Associates to which
defendant Stein disclaimed beneficial ownership).
89. 1Q:00 Results. On May 11, 2000, Organogenesis issued a release published on
Business Wire which purported to announce financial results for the first quarter of 2000.
Defendants again stated that the Company's quarterly results were "consistent with the
Company's ongoing transition from being a research company to being a research-based
operating company," in addition to stating the following:
Revenue from product sales to related party and others were $646,000 for the first quarter of 2000 compared with $543,000 for the fourth quarter of 1999. The growth in product revenue was due to increased sales of Apligraf(R) to Novartis. Total revenues were $1,084,000 for the first quarter of 2000 compared with $1,015,000 for the fourth quarter of 1999. Total costs and expenses were $7,770,000 for the first quarter of 2000 compared with $9,368,000 for the fourth quarter of 1999, which had
43
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 6 of 39
included disproportionately higher occupancy and financing costs. Net loss was $0.21 per share (or $6,686,000) for the first quarter of 2000 compared with $0.27 per share (or $8,353,000) for the fourth quarter of 1999.
The first quarter of 2000 product revenues of $646,000 compare with $318,000 for the first quarter of 1999. The total revenues of $1,084,000 compare with $679,000 for the same quarter in 1999 and the total costs and expenses of $7,770,000 compare with $6,605,000 for the same quarter in 1999. The net loss of $0.21 per share (or $6,686,000) compares with a net loss of $0.19 per share (or $5,926,000) for the same quarter in 1999.
This release also quoted defendant Laughlin, as follows:
Key to Apligraf sales development are two factors: obtaining approval for diabetic foot ulcers and gaining standardized Apligraf reimbursement... The Advisory Panel's recommendation earlier this week is a key achievement towards the diabetic foot ulcer indication. We are equally committed to gaining standardized reimbursement for Apligraf. [Emphasis added.]
90. 1Q:00 Form 10-Q. On or about May 15, 2000, defendants filed with the SEC the
Company's financial results for the first quarter of 2000, the period ended March 31, 2000,
pursuant to a Form 10-Q, signed by defendants Laughlin and Arcari. The Company's first
quarter 2000 Form 10-Q contained the same materially false and misleading financial
information as had previously been announced on May 11, 2000, in addition to reporting, in part,
the following:
Basis of Presentation
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented....
* * *
Costs and Expenses
44
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 7 of 39
Cost of product sales: Cost of product sales was $1,191,000 for the three months ended March 31, 2000, compared to $603,000 for the same period in 1999, due to increased unit sales of Apligraf to Novartis. Cost of product sales includes the direct costs to manufacture and package Apligraf and an allocation of our production related indirect costs. Cost of product sales exceeded product sales due to the start-up costs of new product introduction and the high costs associated with low volume production. We expect production volume to increase and our margins to improve. We expect to continue to expand production operations during 2000. [Emphasis added.]
91. The statements made by defendants and contained in the Company's May 11,
2000 release and first quarter 2000 Form 10-Q, reproduced herein, supra, were each materially
false and misleading and were known by defendants to be false at that time, or were recklessly
disregarded as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) It was not true that "[k]ey to Apligraf sales development are two factors:
obtaining approval for diabetic foot ulcers and gaining standardized Apligraf reimbursement."
Defendants were aware, but did not disclose, that sales of Apligraf and future sales development
prospects were hampered by serious manufacturing and marketing problems, including the
Company's inability to mass produce Apligraf, Novartis' lack of training, experience and
expertise in marketing Apligraf and increasing physician resistance to the product.
(c) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
45
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 8 of 39
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Given the terms,
and the revised terms, of the Novartis marketing agreement - which caused Organogenesis to
lose money on every unit of Apligraf that it produced —farfrom lowering costs, the more units
ofApligraf that Organogenesis produced, the greater its losses would be.
(d) Contrary to defendants' representations that they expected to "continue to
expand production operations," the Company was experiencing serious problems in
manufacturing Apligraf and, according to a former employee of Organogenesis, there was "no
way" the Company could feasibly mass-produce Apligraf given the Company's inadequate
production infrastructure and processes.
(e) Contrary to defendants' representations, the Company's first quarter 2000
Form 10-Q did not reflect the true financial condition of the Company because it failed to
disclose the adverse factors affecting the Company's operations and future viability alleged in
subparagraphs (a) through (d) above and in paragraphs 59-67, supra.
92. On or about June 14, 2000, as President and Chief Executive Officer of
Organogenesis, defendant Laughlin showcased a very positive presentation of the Company at
the Annual Sachs Healthcare Conference in Laguna Niguel, CA.
93. On June 20, 2000, Organogenesis issued a release which announced that the FDA
had given final approval of Apligraf treatment for diabetic foot ulcers in addition to its previous
indication of venous leg ulcers. While no changes had been made to Apligraf for this market
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 9 of 39
application, the FDA indication purportedly allowed Organogenesis to expand its market base to
include this second group of foot ulcer sufferers. On this news, Organogenesis stock traded as
high as $12.75 per share in intra-day trading.
94. Laughlin on CNBC Power Lunch. On June 25, 2000, defendant Laughlin
appeared on the widely disseminated cable financial news show "Power Lunch," on the CNBC
network. When asked by the CNBC interviewer whether Organogenesis had the ability to obtain
profitability through sales of the Company's only product Apligraf, defendant Laughlin
responded, by stating that Organogenesis "can become profitable and will become profitable
with Apligraf alone. The two main drivers of that are diabetic foot ulcer approval which
happened last week and getting that standardized Medicare reimbursement, which has been
slow going. We're optimistic...." [Emphasis added.]
95. Apligraf Sales 7/00. On August 2, 2000, Organogenesis issued a release which
purported to announce Apligraf sales for the month of July 2000. This release stated that the
month "held notable achievements significant to future sales development." Despite this
statement, sales of Apligraf had declined substantially from the prior month, reaching only 912
units in July. Defendant Laughlin, however, suggested that the decline in sales was the result of
the "summer vacation period" - not that they were the result of any production problems within
the Company or any issues with product quality, product acceptance or Novartis' marketing.
96. 2Q:00 Results. On August 14, 2000, Organogenesis issued a release published
on Business Wire which purported to announce financial results for the second quarter 2000.
This quarter defendants stated that the Company was "in the process of transitioning from being
a research company to becoming an operating company with a strong research base," in addition
to stating the following:
47
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 10 of 39
For the second quarter of 2000, total revenues were $6.4 million compared with $0.9 million for the same quarter in 1999. The 2000 revenues include a $5 million milestone payment from Novartis that was received in March and earned in June with the approval of Apligraf for diabetic foot ulcers. Total costs and expenses were $8.5 million during the second quarters of both 2000 and 1999. The 1999 expenses included a non-cash charge of $0.9 million for a technology-related acquisition, while the 2000 expenses show modest increases across each expense category. Net loss was $2.0 million ($0.06 per share), compared with a net loss of $7.6 million ($0.25 per share) for the same quarter in 1999.
The Company reportedly had $22.3 million in cash, cash equivalents and investments at June 30,
2000.
97. In addition to reporting the following, the August 14, 2000 release was also used
by defendant Laughlin to condition investors to believe that Organogenesis had achieved certain
milestones such that it was foreseeable that the Company could achieve profitability in the near-
term. In this regard, defendant Laughlin was quoted in the August 14, 2000 release, as follows:
When we announced our first quarter results three months ago, we stated our commitment to achieving two important drivers ofApligraf sales: FDA approval for diabetic foot ulcers and Medicare reimbursement for the product's cost. We now have tangible achievements in both areas. Apligraf was approved for diabetic foot ulcers in June and its marketing was launched by Novartis in July. Effective this month, Apligraf qualifies for Medicare reimbursement when used in the hospital outpatient setting, such as a hospital-affiliated wound care center. There has also been progress in gaining Medicare reimbursement for Apligraf applied in the doctor's office, with additional activities underway. [Emphasis added.]
Defendant Laughlin also claimed that the Company had 'further strengthened its
manufacturing and management team" with the addition of a new Vice President of
Operations in June 2000.
98. 2Q:00 Form 10-Q. The same day, August 14, 2000, defendants also filed with
the SEC the Company's financial results for the second quarter of 2000, the period ended June
30, 2000, pursuant to a Form 10-Q signed by defendants Laughlin and Arcari. The Company's
48
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 11 of 39
second quarter 2000 Form 10-Q contained the same materially false and misleading financial
information as had been previously announced, in addition to reporting, in part, the following:
Basis of Presentation
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented...
* * *
COSTS AND EXPENSES
Cost of product sales: Cost of product sales was $1,243,000 and $2,434,000 for the three and six months ended June 30, 2000, compared to $1,126,000 and $1,730,000 for the same periods in 1999, due to increased unit sales of Apligraf to Novartis. Cost of product sales includes the direct costs to manufacture and package Apligraf and an allocation of our production related indirect costs. Cost ofproduct sales continues to exceed product sales due to the high costs associated with low volume production. We expect production volume to increase and our margins to improve. We expect to continue to expand production operations during 2000. [Emphasis added.]
99. Apligraf Sales 3Q:00. On October 3, 2000, defendants published a release on
Business Wire which reported record Apligraf sales for September and the third quarter of 2000
—1081 units in September 2000 and a total of 3,232 units during the third quarter of 2000. In
addition to reporting the foregoing, this release also quoted defendant Laughlin who stated that,
"[tJhird quarter Apligraf achievements. . . laid an important foundation for future sales
development" [Emphasis added.]
100. The statements made by defendant Laughlin during the June 25, 2000 CNBC
interview and other statements made by defendants and contained in the Company's August 2,
IM
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 12 of 39
2000 release and Form 10-Q for the second quarter of 2000, reproduced herein, supra, were each
materially false and misleading and were know by defendants to be false at that time, or were
recklessly disregarded as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) Contrary to defendants' representation, it was not true that the Company
could "become profitable and will become profitable with Apligraf alone" and that "the two
main drivers" of profitability would be the approval of Apligraf for diabetic foot ulcer approval
and the receipt of standardized Medicare reimbursement. As defendants were aware, the
disadvantageous terms of the Novartis marketing agreement - under which Organogenesis was
losing, and would continue to lose, money on every unit of Apligraf that it produced - ensured
that the Company could not achieve profitability through the production and sale of Apligraf.
Further, as alleged in paragraphs 59-67, supra, the Company was suffering from a host of
undisclosed financing, manufacturing, marketing and management problems that were obstacles
to the Company's achievement of its purported plan for profitability.
(c) For the same reasons stated in subparagraph (b) above, defendants'
statements that "the two important drivers of Apligraf sales" were obtaining approval for diabetic
foot ulcers and gaining standardized Apligraf reimbursement misled investors into believing that
these were the last two pieces of the sales puzzle, and that given that the Company had now
achieved "tangible achievements in both areas," sales were poised to increase, allowing the
Company to achieve profitability. Defendants were aware, but did not disclose, that sales of
Apligraf and future sales development prospects were hampered by serious manufacturing and
marketing problems, including the Company's inability to mass produce Apligraf, Novartis' lack
50
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 13 of 39
of training, experience and expertise in marketing Apligraf and increasing physician resistance to
the product.
(d) Contrary to defendants' representations that they expected to "continue to
expand production operations," the Company was experiencing serious problems in
manufacturing Apligraf and there was "no way" the Company could feasibly mass-produce
Apligraf given the Company's inadequate production infrastructure and processes.
(e) Defendants' representation that the Company had made "notable
achievements significant to future sales development" in July 2001 despite declining sales
volume, and their suggestion that the decline was the result of the "summer vacation period" was
materially misleading and incomplete given that the Company's sales were adversely affected by
the significant manufacturing and marketing problems, including problems with product quality,
product acceptance and Novartis' marketing, and that these problems were actually exacerbating,
rather than improving, "future sales development."
(f) Contrary to defendants' representation that they had "further
strengthened" the Company's "manufacturing and management team," recent turnover among
the Company's senior management and directors, including the departure of defendant Stein and
others, as well as infighting among senior management, were weakening the Company's
management team and adversely affecting the Company's operations.
(g) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
51
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 14 of 39
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Given the terms,
and the revised terms, of the Novartis marketing agreement - which caused Organogenesis to
lose money on every unit of Apligraf that it produced —far from lowering costs, the more units
ofApligraf that Organogenesis produced, the greater its losses would be.
(h) Defendants' representation that they had established an "important
foundation for future sales development" was materially misleading and incomplete given that
defendants failed to disclose the fundamental manufacturing, marketing and management
problems alleged above, which had actually established a weakened foundation for developing
future sales.
(i) Contrary to defendants' representations, the Company's second quarter
2000 Form 10-Q did not reflect the true financial condition of the Company because it failed to
disclose the adverse factors affecting the Company's operations and future viability alleged in
subparagraphs (a) through (h) above and in paragraphs 59-67, supra.
101. 3Q:00 Results. On November 14, 2000, Organogenesis issued a release
published on Business Wire which purported to announce financial results for the third quarter
2000. Again, defendants heralded the achievements of Apligraf, reporting that Organogenesis
was still "in the process of transitioning from being a research Company to becoming an
operating Company with a strong research base." This release also stated, in part, the following:
52
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 15 of 39
For the three months ended September 30, 2000, total revenues were $1.4 million compared with $0.9 million for the same quarter in 1999. The increase was due to increased product sales to related party and others and increased income from grants and interest. Total costs and expenses were $8.3 million during the third quarter of 2000 compared with $7.4 million for the same quarter in 1999. The increase was due to increased cost of product sales, research and development expenses, interest expense and general and administrative expenses. Net loss was $6.9 million ($0.20 per share), compared with a net loss of $6.5 million ($0.21 per share) for the same quarter in 1999.
In addition to the foregoing, defendant Laughlin was also quoted in this release as conditioning
investors to believe the following:
This summer we made important progress in several areas central to Apligraf sales development. Apligraf was approved and launched for diabetic foot ulcers, qualified for Medicare reimbursement when used in the hospital outpatient setting and marketer Novartis expanded the field force selling the product. We believe the Apligraf sales growth seen in the third quarter is the beginning of the effect of these achievements on sales development. While unit volumes are still small, which adversely affects our cost ofproduction, the trend is encouraging.
102. 3Q:00 Form 10-Q. The same day, November 14, 2000, defendants also filed
with the SEC pursuant to Form 10-Q the Company's financial results for the third quarter of
2000, the period ended September 30, 2000, signed by defendants Laughlin and Arcari. The
Company's Form 10-Q for the third quarter of 2000 contained the same materially false and
misleading financial information as had previously been announced, in addition to reporting, in
part, the following:
Basis of Presentation
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position,
53
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 16 of 39
results of operations and changes in cash flows for the periods presented....
* * *
COSTS AND EXPENSES
Cost of product sales: Cost of product sales was $1,310,000 and $3,744,000 for the three and nine months ended September 30, 2000, compared to $969,000 and $2,699,000 for the same periods in 1999, due to increased unit sales of Apligraf to Novartis. Cost of product sales includes the direct costs to manufacture and package Apligraf and an allocation of our production related indirect costs. Cost of product sales continues to exceed product sales due to the high costs associated with low volume production. We expect production volume to increase and our margins to improve. [Emphasis added.]
103. Apligraf Sales 11/00. Later, on December 4, 2000, Organogenesis announced
that November sales of Apligraf were 1488 units - a new record monthly high. In addition, this
release again quoted defendant Laughlin who stated that, "[w]e are clearly beginning to see
acceleration in the growth of Apligraf sales. October and November establish a new, higher
sales base on which to build. While it is difficult to predict how the December holidays will
impact sales, we expect to begin seeing in the first quarter the impact of the additional sales
representatives that started this past summer." [Emphasis added.]
104. The statements made by defendants and contained in the Company's October 3,
2000 and November 14, 2000 releases and in the Form 10-Q for the third quarter of 2000,
reproduced herein, supra, were each materially false and misleading and were known by
defendants to be false at that time, or were recklessly disregarded as such for the following
reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
54
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 17 of 39
(b) Contrary to defendants' representations that the "trend" with respect to its
ability to increase unit volumes and thus favorably affect the cost of production was
"encouraging," as confirmed by former employees of the Company, Organogenesis was
experiencing substantial manufacturing problems, which were retarding and hindering the
expansion of production scale. Further, defendants were aware but failed to disclose that the
most important factor affecting cost of production was not "unit volumes," but rather the
unfavorable terms of the Novartis marketing agreement, under which Organogenesis was
reimbursed for only a fraction of production costs in connection with units not sold, and received
a share of revenue on units that were sold that was far below cost.
(c) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that were well below the product's manufacturing cost. Given the terms, and the revised
terms, of the Novartis marketing agreement - which caused Organogenesis to lose money on
every unit of Apligraf that it produced —far from lowering costs, the more units of Apligraf
that Organogenesis produced, the greater its losses would be.
55
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 18 of 39
(d) Defendants' public statements touting the "record number" of sales in
November 1999, the fact that recent sales established a "higher sales base on which to build" and
that the Company expected to see "the impact of the additional sales representatives" in the first
quarter of 2001 was materially misleading and incomplete given that, as confirmed by several
former employees of Organogenesis, the Company was experiencing serious manufacturing and
marketing problems that were inhibiting sales and damaging future sales development prospects.
Further, as defendants knew, Novartis' marketing team did not have the proper training,
experience or expertise in selling a product like Apligraf, with the result that Novartis' efforts to
market Apligraf were suffering significantly.
(e) Contrary to defendants' representations, the Company's Form 10-Q for the
third quarter of 2000 did not reflect the true financial condition of the Company because it failed
to disclose the adverse factors affecting the Company's operations and future viability alleged in
subparagraphs (a) through (d) above and in paragraphs 59-67, supra.
105. 500,000 Share Repurchase. On December 6, 2000, defendants issued a release
which announced that the Board of the Company had authorized the repurchase of up to 500,000
shares of Organogenesis common stock - "at the discretion of management." According to
defendant Laughlin, the decision to purchase the Company's stock was made by the Board
because, "[o]ur Board is sensitive to shareholder dilution and views current market conditions
as an opportunity to purchase shares that the Company considers to be undervalued in view of
our prospects." [Emphasis added.] In addition, defendant Laughlin also stated that, "the decision
to authorize a stock buyback program demonstrates the confidence our Board has in the
Company's future." At the time of this announcement, shares of the Company were trading at
approximately $7.50 per share.
56
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 19 of 39
106. Apligraf Sales January 2001. On February 5, 2001, Organogenesis announced
that Apligraf sales had reached another record in January 2001, with 1771 units sold during that
period. In addition, this release again quoted defendant Arcari who stated that, "[w]e are pleased
with the acceleration being seen in Apligraf sales growth."
107. Laughlin on CNBC Power Lunch February 27, 2001. On February 26, 2001,
Organogenesis issued a release which announced the broadening of its 1996 marketing
agreement with Novartis Pharma AG - an agreement which purportedly gave Organogenesis
the right for three years to sell Novartis up to $20 million in equity. Under the purported terms
of this deal, Organogenesis would also receive funding from Novartis to upgrade the Company's
manufacturing plants and equipment. The following day, February 27, 2001, defendant Laughlin
again appeared on nationally televised cable news show CNBC Power Lunch, during which he
was interviewed by Bill Griffeth, and stated, the following:
GRIFFETH: What kind of an increase in revenue do you expect from this expansion of the deal with Novartis?
LAUGHLIN: Let me just run through the deal. And you are right, it is a turning pointfor us. It is a major improvement in our economic situation. Unfortunately, I can't give you the precise details of the deal but let me -- -
LAUGHLIN: [L]et me tell you the major elements of what it is. We have granted Novartis the rights to two additional living tissue products, one that will be entering clinical trials in the next 30 to 60 days and one that is in research. In exchange for that, we will receive a substantial increase in the percentage of the revenue for our living tissue product, which is actually on the market today, called Apligraf. We will also receive funding for a number of different areas which will enable us to expand our business, get into additional markets and drive down our costs. We also received a $20 million stock put. So any time during the next three years we are able at our discretion and our option to sell Novartis $20 million of shares. We may or may not do that, but it is wonderful safety net to have in our pocket.
GRIFFETH: Right. Now, as far as the product agreement goes, though, I know you are meeting with Wall Street analysts to talk about this. Are you raising guidance, though, as far as revenue for this year as a result of this?
57
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 20 of 39
LAUGHLiN: What we are doing and the thing people have been most interested in is giving them guidance on our profitability. What we now feel with the increased revenue, with the funding support that we will get, we are now targeting to pass through break even and reach profitability in the second quarter of next year - sorry, the third quarter of next year.
GRIFFETH: Third quarter of next year. OK. And as a result of this, I am curious, I mean are you finding or at least receiving approval for new applications for Apligraf? I am wondering why Novartis is doing this now. I know I should ask them but maybe you can provide some guidance on that.
LAUGHLiN: I think they are truly convinced that there is major business here. ....Everything is coming together. I think they are saying, yes, this is working. This is going to be a very big business. Let's get into it deeper. Let's commit to the business.
* * *
GPJFFETH: Now and you factor, when you provide this guidance for break even, is that a part of that guidance of the anticipated approval of those products and when they might be available for market?
LAUGHLIN: As we look into the things that go into our break even we are targeting to reach break even with or without those approvals. One thing that we will hit before break even is we hope to be approved for launch into the European market in approximately the second quarter of next year. [Emphasis added.]
At the time of this interview shares of Organogenesis traded at above $12.00.
108. The statements made by defendant Laughlin during the February 27, 2001 CNBC
interview and those statements made by defendants and contained in the Company's February 5,
2001 release, reproduced herein, supra, were each materially false and misleading and were
known by defendants to be false at that time, or were recklessly disregarded as such for the
following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) Contrary to defendants' representations that the Company's stock was
"undervalued in view of our prospects," defendants knew but failed to disclose that defendant
Erani had sought to have stock brokers "manipulate the market for the Company's stock."
58
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 21 of 39
Further, defendants knew but failed to disclose that the Company's ultimate prospects for
achieving profitability were severely compromised by the problems alleged in paragraphs 59-67
above, including the Company's serious manufacturing and marketing problems, its inability to
access as necessary adequate funding to keep the Company viable, the difficulties in achieving
reimbursement for Apligraf, and the disruptive effect on operations that high turnover and
infighting among the Company's senior management was having, and would continue to have
for the foreseeable future.
(c) Defendant Laughlin's representation that Novartis' agreement to grant
Organogenesis a $20 million put option was evidence of Novartis' conviction that "everything is
coming together" and that "yes, this is working" and "is going to be a very big business" was
materially misleading and incomplete for the same reasons as alleged in subparagraph (b) above.
(d) Contrary to defendant Laughlin's representation that under the $20 million
put option with Novartis the Company was "able at our discretion and our option to sell
Novartis $20 million of shares" and that the put option was a "wonderful safety net to have in
our pocket" was untrue. As later revealed by defendants, the Company did not have the ability
to raise the full amount of that funding option at the discretion of the Company. As defendants
knew but failed to disclose at the time, significant conditions precedent to the exercise of the put
option prevented the Company from accessing $10 million of the put option funding, which
ultimately led to the Company's inability to fund operations in 2002. Thus, the "safety net" that
defendants represented they had secured for the Company was only an illusion.
(e) Defendant Laughlin's statements that the revised Novartis marketing
agreement was a "turning point" for the Company and a "major improvement in our economic
situation" and that the Company would receive "a substantial increase in the percentage of the
WI
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 22 of 39
revenue" were untrue and materially misleading. As confirmed by former employees of the
Company, even under the revised terms of the marketing agreement, Organogenesis' share of
revenue from Apligraf sales remained well below Organogenesis' manufacturing costs and could
not lead to profitability. Further, even under the revised terms of the marketing agreement,
Organogenesis was still required to manufacture Apligraf in conformity with Novartis sales
forecasts, which, according to a former employee of Organogenesis, were "always inflated."
(f) Contrary to defendant Laughlin's representation that "the increased
revenue" and "the funding support that we will get" put the Company in the position to "pass
through break even and reach profitability" by the third quarter of 2002, defendants knew that
there was no way the Company could ever achieve profitability - much less achieve it by the
third quarter of 2002 - based on the increased revenue from the revised Novartis marketing
agreement and the $20 million put option with Novartis. Defendants were aware under the
revised agreement Organogenesis would continue to lose money on every unit of Apligraf
produced. Further, as defendants knew but did not disclose at the time, the Company did not
have the ability to raise the full amount of the $20 million put option.
(g) Contrary to defendant Laughlin's representation that the Company
expected to "break even with or without" approvals of additional products, defendants knew that
given the Company's loss of money on every unit of Apligraf under the revised Novartis
marketing agreement and the restrictions on the exercise of the $20 million put option there was
no way that the Company could break even based on sales of Apligraf alone.
109. Needham Report. Following defendant Laughlin's well received CNBC
appearance, analysts at Needham & Co. issued a report on Organogenesis, initiating a "Buy"
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 23 of 39
rating and a near term price target of $16-$18 per share on Organogenesis stock, and stating in
part the following:
INVESTMENT OPINION
We are initiating coverage of Organogenesis Inc. with a Buy rating and a 12-month target price range of $16-$18. Management of skin disorders requiring tissue replacement represents a major unmet need. A leader in its segment of the $400 billion healthcare arena of regenerative medicine, ORG has developed Apligraf, currently approved for two of the most common chronic wounds (venous stasis ulcers and diabetic foot ulcers).
* * *
We believe ORG is currently undervalued compared to its peers. Applying two methods of valuation (market capitalization to revenue ratio of lix as well as P/E ratio of 35x) to our 2004 estimates and discounting back at 10% annually, we arrive at a 12-month target range of $16-$18. [Emphasis added.]
110. Apligraf Sales 2/01. On March 5, 2001, Organogenesis announced that sales of
Apligraf had reached another monthly record, with 1729 units sold in February 2001. In
addition, this release again quoted defendant Arcari who stated that, "Apligraf sales are showing
sustained growth acceleration. Average daily sales in February surpassed those in January, and
both are ahead of the level seen in our record fourth quarter. We are particularly pleased with
this acceleration, because under the recently amended agreement with Novartis,
Organogenesis now receives significantly higher payments for Apligraf" [Emphasis added.]
ill. Erani's Refusal To Provide Standard Audit Confirmations to
PricewaterhouseCoopers. Unbeknownst to the public, as stated by defendant Arcari - then
the Company's CFO - in the Confidential Arcari Document obtained by plaintiffs' counsel, in
March 2001 defendant Erani, then Chairman of the Board of Organogenesis, "[r]efused to sign
standard audit confirmations sent to him by PricewaterhouseCoopers, the Company's auditors,
relating to his holdings of the Company's convertible debt." According to the Confidential
Arcari Document, "this eroded PricewaterhouseCoopers [sic] confidence in managements [sic]
61
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 24 of 39
and the Boards [sic] representations." The Confidential Arcari document further states that other
actions by Erani led to a "loss of the Company's credibility with the Company's service
providers including. . . independent accountants."
112. 4Q and FY:OO Results. On March 30, 2001, Organogenesis issued a release
published on Business Wire which purported to announce financial results for the fourth quarter
and full year 2000, as follows:
For the three months ended December 31, 2000, total revenues were $1.5 million compared with $0.9 million for the same quarter in 1999.... Total operating costs and expenses were $8.5 million during the fourth quarter of 2000 compared with $8.9 million for the same quarter in 1999.... Net loss was $7.4 million ($0.21 per share) for the fourth quarter of 2000 compared with a net loss of $8.4 million ($0.27 per share) for the same quarter in 1999.
For the year ended December 31, 2000, total revenues were $10.2 million compared with $2.7 million in 1999.... The 2000 full-year revenues include a $5 million milestone payment from Novartis for our achievement of FDA approval of Apligraf for diabetic foot ulcers. Full-year revenues also include $1.1 million in research and development support from Novartis recognized in 2000 under SAB 101. Total operating .costs and expenses were $31.6 million in 2000 compared with $30.6 million in 1999.... Net loss was $22.3 million ($0.66 per share) in 2000 compared with a net loss of $28.4 million ($0.93 per share) in 1999. When the one-time cumulative effect charge against income due to adoption of SAB 101 is included, the 2000 net loss becomes $28.6 million ($0.85 per share).
In addition to the foregoing, defendant Laughlin also stated that defendants were also keeping a
tight control over expenses and costs and that Apligraf sales were driving revenues, as follows:
Our increased product revenue in the fourth quarter reflects a significant increase in our unit sales growth rate, compared to the prior quarter. Our first quarter 2001 financials will show an important increase in revenue due to a continuation of this higher unit growth rate as well as the significantly higher revenue per unit which we now receive from Novartis. We are keeping a tight control on our corporate expenses while implementing programs to reduce our manufacturing costs. [Emphasis added.]
113. 2000 Form 10-K. The same day, March 30, 2001, Organogenesis also filed with
the SEC its financial results for full year 2000, pursuant to Form 10-K, signed by defendants
62
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 25 of 39
Laughlin, Erani and Arcari, among others. In addition to repeating many of the same
misrepresentations made in the Company's release, the 2000 Form 10-K also stated that Apligraf
was "mass-produced" and "available to physicians on demand." In the section of the Form 10-
K entitled, "Management's Discussion and Analysis of Financial Condition and Results of
Operations" ("MD&A") defendants also touted the purported benefits of the recent amendment
to the Novartis marketing agreement, stating that the amendment "significantly increases
payments we receive for Apligraf units." The MD&A section of the Form 10-K further stated
that although Organogenesis had "limited experience in sales, marketing and distribution" the
Company had "developed a long-term strategic relationship with Novartis, who has marketing
and sales forces with technical expertise and distribution capability." The MD&A section of
the Form 10-K also stated that "[wJe expect Apligraf commercial sales to continue to
increase" and that "fwje expect production volume to increase due to recent Medicare progress
with coverage for Apligraf, FDA approval of Apligraf for use in diabetic foot ulcers and
expanded Novartis sales and marketing support." The MD&A section of Form 10-K also
touted the Company's purported ability to access funding from Novartis and other sources of
capital, stating that:
Based upon our current plans, we believe existing working capital at December 31, 2000, together with the proceeds of product and other revenues in 2001 and proceeds available from exercising a portion or all of a $20,000,000 equity security put with Novartis, which is at our discretion, will be sufficient to finance operations through at least the first quarter of 2002. We expect to raise additional funds in 2001 through equity financing. [Emphasis added.]
114. Despite the erosion of PricewaterhouseCoopers' confidence in the
representations of the senior officers and directors of Organogenesis and the "loss of the
Company's credibility" with the Company's "independent accountants," as alleged above,
63
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 26 of 39
PricewaterhouseCoopers on March 31, 2001 issued to the Company's shareholders a "Report of
Independent Accountants" certifying Organogenesis' financial statements.
PricewaterhouseCoopers' report, which was included in Organogenesis' 2000 Form 10-K, stated:
In our opinion, the accompanying consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Organogenesis, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. . . . We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
115. During April 2001, Organogenesis also hosted presentations at additional analyst
conferences, including, but not limited to, the Tucker Anthony Sutro Capital Markets 2001
Health Care Conference, held at the Ritz Canton in Laguna Niguel, CA, and the Fifth Annual
American Stock Exchange Emerging Growth Conference, held at the Grand Hyatt Hotel in New
York City. On or about April 17, 2001 analysts at Needham & Co. reiterated their prior "BUY"
rating and continued to encourage investors to expect a near-term price target of $16-$18 per
share.
116. The statements made by defendants and contained in the Company's March 5,
2001 and March 30, 2001 releases and those statements contained in Organogenesis 2000 Form
10-K, reproduced herein, supra, including the MD&A section of that Form 10-K were each
materially false and misleading and were known by defendants to be false at that time, or were
recklessly disregarded as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
64
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 27 of 39
(b) Contrary to defendants' representation that the $20 million put option with
Novartis was available "at [Organogenesis'] discretion," the Company did not have the ability to
raise the full amount of that funding option at the discretion of the Company. As defendants
knew but failed to disclose at the time, significant conditions precedent to the exercise of the put
option prevented the Company from accessing $10 million of the put option funding, which
ultimately led to the Company's inability to fund operations in 2002.
(c) Contrary to defendants' representation that Apligraf could be, and was
being "mass-produced," according to a former Senior Manager of Quality Systems Compliance
for Organogenesis during the Class Period, there was "no way" that the Company could
commercially mass-produce Apligraf given the Company's inadequate production infrastructure
and processes.
(d) Contrary to defendants' representation that the Company made Apligraf
"available to physicians on demand," according to a former Tissue Engineering Specialist with
Novartis during the Class Period, contamination of the product frequently resulted in physicians
not receiving the product when necessary, resulting in increased frustration and disappointment
with the product among physicians.
(e) Defendants' representation that "under the recently amended agreement
with Novartis, Organogenesis now receives significantly higher payments for Apligraf' was
materially misleading and incomplete given that even under the amended agreement
Organogenesis would still receive revenue payments that were well below the product's
manufacturing cost and that Organogenesis would continue losing money on every unit of
Apligraf.
65
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 28 of 39
(f) Defendants' representations touting the "important increase in revenue,"
the "significantly higher revenue per unit" and the "significant[] increases" in "payments the
Company receive[d] for Apligraf units" were materially misleading and incomplete for the same
reasons stated in subparagraph (e) above.
(g) Defendants' representation that they expected Apligraf "commercial sales
to increase" was untrue given the marketing problems that Novartis was experiencing and would
continue to experience because of inadequate marketing support and the problems with the
manufacturing and distribution of Apligraf that were causing frustration among purchasers,
leading to reluctance among physicians to order or re-order Apligraf and damaging Apligrafs
future sales development prospects.
(h) Defendants' representations touting "record" sales for the month of
February 2001 and "sustained growth acceleration" were materially misleading and incomplete
given that, as confirmed by several former employees of Organogenesis, the Company was
experiencing serious manufacturing and marketing problems that were inhibiting sales and
damaging future sales development prospects. Further, as defendants knew, Novartis' marketing
team did not have the proper training or experience in selling a product like Apligraf, with the
result that Novartis' efforts to market Apligraf were suffering significantly.
(i) Contrary to defendants' representation that they were "implementing
programs to reduce [the Company's] manufacturing costs," the Company was incurring
significant manufacturing costs due to the fact that under the revised Novartis marketing
agreement, Organogenesis was required to produce Apligraf in sufficient quantities to meet
Novartis' "always inflated" sales forecasts. According to former employees of Organogenesis,
for every unit of Apligraf manufactured pursuant to Novartis' sales forecasts but not sold,
refti-
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 29 of 39
Organogenesis was required to bear an even greater share of the manufacturing costs than for
units that were sold.
(j) Contrary to defendants' representation that Novartis had "marketing and
sales forces with technical expertise and distribution capability," Novartis' marketing team did
not have the proper training, experience or expertise in selling a product like Apligraf, with the
result that Novartis' efforts to market Apligraf were suffering significantly. In fact, as alleged
above, according to former employees of Novartis and Organogenesis, Novartis "had no idea
what they were doing" when it came to marketing a living-tissue product like Apligraf.
(k) Contrary to defendants' representation that they "expect[ed] production
volume to increase due to recent Medicare progress with coverage for Apligraf," defendants
were encountering significant physician resistance to the product due to difficulties in obtaining
Medicare and Medicaid reimbursement for Apligraf.
(1) Defendants' representation heralding "expanded Novartis sales and
marketing support" was materially materially misleading and incomplete given that defendants
failed to disclose that Novartis' marketing team did not have the proper training, experience or
expertise in selling a product like Apligraf, with the result that Novartis' efforts to market
Apligraf were suffering significantly. In fact, as alleged above, according to former employees of
Novartis and Organogenesis, Novartis "had no idea what they were doing" when it came to
marketing a living-tissue product like Apligraf.
(m) Defendants' representation that it had, or had access to, sufficient funds to
finance operations through "at least the first quarter of 2002" based in part on "proceeds of
product," and proceeds available from the $20 million put option was untrue. As defendants
were well aware but did not disclose (i) revenues from sales of Apligraf were well below costs of
67
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 30 of 39
production and thus the product was actually causing the Company to lose money; and (ii)
significant conditions precedent to the exercise of the put option prevented the Company from
accessing $10 million of the put option funding, which ultimately led to the Company's inability
to fund operations in 2002. Indeed, well before the end of the first quarter of 2002, the Company
revealed that it "would have to curtail or discontinue" all operations if it could not raise
additional funding.
(n) Defendant PricewaterhouseCoopers' certification of the Company's
financial statements was materially misleading and incomplete because it failed to disclose that,
according to the Confidential Arcari Document, PricewaterhouseCoopers' confidence in the
representations of the senior officers and directors of Organogenesis had been eroded and that
the Company had lost credibility in the eyes of PricewaterhouseCoopers.
117. 1Q:01 Results. On April 27, 2001, defendants announced more purported good
news. That day, the Company published a release, announcing results for first quarter of 2001,
with product revenues "nearly triple over prior year period." This release also stated that the
Company had made another amendment to its marketing agreement with Novartis which
purportedly gave Organogenesis "significantly higher payments" on sales of Apligraf as well as
additional funding support. In addition, this release also stated that:
For the three months ended March 31, 2001, total revenues were $2.5 million compared with $1.2 million for the same quarter in 2000. Product sales to related party were $1.8 million in the first quarter of 2001, compared with $0.6 million for the same period in 2000, due to increased sales of Apligraf and the higher payments Organogenesis now receives from Novartis for each unit ofApligraf.
Total operating costs and expenses were $8.6 million during the first quarter of 2001 compared with $7.3 million for the same quarter in 2000. The first quarter of 2001 cost of product sales increased by $0.7 million due to increased sales of Apligraf. During the same period, research and development costs increased by $0.6 million due to increased clinical, process development and product development expenses. General and
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 31 of 39
administrative expenses decreased slightly. Net loss was $6.5 million ($0.19 per share) for the first quarter of 2001 compared with a net loss of $6.4 million ($0.21 per share) for the same quarter in 2000. When the one-time cumulative effect in change in accounting principle charge due to the adoption of SEC Staff Accounting Bulletin No. 101 - "Revenue Recognition in Financial Statements" is included, the first quarter of 2000 net loss becomes $12.8 million ($0.41 per share).
This release also quoted defendant Arcari, as follows:
Our product margin improved significantly over last year. Not only did product revenue increase, but per unit costs decreased as a result of process improvements. We tightly controlled our corporate expenses while increasing our investment in process development to further reduce manufacturing costs. Under our amended agreement with Novartis, we received nearly $1.0 million in the first quarter of 2001 for manufacturing facility improvements. [Emphasis added.]
118. 1Q:01 Form 10-Q. On or about April 27, 2001, defendants also filed with the
SEC the Company's financial results for the first quarter of 2001, the period ended March 31,
2001, pursuant to a Form 10-Q signed by defendants Laughlin and Arcari. The Company's
Form 10-Q for the first quarter of 2001 contained the same materially false and misleading
financial information as had been announced previously, in addition to reporting, in part, the
following:
Basis of Presentation
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented....
* * *
Costs and Expenses
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 32 of 39
Cost of product sales: Cost of product sales increased 50% to $2,196,000 in the first quarter of fiscal 2001, from $1,467,000 for the comparable quarter last year, due to increased unit sales of Apligraf to Novartis. Cost of product sales includes the direct costs to manufacture and package Apligraf and an allocation of our production related indirect costs. Cost of product sales continues to exceed product sales due to the high costs associated with low volume production. We expect production volume to increase and our margins to continue to improve during 2001. [Emphasis added.]
* * *
[W]e believe existing working capital at December 31, 2000, together with the proceeds of product and other revenues in 2001 and proceeds available from sales of shares to the underwriter and/or exercising a portion or all of a $20,000,000 equity security put with Novartis, which is at our discretion, will be sufficient to finance operations through at least the first quarter of 2002. We expect to raise additional funds in 2001 through equity financing. [Emphasis added.]
119. The statements made by defendants and contained in the Company's April 27,
2001 release and in the Form 10-Q for the first quarter of 2001, reproduced herein, supra, were
each materially false and misleading and were known by defendants to be false at that time, or
were recklessly disregarded as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) Defendants' representation that it had, or had access to, sufficient funds to
finance operations through "at least the first quarter of 2002" based in part on "proceeds of
product," and proceeds available from the $20 million put option was untrue. As defendants
were well aware but did not disclose (i) revenues from sales of Apligraf were well below costs of
production and thus the product was actually causing the Company to lose money; and (ii)
significant conditions precedent to the exercise of the put option prevented the Company from
accessing $10 million of the put option funding, which ultimately led to the Company's inability
to fund operations in 2002.
"C
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 33 of 39
(c) Contrary to defendants' representation that the $20 million put option with
Novartis was available "at [Organogenesis'] discretion," the Company did not have the ability to
raise the full amount of that funding option at the discretion of the Company. As defendants
knew but failed to disclose at the time, significant conditions precedent to the exercise of the put
option prevented the Company from accessing $10 million of the put option funding, which
ultimately led to the Company's inability to fund operations in 2002.
(d) Defendants' representations touting the "important increase in revenue,"
the "significantly higher revenue per unit" and the "significant[] increases" in "payments the
Company receive[d] for Apligraf units" were materially misleading and incomplete because
defendants failed to disclose that even under the amended agreement Organogenesis would still
receive revenue payments that were well below the product's manufacturing cost and that
Organogenesis would continue losing money on every unit of Apligraf.
(e) Defendants' representations touting a "product revenue increase," the
decrease of per unit costs and its investment "to further reduce manufacturing costs" were
materially misleading and incomplete given that defendants knew but failed to disclose that the
Company was incurring significant manufacturing costs due to the fact that under the revised
Novartis marketing agreement, Organogenesis was required to produce Apligraf in sufficient
quantities to meet Novartis' "always inflated" sales forecasts. According to former employees of
Organogenesis, for every unit of Apligraf manufactured pursuant to Novartis' sales forecasts but
not sold, Organogenesis was required to bear an even greater share of the manufacturing costs
than for units that were sold.
(f) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
71
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 34 of 39
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Given the revised
terms of the Novartis marketing agreement - which caused Organogenesis to lose money on
every unit of Apligraf that it produced —far from lowering costs, the more units of Apligraf
that Organogenesis produced, the greater its losses would be.
(g) Contrary to defendants' representations, the Company's Form lO-Q for the
first quarter of 2001 did not reflect the true financial condition of the Company because it failed
to disclose the adverse factors affecting the Company's operations and future viability alleged in
subparagraphs (a) through (f) above and in paragraphs 59-67, supra.
120. 1.9 Million Share Offering. Later the same day, April 27, 2001, Organogenesis
also announced that it had filed a post-effective amendment to its registration statement covering
the offering of an additional 1.9 million shares of common stock. Days later on May 8, 2001,
Organogenesis published a release on Business Wire which announced that the Company had
entered into an underwriting agreement with UBS Warburg LLC, as underwriter, providing that
on any trading day during the next two years the Company could elect to issue and sell to the
underwriter a number of shares of common stock that is not less than 5% and not more than 25%
72
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 35 of 39
of the average trading volume of the common stock on the American Stock Exchange for the
previous five days, up to an aggregate of 1,900,000 shares. 4
121. Following the announcement and report of results for the first quarter of 2001,
analysts at Needham & Co. again reiterated a "Buy" rating on shares of Organogenesis and
continued to advise investors to expect a near-term trading price of $16-$18 per share for the
Company.
122. Laughlin Quits. On May 16, 2001, the Company issued a release announcing
that defendant Laughlin had suddenly resigned from Organogenesis and that Michael Sabolinski,
former Senior Vice President Medical and Regulatory Affairs, would become President, Chief
Executive Officer and a member of the Board of the Company. According to the Company's
release, defendant Sabolinski was primarily responsible for the development of Apligraf. In
addition, the release also noted that, "this transition occurs at an important time for
Organogenesis as the Company focuses on increasing market penetration with Apligraf and
leveraging core technologies to commercialize new products." While no reason was given for
defendant Laughlin's departure, defendant Sabolinski was quoted in this release as thanking
defendant Laughlin for "all he achieved for Organogenesis."
123. $13.5 Million Equity Offering. On or about May 17, 2001, defendants again
capitalized on the artificial inflation in the price of Organogenesis shares that their false and
misleading representations had caused, and filed a Prospectus with the SEC in connection with
the sale of 1.9 million shares of Organogenesis common stock priced at $7.75 per share. Gross
proceeds from the sales of these shares was estimated, at that time, at over $13.5 million.
The sale price of the shares to the underwriter was to be the volume-weighted average price per share at which shares of the common stock traded on the American Stock Exchange during regular trading hours on each purchase date less underwriter's commissions.
73
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 36 of 39
According to the Prospectus, this offering was part of the Company's previously filed, 3.0
million share Shelf Registration Statement.
124. PricewaterhouseCoopers' Refusal to Support Additional Funding Initiatives.
Unbeknownst to the public, as reported by defendant Arcari - then the Company's CFO - in
the Confidential Arcari Document obtained by plaintiffs' counsel, in May 2001 defendant Erani,
then Chairman of the Board of Organogenesis, "[h]indered the process for gaining approval to
exercise the Novartis put option by May 31, 2001, a commitment which was made to
PricewaterhouseCoopers (PWC), our independent auditors." The Company had made this
commitment to exercise the put option to PricewaterhouseCoopers in order to "gain [sic]
necessary comfort letter from PWC to allow us to sell common shares" under an equity offering
with UBS Warburg. The Confidential Arcari Document goes on to state that "[sJince then PWC
has refused to grant any consents or comfort letters because we violated our commitment."
PricewaterhouseCoopers apparently was sufficiently alarmed by the Company's hindrance of
this process, and the violation of the Company's aforementioned commitment, that, according to
the Confidential Arcari Document, it refused to issue any further "comfort letters" to the
Company. PricewaterhouseCoopers, however, never publicly disclosed the Company's
"hindering" of the process for obtaining this critical funding or its own refusal to support the
Company's future financing initiatives.
125. Apligraf Sales 5101. On June 5, 2001, Organogenesis announced that sales of
Apligraf had again reached above 1750 units, for May 2001. According to defendant Sabolinski,
who was quoted in the Company's release, "ft/he May sales figures show sustained support for
Apligraf use, and we have accelerated our plans to ramp up production to meet the strong
growth forecastfor the second half of this year." [Emphasis added.]
'Li
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 37 of 39
126. While sales for May 2001 were actually less than April sales (1758 units vs. 1813
units), defendants did not revise guidance in any way, and continued to advise analysts and
investors that the Company was still on track to register sequential growth in unit sales and
achieve profitability. As evidence of defendants' further representations, on June 6, 2001,
analysts at Needham & Co. reiterated a "Buy" rating on shares of the Company, and continued to
maintain a near-term price target of $16-$18 per share.
127. $1.44 Million Private Placement. On June 18, 2001, Organogenesis raised
another $1.44 million through the sale of shares of stock through the UBS Warburg underwriting
previously announced. Pursuant to this agreement, between May 21, 2001 and June 18, 2001,
defendants caused the Company to sell over 186,000 shares of stock for at least $1.44 million.
128. Apligraf Sales 7/01. On August 2, 2001, Organogenesis announced that sales of
Apligraf reached another monthly record sales level: 2015 units sold in July 2001. This release
also quoted defendant Sabolinski, as stating that, "[wJe are delighted with the growth in sales
seen between June and July. Apligraf unit sales have multiple drivers in place. . . We are
planning accelerating growth in Apligraf production to meet the increasing demand
anticipated." [Emphasis added.]
129. $10 Million Equity Sale to Novartis. On August 7, 2001, Organogenesis issued
a release announcing that it had elected to sell $10 million in equity to Novartis, pursuant to the
terms of its amended, $20 million stock sales agreement.
130. 2Q:01 Results. On August 13, 2001, defendants published a release on Business
Wire, which purported to announce financial results for the second quarter 2001, the period
ended June 30, 2001, which stated that there was "sustained market demand for Apligraf and the
75
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 38 of 39
Company accelerated its plans to ramp up production to meet the strong sales forecast for the
second half of this year," in addition to stating the following:
Reflecting the growth in product sales and the 2001 amendment to the agreement with Novartis, for the three months ended June 30, 2001, product sales to related party were $1.7 million in 2001 compared with $0.7 million for the same period in 2000. Total operating revenues were $2.1 million in the second quarter of 2001 compared with $1.3 million for the same quarter in 2000, excluding a $5 million milestone payment from Novartis for the approval of Apligraf for diabetic foot ulcers. Total operating costs and expenses were $ 9.1million during the second quarter of 2001 compared with $8.0 million for the same quarter in 2000, excluding a $1.2 million ($0.04 per share) one-time severance expense in 2001 for a former executive officer. Cost of product sales increased by $1.3 million due to increased sales of Apligraf and ramping up production to meet anticipated increased demand; research and development as well as general and administrative costs slightly decreased. Net loss was $8.6 million ($0.25 per share) for the second quarter of 2001 compared with a net loss of $1.8 million ($0.05 per share) for the same quarter in 2000.
* * *
[Defendant] Arcari said, "Our year-to-date revenue from product sales is nearly triple that of the same period last year. Our cost of goods per unit compares favorably with the same period last year, but is up moderately from the previous quarter due to accelerating our plans to ramp up production. To strengthen our cash position, we have exercised our right to sell Novartis $10 million inequity. We retain the right to sell Novartis an additional $10 million in equity." [Emphasis added.]
131. 2Q:01 Form 10-Q. The following day, August 14, 2001, the Company also filed
with the SEC the Company's financial results for the second quarter of 2001, the period ended
June 30, 2001, pursuant to a Form 10-Q signed by defendants Sabolinski and Arcari. The
Company's Form 10-Q for the second quarter of 2001 contained the same materially false and
misleading financial information as had previously been announced, in addition to reporting, in
part, the following:
Basis of Presentation
,11
Case 1:04-cv-10027-JLT Document 58-3 Filed 12/22/04 Page 39 of 39
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented.
* * *
COSTS AND EXPENSES
Cost of product sales: Cost of product sales for the quarter ended June 30, 2001 increased 82% to $2,837,000, from $1,557,000 for the comparable quarter last year. Cost of product sales for the six-month period ended June 30, 2001 increased 66% to 5,033,000, from $3,024,000 for the comparable period last year. These increases were due to increased unit sales of Apligraf to Novartis, additional scrap costs and higher allocations of depreciation and occupancy costs. Cost of product sales includes the direct costs to manufacture, quality inspect and package Apligraf and an allocation of our production-related indirect costs. Cost of product sales continues to exceed product sales due to the high costs associated with low volume production. We expect production volume to increase and our margins to continue to improve during 2001. We expect that we will have to revise standard costs and the allocation of costs to product sales in the future as we continue to modify our manufacturing processes. [Emphasis added.]
132. In addition to the foregoing, the Form 10-Q for the second quarter of 2001 also
reported that the Company paid severance to a retiring senior executive, as follows:
Severance Agreement:
In May 2001, we entered into a separation of employment agreement with a former executive officer, which resulted in the recording of a one-time severance expense of $1,233,000 during the quarter ended June 30, 2001. The separation of employment agreement provides for amounts to be paid over two years and supercedes the previous employment agreement. It has been filed as exhibit 10(ff) to this Form 1OQ.
77
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 1 of 39
Attached to the Form 10-Q for the second quarter of 2001 was a copy of defendant Laughlin's
May 2001 Severance Agreement which reported that the vast majority of the Company's $1.233
million charge was to cover the cost of payments made by Organogenesis directly to Laughlin.
133. The statements made by defendants on June 5, 2001 and contained in the
Company's August 2, 2001 and August 13, 2001 releases and in the Company's Form l0-Q for
the second quarter of 2001, reproduced herein, supra, were each materially false and misleading
and were known by defendants to be false at that time, or were recklessly disregarded as such for
the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
(b) Defendants' announcement that the Company had elected to sell $10
million in equity to Novartis, pursuant to the terms of its amended $20 million stock sales
agreement was materially misleading and incomplete given that defendants knew but failed to
disclose that the Company was informed that defendant Erani had sought to have stock brokers
"manipulate the marketfor the Company's stock."
(c) Contrary to defendants' representation that Organogenesis "retain[s] the
right to sell Novartis an additional $10 million in equity," the Company did not have the ability
to raise the full amount of that funding option at the discretion of the Company. As defendants
knew but failed to disclose at the time, significant conditions precedent to the exercise of the put
option prevented the Company from accessing $10 million of the put option funding, which
ultimately led to the Company's inability to fund operations in 2002.
(d) Defendants' representations touting "sustained support for Apligraf use,"
"sustained market demand for Apligraf," the acceleration of a plan to "ramp up production to
78
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 2 of 39
meet the strong growth forecast for [the] second half of this year" and the "increasing demand
anticipated" were materially misleading and incomplete given that defendants knew but failed to
disclose that significant manufacturing and distribution problems, contamination issues,
inadequate marketing support, and difficulties in obtaining reimbursement for Apligraf were
causing increasing frustration among physicians, who were becoming less willing to order or re-
order Apligraf for their patients. Further, defendants knew but failed to disclose that the
purported "strong growth forecast" and "increasing demand anticipated" for Apligraf were
illusory, given that, as confirmed by a former employee of Organogenesis, Novartis' sales
forecasts were "always inflated."
(e) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that was well below the product's manufacturing cost to Organogenesis. Given the revised
terms of the Novartis marketing agreement - which caused Organogenesis to lose money on
every unit of Apligraf that it produced —far from lowering costs, the more units of Apligraf
that Organogenesis produced, the greater its losses would be.
79
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 3 of 39
(f) Contrary to defendants' representations, the Company's Form 10-Q for the
second quarter of 2001 did not reflect the true financial condition of the Company because it
failed to disclose the adverse factors affecting the Company's operations and future viability
alleged in subparagraphs (a) through (e) above and in paragraphs 59-67, supra.
134. Needham Report. The materially false and misleading statements issued by
defendants had their intended effect. Following the publication of Organogenesis' second
quarter 2001 results, on August 14, 2001, Needham issued another report on the Company which
again reiterated a "Buy" rating and issued a near-term price target of $16-$18 per share, and
stating the following:
We reiterate our BUY rating and 12-month target range of $16-$18. We used two methods to reach this valuation target. In the first instance, we applied a market capitalization to revenues ratio of lix for the year 2004. In the second instance, we applied a 35x multiple to the 2004 estimates. To both these calculations, we used a 10% discount per year, given the fact that Apligraf is already on the market thereby less product uncertainty exists. Using these metrics, we arrived at a target price range of $ 16-18.
135. Apligraf Sales August 2001. On September 6, 2001, Organogenesis issued a
release which announced that sales of Apligraf reached another monthly record sales level, with
2150 units sold in August 2001. This release also quoted defendant Sabolinski, who stated that,
"We are pleased with the sustained strength in Apligraf sales that has been seen through the
summer months. We are on track for the third quarter of 2001 to have substantially higher
sales than our record second quarter." [Emphasis added.]
136. On September 7, 2001, defendants published a release which purported to
announce that Organogenesis had increased its capacity to manufacture Apligraf. Accordingly,
the Company's release quoted defendant Sabolinski, who stated the following:
Our Company is now producing Apligraf at a rate of over 40,000 units per year. I am pleased that the manufacturing ramp-up I committed to when I became CEO in May is on track. We anticipate increasing this production
80
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 4 of 39
rate in the near term to meet forecasted demand. The demand has been driven by an increase in sales and marketing activity, the diabetic foot ulcer supplement approval, and favorable reimbursement policies in the hospital and physician's office. [Emphasis added.]
137. On or about September 21, 2001, Dow Jones news service reported that Apligraf
had received Medicare reimbursement in all 50 states.
138. 3 New Products. On September 24, 2001, Organogenesis issued a release
announcing that its experiences selling Apligraf had been so successful that defendants would
begin commercializing three additional new proprietary products during the fourth quarter of
2001. According to the release, these products would be marketed directly by Organogenesis
using its own marketing personnel and this purportedly would "advanc[eJ the Company from a
research, clinical/regulatory, manufacturing Company to a fully integrated medical products
Company." [Emphasis added.] This release also quoted defendant Sabolinski, as follows:
Commercializing our own products, with our own sales and marketing team, brings Organogenesis to a new stage. We receive the full revenue from the products we commercialize ourselves, which will add to our revenue stream beginning in October. We look forward to these products contributing to the overall profitability of the Company. Having our own sales force also paves the way for Organogenesis commercializing additional products in the future. [Emphasis added.]
139. Apligraf Sales 3Q:01. On October 4, 2001, Organogenesis issued a release
which purported to announce strong sales of Apligraf during the third quarter of 2001, with 6606
Apligraf units sold during the quarter. In addition to the foregoing, this release also quoted
defendant Sabolinski, who stated that, "ftJhis has been a very significant quarter for the
Company. Apligraf sales continue to increase and the product is now reimbursed by Medicare
in all fifty states. . . . In addition, we received marketing clearance for the third
FortaFlex(TM)-based product, FortaGen(TM), and plan to launch four new products in October
by an Organogenesis Institutional sales force." [Emphasis added.]
81
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 5 of 39
140. On or about October 9, 2001, Organogenesis presented at the UBS Warburg
Global Life Sciences Conference in New York City. Later on October 24, 2001, Organogenesis
also presented at the Techvest Emerging Healthcare Forum, also held in New York City.
141. $20.25 Million Additional Funding. On October 16, 2001, Organogenesis
issued a release announcing that defendants had raised another $20.25 million from several
financing activities, including another $10 million from Novartis and an additional $10.25
million from two equity placements to institutional investors and/or Company directors. One of
the placements was made via the sale of the 1.67 million registered common shares remaining
under the Company's existing shelf registration, and the other placement was for 503,876
unregistered shares of common stock and attached warrants. This release also quoted defendant
Sabolinski who stated that, "[wJe are pleased to have completed this round offinancing, an
important step in achieving key corporate milestones including realizing profitability sooner.
Furthermore, these proceeds will enable us to accelerate additional key programs for our lead
product, Apligraf, and other notable products in our development pipeline."
142. On November 1, 2001, Dow Jones news service reported that defendants had
registered at least 2.7 million shares of common stock on behalf of certain shareholders.
According to this report, of the shares registered 2.18 million were issuable to Novartis upon
conversion of a $10 million 7% convertible subordinated promissory note that would mature on
March 29, 2004. In addition, at this time, Organogenesis also registered at least 503,876 shares
issued to two of the Company's directors and an investor in a private equity transaction on
September 5, 2001. According to this report, Organogenesis would receive no proceeds from the
sale of the shares by the stockholders.
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 6 of 39
143. 3Q:01 Results. On November 13, 2001, defendants published a release on
Business Wire, which purported to announce financial results for the third quarter of 2001, the
period ended September 30, 2001, which stated that:
Organogenesis Inc. (AMEX: ORG) today reported its financial results for the third quarter and nine months ended September 30, 2001. Product sales to related party were $2.2 million in the third quarter of 2001, representing a 211% increase over $0.7 million for the same period in 2000. This increase reflects the growth in Apligraf(R) unit sales and the new pricing in the 2001 amended agreement with Novartis. Total revenues increased 124% to $3.0 million in the third quarter of 2001 compared with $1.3 million for the same quarter in 2000. Total operating costs and expenses were $9.8 million during the third quarter of 2001 compared with $7.7 million for the same quarter in 2000. Cost of product sales increased by $1.7 million due to increased sales of Apligraf and costs related to ramping up production to meet anticipated future increased Apligraf demand.
Research and development costs decreased slightly to $4.1 million compared to $4.4 million in 2000. Selling, general and administrative costs increased by $0.7 million primarily due to selling expenses related to preparations for the commercial launches of the Company's FortaPerm(TM), FortaGen(TM) and Revitix(TM) products. Net loss was $7.4 million or $0.21 per share for the third quarter of 2001 compared with a net loss of $6.7 million or $0.19 per share for the same quarter in 2000.
Again, defendant Sabolinski was quoted in the Company's release as follows:
Our latest financial results reflect our strategy of implementing programs to support the success of Apligraf, while embarking on initiatives that will position us to capitalize on additional opportunities in the emerging tissue engineering sector.
144. 3Q:01 Form 10-Q. The following day, November 14, 2001, defendants also filed
with the SEC the Company's financial results for the third quarter of 2001, the period ended
September 30, 2000, pursuant to a Form l0-Q signed by defendants Sabolinski and Arcari. The
Company's Form 10-Q for the third quarter of 2001 contained the same materially false and
misleading financial information as had previously been announced, in addition to reporting, in
part, the following:
Basis of Presentation
83
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 7 of 39
The accompanying unaudited consolidated financial statements of Organogenesis Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X... In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and changes in cash flows for the periods presented....
* * *
COSTS AND EXPENSES
Cost of product sales: Cost of product sales for the quarter ended September 30, 2001 increased 110% to $3,268,000, from $1,557,000 for the comparable quarter last year. Cost of product sales for the nine-month period ended September 30, 2001 increased 81% to $8,301,000, from $4,581,000 for the comparable period last year. These increases were due to increased unit sales of Apligraf to Novartis, higher allocation of depreciation and occupancy costs, and increased scrap charges during the month of September due to the suspension of commercial sales of Apligraf following the September 11, 2001 terrorist attack. Cost of product sales includes the direct costs to manufacture, quality inspect and package Apligraf and an allocation of our production-related indirect costs. Cost of product sales continues to exceed product sales due to the high costs associated with low volume production. We expect production volume to increase and our margins to continue to improve during the remainder of 2001. We expect that we will have to revise standard costs and the allocation of costs to product sales in the future as we continue to modify our manufacturing processes. [Emphasis added.]
145. The statements made by defendants and contained in the Company's releases on
September 6, September 7, September 24, October 16, and November 13, 2001 and those
statements contained in the Company's Form 10-Q for the third quarter of 2001, reproduced
herein, supra, were each materially false and misleading and were known by defendants to be
false at that time, or were recklessly disregarded as such for the following reasons:
(a) Defendants failed to disclose the material adverse factors affecting the
Company alleged in paragraphs 59-67, supra.
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 8 of 39
(b) Defendants' October 16, 2001 release announcing the Company's equity
placements and defendant Sabolinski's representation that the Company's financing activities
were "an important step in achieving key corporate milestones including realizing profitability
sooner" were materially misleading and incomplete given that defendants knew but failed to
disclose that the Company had been informed that defendant Erani had sought to have stock
brokers "manipulate the marketfor the Company's stock."
(c) Contrary to defendants' representations that they were expecting new
initiatives to help the Company achieve "overall profitability of the Company," defendants knew
that the Company's ultimate prospects for achieving profitability were severely compromised by
the problems alleged in paragraphs 59-67, supra, including the Company's serious
manufacturing and marketing problems, its inability to access adequate funding to keep the
Company viable, the difficulties in achieving reimbursement for Apligraf, and the disruptive
effect on operations that high turnover and infighting among the Company's senior management
was having, and would continue to have for the foreseeable future.
(d) Defendants' representations touting "sustained strength in Apligraf sales,"
and "substantially higher sales" in the third quarter of 2001 were materially misleading and
incomplete given that defendants knew but failed to disclose that manufacturing and distribution
problems, contamination issues, inadequate marketing support, and difficulties in obtaining
reimbursement for Apligraf were causing increasing frustration among physicians, who were
becoming less willing to order or re-order Apligraf for their patients. Further defendants knew
but failed to disclose that the purported "strong growth forecast" and "increasing demand
anticipated" for Apligraf were illusory, given that, as confirmed by a former employee of
Organogenesis, Novartis' sales forecasts were "always inflated."
85
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 9 of 39
(e) Defendant Sabolinski's representation anticipating increasing the Apligraf
"production rate in the near term to meet forecasted demand" were materially misleading and
incomplete given that the Company was experiencing continuing significant manufacturing and
marketing problems which were hampering manufacturing and which made it unfeasible to
sufficiently increase production scale. Further defendants knew but failed to disclose that the
purported "forecasted demand" for Apligraf was illusory, given that, as confirmed by a former
employee of Organogenesis, Novartis' sales forecasts were "always inflated."
(f) Contrary to defendants' representations that production volume would
increase and that as a consequence of that increase the Company's margins would improve, as
confirmed by former employees of Organogenesis, the Company was experiencing serious
problems in manufacturing Apligraf and there was "no way" the Company could feasibly mass-
produce Apligraf. Further, it was not true that costs exceeded sales due to start-up costs and the
high costs of low volume production, and that the Company's margins would improve as
production volume increased. As confirmed by former employees of Organogenesis, it was well
known by the upper management of the Company that, throughout the Class Period,
Organogenesis was losing money on every sale of Apligraf because of the disadvantageous terms
of the Novartis marketing agreement - under which Novartis shared revenue from Apligraf
sales that were well below the product's manufacturing cost. Given the revised terms of the
Novartis marketing agreement - which caused Organogenesis to lose money on every unit of
Apligraf that it produced - far from lowering costs, the more units of Apligraf that
Organogenesis produced, the greater its losses would be.
(g) Contrary to defendants' representations, the Company's Form 10-Q for the
third quarter of 2001 did not reflect the true financial condition of the Company because it failed
T7
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 10 of 39
to disclose the adverse factors affecting the Company's operations and future viability alleged in
subparagraphs (a) through (h) above and in paragraphs 59-67, supra.
146. Needham Report. On November 16, 2001, with shares of the Company now
trading at just above $4.00 per share, analysts at Needham & Co. were finally forced to adjust
downward their near-term Organogenesis price target to $9-00-$11.00 per share from $16.00-
$18.00 per share. At this time, however, Needham did not reduce its "Buy" rating on the
Company, and also stated that, at current trading levels shares of Organogenesis were "currently
undervalued," as follows:
We believe that Organogenesis is currently undervalued, given that Apligraf is the first and only product containing living human cells to prove efficacy and gain FDA PMA marketing approval and now having qualified nationally for reimbursement under Medicare for outpatient use. ORG's enhanced management team and Novartis agreement is a further indicator of ORG's potential. In addition, we believe there will be a number of key events over the next several quarters that will serve to significantly increase the visibility of Organogenesis and its products and further attract substantial investor interest in the company and its products, such as continued growth in Apligraf sales and postmarketing research as well as progression of VITRIX clinical trials. [Emphasis added.]
147. On January, 4, 2002, only days before the end of the Class Period, defendant
Erani announced his sudden and unexpected departure from Organogenesis. According to the
Company's release, defendant Erani resigned to "pursue personal business interests."
THE TRUE FINANCIAL AND OPERATIONAL CONDITION OF ORGANOGENESIS IS BELATEDLY DISCLOSED
148. No Money to Fund Operations. On or about January 30, 2002, defendants filed
with the SEC a report pursuant to Form 8-K, signed by defendant Arcari, which stated for the
first time that the Company was running out of money and that it would be forced into
insolvency unless it could raise at least $15 million in the immediate near term. The Form 8-K
stated, in part, the following:
87
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 11 of 39
On January 30, 2002, the Registrant filed a Registration Statement on Form S-3 to register the resale of shares held by certain of its selling security holders. As a part of that document, the Registrant included an updated set of risk factors relating to its business. The Registrant intends, by filing such updated risk factors with this Current Report on Form 8-K, to provide such risk factors as part of its documents filed pursuant to the Securities Exchange Act of 1934.
* *
We have incurred significant operating losses in funding the research, development, testing and marketing of our products in every year of our existence. We incurred net losses of $14,031,000 for the year ended December 31, 1998, $28,350,000 for the year ended December 31, 1999, $28,605,000 for the year ended December 31, 2000 and $22,561,000 for the nine months ended September 30, 2001. The extent offuture losses and the time required to achieve profitability are highly uncertain, and we may never achieve a profitable level of operations or, even i f we achieve profitability, we may not be able to sustain it on an ongoing basis. [Emphasis added.]
149. In addition to the foregoing, the January 30, 2002 Form 8-K also revealed for the
first time that the Company would need to raise additional funds by the end of the first quarter of
2002, but that Organogenesis might be unable to raise such necessary funds, in which case it
would then be forced to curtail or discontinue all operations. In this regard, the Form 8-K also
stated, in part, the following:
We will need to raise additional funds by the end of the first quarter of 2002, but may be unable to raise the funds, in which case we would have to curtail or discontinue our activities. [Emphasis added.]
We will seek to raise $15 million from the sale of equity securities that have not been registered under the Securities Act of 1933; such securities may not be sold in the United States absent registration or an exemption from registration. Based upon our current forecasts, we believe that proceeds from proposed equity financings of approximately $15 million, together with our existing cash, cash equivalents and credit line and product and other revenues, will be sufficient to finance operations through at least the next twelve months. This projection is based on assumptions regarding our operating cash requirements and revenues from sales of Apligraf and other products, any of which could prove to be incorrect. We are currently seeking additional funding but our research, development, manufacturing and other activities may require that we raise substantial additional funds. We may not be able to obtain the proposed $15 million in new financing or
88
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 12 of 39
any additional funding on terms favorable to us or our stockholders, if at all. Equity financings would dilute your ownership in us.
150. In answer to the question as to why the Company could not access the $10 million
that defendants had previously reported would be available, the Form 8-K suddenly revealed that
the Novartis commitment was subject to certain conditions - ones the Company had no way of
satisfying - such that this money was also not available, as follows:
Although we have a contractual put option to sell an additional $10 million of our securities to Novartis, we must satisfy a number of conditions in order to exercise that option. If we do not satisfy these conditions and Novartis is unwilling to waive any unsatisfied conditions, we will be unable to sell additional securities to Novartis pursuant to the put option. In addition, even if we satisfied the conditions, the closing would occur no sooner than 90 days following the day we send the put option exercise notice. If adequate funds are not available to us when needed, we will be required to delay, scale back or eliminate our research and development programs or license to third parties products or technologies that we would otherwise undertake to develop ourselves and otherwise reduce our level of operations. The failure to have adequate liquidity could result in our receiving a "going concern" opinion from our auditors. [Emphasis added.]
151. While shares of the Company made virtually no move on the day the Company's
Form 8-K was filed, in the days immediately before its filing, shares of the Company dropped
precipitously - falling over 40% due to leakage in the three days prior to its filing with the SEC.
Prior to this sudden and inexplicable decline, which occurred on volume abnormally above the
stock's daily average, shares of Organogenesis traded at approximately $3.70 per share, on
January 28, 2002. The day the Form 8-K was filed, Organogenesis shares traded down to $2.44
per share. Within days, as investors digested the implications of the Company's SEC filing,
shares of Organogenesis fell to as low as $1.32 on February 7, 2002 - a decline of almost 95%
compared to the Class Period high of over $22.00 per share reached on March 7, 2000.
152. Later, on February 25, 2002, Dow Jones news service reported that
Organogenesis had declared that it would engage in a "restructuring" and would lay-off at least
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 13 of 39
16% of its workforce in order to cut overhead by at least $5 million. Also, according to Dow
Jones and a Company press release, on March 21, 2002, the Company raised $16 million by
issuing "convertible preferred shares," convertible into shares of common stock of the Company
at a fixed conversion price of $1.45 per share, and by selling 7.2 million unregistered shares of
Company stock. The "vulture capitalists" who arranged for these "toxic convertibles" 5 as well as
the purchase of an additional 7.2 million shares for payments of only $10 million, were identified
by the Company only as "institutional shareholders."
153. On April 3, 2002, Organogenesis announced sales of Apligraf for the first quarter
of 2002 which, at 7,100 units, was well below forecast sales for 2002 of 40,000 units. Following
the release of results for the first quarter of 2002, on April 11, 2002, defendants hosted a
conference call, the transcript of which was subsequently published. During the question and
answer, call-in section of this call, the following statements were also made:
BRUCE BREWSTER (ph), BREWSTER ASSET MANAGEMENT: Over the last number of years it seems to be that you have been very successful from a medical point of view. And from the point of view of sales of Apligraf. I don't think we can say the same thing about the business results.
It seems to me that the underlying reason for your lack of success in - from a business point of view, is your original deals with Sandos (ph) and Novartis and the amount of revenue that you get from the sale of Apligraf.
You're entering into - you did adjust that recently. You're entering into new transactions with other partners. Are these transactions organized in such a way that you'll have more possibility of overall profitability and therefore business success?
* * *
"Toxic," because the greater Organogenesis' share price declined, the more stock the Company would have to issue to meet this obligation, the greater shareholder dilution, the lower the price of the Stock, the more stock that would be required to be issued to meet this obligation...
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 14 of 39
RICHARD CARAFF (ph), OPPENHEIMER: Yes, I certainly am pleased to hear of approval by the 50 states and hope that that word gets out to the doctors, many of whom at least in our limited experience in Boston are not completely aware.
But the other part which is a question, some doctors that I've spoken to are very happy and satisfied with using Apligraf on complex cases. But they complain on less complex cases Apligraf is a rather expensive procedure to use compared to other procedures. Do we have any way of broadening the market by means of price? Could you comment upon that please?
STEVEN BERNITZ: I think the major - if it in looking at the cost of the product should be in looking at the pharmo-economics of the product rather than the price of the product.
If you look at the complications associated with diabetic foot ulcers in terms of bone infections and amputations and actually mortality associated with the complications from these wounds, while I would like to say that we have done rigorous studies. And to show that I think one that there's an opportunity to do so, and I think that's an important area for both companies going forward.
There have been some studies with venous leg ulcers that show that Apligraf can be a very cost effective treatment for those. And actually given that, one would expect that data for diabetic foot ulcers to be more compelling.
And I think that you also touched on another important point which is the knowledge and confidence in the reimbursement process. Which is that a doctor may have tried the product, a year or so ago and or heard from a doctor that tried the product a year or more ago and had some difficulty. Or had to go through a rigorous approval process to get it the product reimbursed. [Emphasis added.]
154. In addition to the foregoing, when asked about the why the Company could not
access the second $10 million tranche of the aforementioned Novartis commitment, defendants
stated the following:
JOHN BERGER (ph): Could you also go over briefly the encumbrances on the second traunch of capital from - that's available from Novartis? And when that traunch would be available to be utilized since this latest financing.
JOHN ARCARI: Well the second put is equal in amount to the first. It's 10 million. The time period between exercising a put and receiving money is a minimum of 90 days. But the thing that really distinguishes the second put from the first is the hurdles you have to get through on the second put.
91
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 15 of 39
And they're inherently more difficult. There are more hoops to jump through. So it's much more difficult to access that money than was the first traunch.
STEVEN BERNITZ: So we look at that as an upside. If it is available there's no where in our plans that we are counting on that money. And we don't anticipate exercising that put. [Emphasis added.]
155. Going Concern Opinion. On April 16, 2002, when the Company filed its year
end financial statement with the SEC, pursuant to Form 10-K, its outside auditor
PricewaterhouseCoopers LLP issued a "going concern" opinion, which stated that the auditors
had "substantial doubt" about Organogenesis' ability to continue as a going concern.
According to PricewaterhouseCoopers, "the Company has suffered recurring losses from
operations, has a working capital deficiency, a stockholder's deficit, and has long-term debt that
may become immediately due upon an event of default." [Emphasis added.]
156. Following this announcement, shares of Organogenesis fell to as low as $0.60 per
share on April 17, 2002. In the days that followed, shares of the Company traded even lower, to
as low as $0.41 per share by May 1, 2002.
157. Remarkably, in response to this statement by PricewaterhouseCoopers, the same
day, April 16, 2002, defendants issued a release on Business Wire which stated that, although
Organogenesis had received the aforementioned report, "we believe that, based on our current
forecasts, the Company has sufficient liquidity to finance operations and achieve break even by
year-end 2002." [Emphasis added.] This post-Class Period statement was as far from the truth
as defendants' other statements made within the Class Period. Despite this absurd claim, on
August 16, 2002, defendants revealed that the Company would delay filing its quarterly report
for the second quarter of 2002 and that Organogenesis was reviewing a possible material "asset
impairment" charge. According to a statement made by the Company at this time, "management
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 16 of 39
is unable to conclude the amount of such impairment or that the financial statements . . . are
probably presented on a 'going concern' basis rather than on a 'liquidation of assets' basis."
158. Needham Rating Suspended. It was not until July 12, 2002, with shares of the
Company now trading below $0.20 per share, however, that analysts at Needham & Co. finally
placed the Company's stock rating "Under Review." With Organogenesis on life-support,
Needham analysts reported the following:
Recent events leave future uncertain.
Disappointing sales figures/ higher than expected burn rate. Organogenesis announced that Apligraf sales decreased approximately 7-10% for 2Q02, compared with our estimates for an increase in sales of 25%.
Additionally, the company stated that the burn rate for the quarter was $7.5 MM, versus our estimates of $4.3MM, resulting in $3.7MM of cash at the end of 2Q02. Additional cost cutting measures have been initiated to lower the burn rate from $2.5MM/month to $1.lMMlmonth. Using the revised burn rate, Organogenesis will be able to fund operations for 3Q02 before seeking additional capital.
Challenging management strategy. Organogenesis announced that it has entered into discussions with Novartis Pharma AG to reacquire commercialization rights to Apligraf. However, in order to complete negotiations, Organogenesis must raise sufficient capital necessary to reacquire [rights to] Apligraf and build the necessary infrastructure necessary to market and distribute the product.
Additionally, Organogenesis stated that it would seek a corporate partner for the marketing of the Fortagen, Fortaperm, and Revitix product lines. While this decision will result in a reduction of costs related to the sales and marketing infrastructure set up by the company, the partnership will also result decreased revenues, as revenues become royalty based.
Our conclusions. Despite the efforts of management, Apligraf sales continue to grow at a slower than anticipated rate. The lower than expected sales growth and higher than anticipated burn rate results in approximately 3 months of cash ($3. 7MM) for on going operations, which leaves the company below budgeted forecasts. While major initiatives are being discussed including the reacquiring of rights to Apligraf and raising of funds for continued operations, we believe that multiple challenges exist for Organogenesis. Therefore, given the lack of Apligraf sales growth, the higher than expected burn
93
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 17 of 39
rate, the challenging business strategy undertaken by management, and sub-optimal cash position, we are placing our rating under review. We are currently evaluating the company's options and will continue to monitor events going forward. [Emphasis added.]
159. Never Achieve Profitability. Huge Layoffs. Halt Apligraf Production. On
August 21, 2002, with Organogenesis shares trading at $0.09 per share, the Company's common
stock was suspendedfrom trading on the American Stock Exchange. On September 13, 2002,
the Company announced that it had temporarily halted shipments of Apligraf and had furloughed
over 110 of its employees, as a result of the Company's "current lack of cash flow." Defendants
also blamed the current crisis upon its inability to renegotiate its marketing agreement with
Novartis, which was described as "not sustainable." On September 13, 2002, defendants also
revealed that a Chapter 11 bankruptcy filing was a possibility.
160. Product Recalls. In addition to the foregoing, by mid-September 2002,
production quality at Organogenesis had deteriorated so substantially that an entire batch of
Apligraf had been recalled. Alarmingly, because Apligraf has such a short shelf life, at the time
of this "recall," of the 193 affected units at least 72 had already been applied to patients. In total,
this was at least the fourth time since 1999 that the Company had been forced to recall Apligraf
because of contamination.
161. Post Class Period Scheme to Leverage Buyout. Having reduced the value of the
Company's stock to mere pennies per share, and having lost the ability to sell more stock or offer
debt, or raise money through private or public offerings, defendants next sought to take what was
left of Organogenesis for themselves. Thus, on or about September 25, 2002, defendants caused
the Company to file for Chapter 11 protection from creditors in United States Bankruptcy Court
for the Eastern District of Massachusetts.
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 18 of 39
162. As defendants knew throughout the Class Period, Organogenesis could not
produce enough cash flow from operations to support its operations under the terms of its
agreement with Novartis given that it was losing money on each sale under the Novartis
agreement. Thus, on November 20, 2002, immediately after defendants placed the Company into
bankruptcy, defendants forced Novartis to agree to transfer back to them the worldwide
marketing and distribution rights for Apligraf. Novartis acquiesced to defendants' demand,
rather than risk losing its entire investment in the Company - including at least $10 million in
unsecured debt which Novartis still hoped to collect.
163. The following day, November 21, 2002, the Boston Globe reported that, pursuant
to the terms of the proposed, revised deal between Novartis and defendants:
* The two companies had agreed to work together for another seven months, during which Novartis would continue to market and distribute Apligraf.
* When the Company emerges from Chapter 11 bankruptcy protection, marketing and distribution rights will return to defendants. Two years later, Novartis will earn royalties on sales of Apligraf, lasting for five years.
* Novartis also agreed to purchase at least 200 units of the product each week from defendants.
* Novartis also agreed to loan $3 million to Organogenesis, to be repaid 18 months after the company emerges from bankruptcy.
* Novartis agreed to have a $10 million investment it made in the company last year treated as a general claim, to be repaid with other unsecured creditors of Organogenesis.
* The pact also provides hope for dozens of employees who were laid off in September, when Organogenesis abruptly shut down, with a minimum of 75 people anticipated to return to work within several weeks of this announcement.
Although the precise payment terms were sealed by the Bankruptcy Court, at that time
Organogenesis' vice president and general counsel, Jeffrey L. Dow, stated that, "[t]he prices are
95
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 19 of 39
considerably more favorable than the $350 a unit we were getting under the old payments. It's
clear we are getting the great bulk of the revenue from Novartis' sales. . . ."
164. By June 23, 2003, defendants announced that they had caused the Company to
file an Amended Plan of Reorganization with the United States Bankruptcy Court. According to
defendants, the Plan incorporated "a funding proposal from a group of unsecured creditors -
including current and former officers and directors of the Company," and put in motion a
timeline for emerging from Chapter 11 protection in August 2003. The Plan also anticipated a
cash distribution of 35% to be made to the holders of allowed general unsecured claims, but that
no distribution would be made on shares of the Company's outstanding preferred and
common stock, which would be cancelled on the Plan's effective date. Under the Plan, all
shares of new common stock of the Company, as reorganized, would be distributed to the
members of the plan funding group and the holder(s) of the $10.35 million allowed claim of
Novartis.
165. Days later, however, on June 26, 2003, the Boston Globe reported more disturbing
news regarding defendants' continued interference with the bankruptcy proceeding, and
documented their continued attempts to place their own interests over and above the interests of
the outside shareholders of the Company, as follows:
If all goes as expected at a hearing in U.S. Bankruptcy Court in Boston today, creditors could be solicited next week for their approval of a reorganization plan turning ownership of the life sciences company and its sophisticated medical technology to a group led by two cousins who operate chains of clothing stores like Strawberry and Pay-Half.
Did recently installed chief executive Alan Ades, also a leader of the group in line to buy the company, impede other potential bidders, a tactic that could have protected his own financial interests? Did the previous CEO, seemingly ousted last fall, try to use his own inside connections seeking proprietary information for a bid with private investors that could have put him back in charge?
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 20 of 39
* * *
Ades, his cousin Albert Erani, and a small group of others that includes thçir relatives would end up with the company at a seemingly modest price, though their total cost is hard to calculate....
* * *
Steven Bernitz, the company's chief executive at the time of the bankruptcy filing, quit as he was about to be fired in October and Ades took charge, according to the company. A short time later, the company tracked celiphone calls between Bernitz and another executive still employed at Organogenesis, Jeffrey Dow, and fired him. Company lawyers questioned whether confidential information was being leaked.
Soon, it became clear Bernitz was formally advising a private equity firm circling to make a bid on company assets. His lawyer claimed the company was harassing Bern itz because Ades "wants to end up with the company."
"He has been very successful at chilling the sale," the lawyer, Stephen Gordon, said in a transcript of a bankruptcy court hearing. [Emphasis added.]
166. Despite defendants' actions, on August 14, 2003, Judge William Hillman in U.S.
Bankruptcy Court for the Eastern District of Massachusetts in Boston cleared the way for the
Company to emerge from bankruptcy under the full dominance and control of the Individual
Defendants by or about August 26. The insider group led by interim CEO Alan Ades and his
partner and cousin, Albert Erani, would buy a $10.5 million unsecured claim in the form of a
bond held by pharmaceutical giant Novartis. Ades, who co-founded A&E Stores with Erani,
would be the interim CEO, president and chairman of the new company. Novartis agreed to
convert the $3 million in debtor-in-possession financing it provided into a $3 million exit loan.
According to John Hutchins, Boston counsel for Novartis at Kirkpatrick & Lockhart LLP, who
was quoted at this time, the final terms of this bankruptcy restructuring actually amounted to a
97
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 21 of 39
"leveraged acquisition" by the insider group because they had bought up the $10.5 million
Novartis unsecured claim and were investing additional funding.
167. Thus, in less than one year, not only were defendants successful in thwarting
other interested bidders and in facilitating defendants Erani and Ades and their family members'
gaining total control over the Company but, within that time, defendants were also able to cause
Organogenesis to emerge from bankruptcy having completed its restructuring plan. As a result
of this restructuring, new shares were issued to defendant Erani and Ades and their family
members - the new owners of the Company - and the shareholders who purchased and/or
otherwise acquired shares of the Company during the Class Period received nothing for their
Organogenesis shares.
168. The market for Organogenesis securities was open, well-developed and efficient
at all relevant times. As a result of these materially false and misleading statements and failures
to disclose, Organogenesis common stock traded at artificially inflated prices during the Class
Period. Plaintiffs and other members of the Class purchased or otherwise acquired
Organogenesis securities relying upon the integrity of the market price of Organogenesis
securities and market information relating to Organogenesis, and have been damaged thereby.
169. During the Class Period, defendants materially misled the investing public,
thereby inflating the price of Organogenesis common stock by publicly issuing false and
misleading statements and omitting to disclose material facts necessary to make defendants'
statements, as set forth herein, not false and misleading. Said statements and omissions were
materially false and misleading in that they failed to disclose material adverse information and
misrepresented the truth about the Company, its business and operations, as alleged herein.
98
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 22 of 39
170. At all relevant times, the material misrepresentations and omissions particularized
in this Complaint directly or proximately caused or were a substantial contributing cause of the
damages sustained by plaintiffs and other members of the Class. As described herein, during the
Class Period, defendants made or caused to be made a series of materially false or misleading
statements about Organogenesis' business, prospects and operations. These material
misstatements and omissions had the cause and effect of creating in the market an unrealistically
positive assessment of Organogenesis and its business, prospects and operations, thus causing the
Company's securities to be overvalued and artificially inflated at all relevant times. Defendants'
materially false and misleading statements during the Class Period resulted in plaintiffs and other
members of the Class purchasing the Company's securities at artificially inflated prices, thus
causing the damages complained of herein.
ADDITIONAL ALLEGATIONS AGAINST PRICE WATERHOUSECOOPERS
171. Defendant PricewaterhouseCoopers is a worldwide firm of certified public
accountants, auditors, and consultants. According to its website, www.pwc.com ,
PricewaterhouseCoopers "is the world's leading professional services organization."
PricewaterhouseCoopers touts its expertise pertaining to the pharmaceutical and healthcare
industries, such as, Organogenesis, stating that PricewaterhouseCoopers is "the professional
services firm of choice among the world's leading pharmaceutical and healthcare products
companies" and "the auditors of the largest share of the world's leading pharmaceutical
companies and provide tax and business advisory services to many of the industry's other major
players."
172. Through its Boston, Massachusetts office, PricewaterhouseCoopers served as
Organogenesis' auditor and principal accounting firm prior to and during the Class Period. By
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 23 of 39
virtue of its relationship with Organogenesis and the nature of the auditing and consulting
services rendered to the Company, defendant PricewaterhouseCoopers and its personnel were
regularly present at Organogenesis and had intimate knowledge of Organogenesis' financial
reporting practices based on its access to confidential internal corporate, financial, operating and
business information.
173. PricewaterhouseCoopers was required to audit the Company's financial
statements in accordance with Generally Accepted Auditing Standards ("GAAS"), 6 and to report
the audit results to Organogenesis, the board of directors, the audit committee, and the members
of the investing public, including plaintiffs and other members of the Class. With knowledge of
Organogenesis' true financial condition, or in reckless disregard thereof,
PricewaterhouseCoopers certified the materially false and misleading financial statements of
Organogenesis, described below, and provided unqualified Independent Auditors' Reports,
which were included in the SEC filings and publicly disseminated statements. Without these
materially false and misleading unqualified audit opinions, the fraud alleged above could not
have been perpetrated.
174. In acting as the Company's independent auditors and certifying the Company's
year-end financial statements, PricewaterhouseCoopers ignored multiple "red flags," which
caused PricewaterhouseCoopers to lose faith in the credibility of the Company and eroded
PricewaterhouseCoopers' confidence in the representations of the senior officers and directors of
the Company, despite the fact that auditors are required to exercise professional skepticism when
6 GAAS, as approved and adopted by the American Institute of Certified Public Accountants
("AICPA")' relate to the conduct of the individual audit engagements. Statements on Auditing Standards (codified and referred to as AU § ) are recognized by the AICPA as the interpretation of GAAS.
100
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 24 of 39
performing audit procedures. In doing so, PricewaterhouseCoopers violated Generally Accepted
Auditing Standards ("GAAS"). For example:
(a) According to the Confidential Arcari Document, by March 2001
PricewaterhouseCoopers' "confidence in managements [sic] and the Boards [sic]
representations" had been "eroded."
(b) According to the Confidential Arcari Document, defendant Erani's failure
to sign standard audit confirmations sent to him by PricewaterhouseCoopers, then the
Company's Chairman of the Board, caused a "loss of the Company's credibility" with
PricewaterhouseCoopers.
(c) According to the Confidential Arcari Document, as a result of the
Company's violation of a commitment to PricewaterhouseCoopers in connection with the
exercise of the first tranche of the Novartis put option in May 2001, PricewaterhouseCoopers
informed defendants that it refused to support any future financing initiatives by the Company.
According to the Confidential Arcari Document, defendant Erani "[h]indered the process for
gaining approval to exercise the Novartis put option by May 31, 2001, a commitment, which was
made to PricewaterhouseCoopers (PWC), our independent auditors." The Confidential Arcari
Document states that "[sJince then PWC has refused to grant any consents or comfort letters
because we violated our commitment."
(d) PricewaterhouseCoopers knew of, or recklessly disregarded, the terms of
the Novartis marketing agreement, which was economically unsustainable for Organogenesis
given that Organogenesis was losing money on every unit of Apligraf that it produced and that
this the Company lacked the ability to fund operations through product sales.
101
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 25 of 39
(e) Given these "red flags," PricewaterhouseCoopers knew or recklessly
disregarded the fact that the Company suffered from a chronic and systemic lack of internal
controls such that its financial reporting was inherently corruptible, subject to manipulation, and
unreliable, resulting in materially false and misleading financial statements during the Class
Period.
175. These "red flags" alerted PricewaterhouseCoopers that there were serious
concerns with management's character and integrity. These concerns with management's
character and integrity should, in turn, have caused PricewaterhouseCoopers to scrutinize the
sufficiency of Organogenesis' internal controls. The internal control deficiencies include a lack
of a stated and demonstrable commitment by senior management to set appropriate standards of
ethics, integrity, accounting, and corporate governance.
176. PricewaterhouseCoopers' concerns with management's character and integrity
also should have caused PricewaterhouseCoopers to re-evaluate its risk assessments. GAAS
requires that "risk assessments, and accordingly, any reevaluations of risk assessments, should be
made with consideration of applicable risk factors." AU § 316.12, 316.14. The auditor's
response to a risk assessment should be "influenced by the nature and significance of the risk
factors identified as being present." AU § 316.25. One of the principal categories of "risk
factors that relate to misstatements arising from fraudulent financial reporting" is
"management's characteristics and influence over the control environment" AU § 316.16
(emphasis added). Those factors pertain to, among other things, management's "attitude
relating to internal control and the financial reporting process." Id n. 27 (emphasis added).
However, in contrast to the requirements of GAAS, PricewaterhouseCoopers conducted the
financial statement audit for Organogenesis' year-end 2000, under an assessment of risk that
102
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 26 of 39
remained unchanged by facts and events that called into question the character and integrity of
Organogenesis' most senior management, in contravention of GAAS.
177. PricewaterhouseCoopers did not exercise due professional care in performing the
audit and preparing the audit report, as it was required to do, because it failed to: (i) obtain
sufficient competent evidential matter to support the assertions in the financial statements; (ii)
maintain an attitude of professional skepticism; and (iii) render an accurate audit report on behalf
of Organogenesis.
178. PricewaterhouseCoopers violated GAAS Standard of Reporting No. 4 that
requires that, when an opinion on the financial statements as a whole cannot be expressed, the
reasons therefore must be stated. PricewaterhouseCoopers should have stated that no opinion
could be issued by it on Organogenesis' year-end 2000 financial statement or issued an adverse
opinion stating that the 2000 financial statement was not fairly presented.
179. PricewaterhouseCoopers violated GAAS General Standard No.2 which requires
that an independence in mental attitude is to be maintained by the auditor in all matters related to
the assignment.
180. PricewaterhouseCoopers violated Statement on Auditing Standards No. 82 in that
it failed to adequately consider the risk that the audit financial statements of Organogenesis were
free from material misstatement, whether caused by errors or fraud. PricewaterhouseCoopers
knew or recklessly disregarded numerous risks relevant to financial reporting including events
and circumstances that occurred or existed at Organogenesis during the Class period, which
adversely affected Organogenesis' ability to initiate, record, process, and report financial data
consistent with the assertions of management in the financial statements.
103
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 27 of 39
181. PricewaterhouseCoopers violated GAAS and the standards set forth in Statement
on Auditing Standards Nos. 1 and 53 by, among other things, failing to adequately plan its audit
and properly supervise the work of assistants and to establish and carry out procedures
reasonably designed to search for and detect the existence of errors and irregularities that would
have a material effect upon the financial statements.
182. PricewaterhouseCoopers violated GAAS and the standards set forth in Statement
on Auditing Standards No. 8, by failing to take appropriate action relating to material
misstatements and omissions of fact contained in the Management's Discussion and Analysis of
Financial Condition and Results of Operations ("MD&A") section of Organogenesis' 2000 Form
10-K.
183. PricewaterhouseCoopers violated GAAS Standard of Field Work No. 2, which
requires the auditor to make a proper study of existing internal controls, including accounting,
financial and managerial controls, to determine whether reliance thereon was justified, and if
such controls are not reliable, to expand the nature and scope of the auditing procedures to be
applied. This standard required PricewaterhouseCoopers to obtain a sufficient understanding of
Organogenesis' internal control structure to adequately plan the audit and to determine the
nature, timing and extent of tests to be performed. In all audits, the auditor should perform
procedures to obtain a sufficient understanding of three elements of an entity's internal control
structure: the control environment, the accounting system, and control procedures. For example,
"[t]he auditor's understanding of internal control over revenue transactions ordinarily will
include the client's policies and procedures for. . . shipping goods, relieving inventory, billing
and recording sales transactions, receiving and recording sales returns, and authorizing and
104
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 28 of 39
issuing credit memos." AICPA Audit Guide: Auditing Revenue in Certain Industries ("AAG-
REV") 1.112.
184. As a result of its failure to accurately report on Organogenesis' 2000 financial
statement, PricewaterhouseCoopers utterly failed in its role as an auditor as defined by the SEC.
SEC Accounting Series Release No. 296, Relationships Between Registrants and Independent
Accountants, Securities Act Release No. 6341, Exchange Act Release No. 18044, states in part:
Moreover, the capital formation process depends in large part on the confidence of investors in financial reporting. An investor's willingness to commit his capital to an impersonal market is dependent on the availability of accurate, material and timely information regarding the corporations in which he has invested or proposes to invest. The quality of information disseminated in the securities markets and the continuing conviction of individual investors that such information is reliable are thus key to the formation and effective allocation of capital. Accordingly, the audit function must be meaningfully performed and the accountants' independence not compromised. The auditor must be free to decide questions against his client's interests if his independent professional judgment compels that result. [Emphasis added.]
185. As a result, PricewaterhouseCoopers' opinions, which represented that
Organogenesis' 2000 year-end financial statement was presented in conformity with GAAP,
were materially false and misleading because PricewaterhouseCoopers knew that it was required
to adhere to each of the herein described standards and principles of GAAS, including the
requirement that the financial statements comply in all material respects with GAAP.
PricewaterhouseCoopers, in issuing its unqualified opinions, knew or recklessly disregarded the
fact that by doing so it was engaging in gross departures from GAAS, thus making its opinions
false, and issued such certifications knowing or recklessly disregarding that GAAS had been
violated.
186. PricewaterhouseCoopers knew or recklessly disregarded facts that indicated that it
should have: (a) disclaimed or issued adverse opinions on Organogenesis' 2000 year-end
105
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 29 of 39
financial statements; or (b) withdrawn, corrected or modified its opinion for the year ended
December 31, 2000.
ADDITIONAL SCIENTER ALLEGATIONS
187. As alleged herein, defendants acted with scienter in that each defendant knew that
the public documents and statements issued or disseminated in the name of the Company were
materially false and misleading; knew that such statements or documents would be issued or
disseminated to the investing public; and knowingly and substantially participated or acquiesced
in the issuance or dissemination of such statements or documents as primary violations of the
federal securities laws. As set forth elsewhere herein in detail, defendants, by virtue of their
receipt of information reflecting the true facts regarding Organogenesis, their control over,
and/or receipt and/or modification of Organogenesis' allegedly materially misleading
misstatements and/or their associations with the Company which made them privy to
confidential proprietary information concerning Organogenesis, participated in the fraudulent
scheme alleged herein.
188. In addition, throughout the Class Period, while in possession of material adverse
non-public information, defendants caused the Company to issue and/or register for sale millions
of shares of Company stock. Defendants were motivated to materially misrepresent to the SEC
and investors the true financial condition of the Company in order to raise over $68 million in
total proceeds from the sales of Organogenesis securities through public stock offerings, private
equity offerings and other debt and/or equity sales, which defendants failed to utilize in avoiding
Organogenesis' bankruptcy. Moreover, as further evidence of defendants' motivation to engage
in the illegal scheme described herein, on or about April 21, 2000 defendant Stein registered for
sale over $6.9 million of his privately held Organogenesis stock - approximately half of the
IWO
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 30 of 39
Company shares he personally owned and controlled while in possession of material adverse
non-public information. In addition to registering for sale over $6.9 million of his privately held
Organogenesis stock on April 21, 2000, defendant Stein - according to defendant Stein's
counsel - also sold a certain amount of stock in 2001 (during the Class Period) and 2002.
According to defendant Stein's counsel, defendant Stein incurred losses on sales of
Organogenesis stock "in excess of $7,000,000." Even if true, the representation by defendant
Stein's counsel that defendant Stein did not profit from these stock sales does not negate the
strong inference of scienter and motive created by his registration of stock for sale - a clear
indication of his intent to sell the Company's stock and profit therefrom. Other company
insiders, including Defendant Michael Sabolinski, took advantage of the artificially inflated
prices of the Company's stock during the Class Period by selling shares of the Company's stock
and reaping over $400,000 in proceeds therefrom. Company insiders, including defendants Stein
and Sabolinski, registered for sale and/or sold Organogenesis shares while in possession of
material adverse non-public information, as follows:
INSIDER Herbert Stein TOTAL
SHARES REGISTERED FOR SALE
PROPOSED DATE OF NO. OF PROPOSED PRICE
TRANSACTION SHARES PER SHARE 4/21/2000 732,423.00 $9.44
732,423.00
TOTAL VALUE OF SECURITIES
REGISTERED $6,912,242.10 $6,912,242.10
107
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 31 of 39
SHARES SOLD
INSIDER Michael L. Sabolinski Nancy L. Parenteu Nancy L. Parenteu Nancy L. Parenteu Nancy L. Parenteu
TOTAL
DATE OF SALE 6/20/2000 5/10/2001 5/9/2001 5/7/2001 5/7/2001
NO. OF SHARES SOLD 12,208.00 15,000.00 5,000.00 10,000.00 5,000.00
47,208
PRICE PER SHARE $10.39 $8.18 $8.56 $9.00 $8.97
TOTAL VALUE OF SALE $126,841.12 $122,640.00 $42,813.00 $90,000.00 $44,850.00
$427,144.12
189 The registration and/or sales of millions of shares of Company stock during the
Class Period, which sales were designed and/or permitted by the Individual Defendants as well
as numerous other high-level senior executives of Organogenesis further evidences defendants'
motive to perpetrate the fraudulent scheme detailed herein. In addition, defendants also caused
the Company to engage in the sale of tens of millions of dollars in other sales of Organogenesis
securities pursuant to stock offerings, private equity offerings and other debt and/or equity sales
during the Class Period, including the following:
TRANSACTION $9.4M Equity Sale $1.4M Equity Sale $5.27M Equity Sale $1.9M Share Offering $1.44M Private Placement $10M Equity Sale to Novartis $20.25M additional Funding
DATE OF SALE 2/24/2000 2/25/2000 3/09/2000 4/27/2001
6/18/2001
NO. OF SHARES SOLD 688,000 100,000 300,000 1,900,000
186,000
8/07/2001
10/16/2001 2,173,876
TOTAL VALUE OF SALE $9,400,000.00 $1,400,000.00 $5,270,000.00 $13,500,000.00
$1,440,000.00
$10,000,000.00
$20,250,000.00
$61,260,000
PRICE PER SHARE
$7.75
108
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 32 of 39
TOTAL ALL DEBT AND EQUITY REGISTERED FOR SALE AND/OR SOLD BY THE COMPANY, DEFENDANTS AND INSIDERS DURING THE CLASS PERIOD = $68,599,386.22
APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE
190. At all relevant times, the market for Organogenesis' securities was an efficient
market for the following reasons, among others:
(a) Organogenesis stock met the requirements for listing, and was listed and
actively traded on the American Stock Exchange, a highly efficient and automated market;
(b) As a regulated issuer, Organogenesis filed periodic public reports with the
SEC and the American Stock Exchange;
(c) Organogenesis regularly communicated with public investors via
established market communication mechanisms, including through regular disseminations of
press releases on the national circuits of major newswire services and through other wide-
ranging public disclosures, such as communications with the financial press and other similar
reporting services; and
(d) Organogenesis was followed by several securities analysts employed by
major brokerage firm(s) who wrote reports which were distributed to the sales force and certain
customers of their respective brokerage firm(s). Each of these reports was publicly available and
entered the public marketplace.
191. As a result of the foregoing, the market for Organogenesis securities promptly
digested current information regarding Organogenesis from all publicly available sources and
reflected such information in Organogenesis stock price. Under these circumstances, all
purchasers of Organogenesis securities during the Class Period suffered similar injury through
109
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 33 of 39
their purchase of Organogenesis securities at artificially inflated prices and a presumption of
reliance applies.
NO SAFE HARBOR
192. The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to any of the allegedly false statements pleaded in this complaint.
Many of the specific statements pleaded herein were not identified as "forward-looking
statements" when made. To the extent there were any forward-looking statements, there were no
meaningful cautionary statements identifying important factors that could cause actual results to
differ materially from those in the purportedly forward-looking statements. Alternatively, to the
extent that the statutory safe harbor does apply to any forward-looking statements pleaded
herein, defendants are liable for those false forward-looking statements because at the time each
of those forward-looking statements was made, the particular speaker knew that the particular
forward-looking statement was false, and/or the forward-looking statement was authorized
and/or approved by an executive officer of Organogenesis who knew that those statements were
false when made.
FIRST CLAIM
Violation Of Section 10(b) Of The Exchange Act And Rule 10b-5
Promulgated Thereunder Against All Defendants
193. Plaintiffs repeat and re-allege each and every allegation contained above as if
fully set forth herein.
194. During the Class Period, defendants carried out a plan, scheme and course of
conduct which was intended to and, throughout the Class Period, did: (i) deceive the investing
public, including plaintiffs and other Class members, as alleged herein; (ii) enable the Individual
110
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 34 of 39
Defendants and other Organogenesis insiders to register for sale and/or sell more than $68
million of the Company's and/or their personally-held Organogenesis common stock to the
unsuspecting public; and (iii) cause plaintiff and other members of the Class to purchase
Organogenesis securities at artificially inflated prices. In furtherance of this unlawful scheme,
plan and course of conduct, defendants, jointly and individually (and each of them), took the
actions set forth herein.
195. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made
untrue statements of material fact and/or omitted to state material facts necessary to make the
statements not misleading; and (c) engaged in acts, practices, and a course of business which
operated as a fraud and deceit upon the purchasers of the Company's securities in an effort to
maintain artificially high market prices for Organogenesis securities in violation of Section 10(b)
of the Exchange Act and Rule lOb-5. All defendants are sued either as primary participants in
the wrongful and illegal conduct charged herein or as controlling persons as alleged below.
196. Defendants, individually and in concert, directly and indirectly, by the use, means
or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a
continuous course of conduct to conceal adverse material information about the business,
operations and future prospects of Organogenesis as specified herein.
197. These defendants employed devices, schemes and artifices to defraud, while in
possession of material adverse non-public information and engaged in acts, practices, and a
course of conduct as alleged herein in an effort to assure investors of Organogenesis' value and
performance and continued substantial growth, which included the making of, or the
participation in the making of, untrue statements of material facts and omitting to state material
facts necessary in order to make the statements made about Organogenesis and its business
111
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 35 of 39
operations and future prospects in the light of the circumstances under which they were made,
not misleading, as set forth more particularly herein, and engaged in transactions, practices and a
course of business which operated as a fraud and deceit upon the purchasers of Organogenesis
securities during the Class Period.
198. Each of the Individual Defendants' primary liability, and controlling person
liability, arises from the following facts: (i) the Individual Defendants were high-level executives
and/or directors at the Company during the Class Period and members of the Company's
management team or had control thereof; (ii) each of these defendants, by virtue of his
responsibilities and activities as a senior officer and/or director of the Company was privy to and
participated in the creation, development and reporting of the Company's internal budgets, plans,
projections and/or reports; (iii) each of these defendants enjoyed significant personal contact and
familiarity with the other defendants and was advised of and had access to other members of the
Company's management team, internal reports and other data and information about the
Company's finances, operations, and sales at all relevant times; and (iv) each of these defendants
was aware of the Company's dissemination of information to the investing public which they
knew or recklessly disregarded was materially false and misleading.
199. The defendants had actual knowledge of the misrepresentations and omissions of
material facts set forth herein, or acted with reckless disregard for the truth in that they failed to
ascertain and to disclose such facts. Such defendants' material misrepresentations and/or
omissions were done knowingly or recklessly and for the purpose and effect of concealing
Organogenesis' operating condition and future business prospects from the investing public and
supporting the artificially inflated price of its securities. As demonstrated by defendants'
overstatements and misstatements of the Company's business, operations and earnings
112
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 36 of 39
throughout the Class Period, defendants, if they did not have actual knowledge of the
misrepresentations and omissions alleged, were reckless in failing to obtain such knowledge by
deliberately refraining from taking those steps necessary to discover whether those statements
were false or misleading.
200. As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market price of Organogenesis
securities was artificially inflated during the Class Period. In ignorance of the fact that market
prices of Organogenesis' publicly-traded securities were artificially inflated, and relying directly
or indirectly on the false and misleading statements made by defendants, or upon the integrity of
the market in which the securities trade, and/or on the absence of material adverse information
that was known to or recklessly disregarded by defendants but not disclosed in public statements
by defendants during the Class Period, plaintiffs and the other members of the Class acquired
Organogenesis securities during the Class Period at artificially high prices and were damaged
thereby.
201. At the time of said misrepresentations and omissions, plaintiffs and other
members of the Class were ignorant of their falsity, and believed them to be true. Had plaintiff
and the other members of the Class and the marketplace known the truth regarding the problems
that Organogenesis was experiencing, which were not disclosed by defendants, plaintiffs and
other members of the Class would not have purchased or otherwise acquired their Organogenesis
securities, or, if they had acquired such securities during the Class Period, they would not have
done so at the artificially inflated prices which they paid.
202. By virtue of the foregoing, defendants have violated Section 10(b) of the
Exchange Act, and Rule 1 Ob-5 promulgated thereunder.
113
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 37 of 39
203. As a direct and proximate result of defendants' wrongful conduct, plaintiffs and
the other members of the Class suffered damages in connection with their respective purchases
and sales of the Company's securities during the Class Period.
SECOND CLAIM
Violation Of Section 20(a) Of The Exchange Act Against The Individual Defendants
204. Plaintiffs repeat and re-allege each and every allegation contained above as if
fully set forth herein.
205. The Individual Defendants acted as controlling persons of Organogenesis within
the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their high-level
positions, and their ownership and contractual rights, participation in and/or awareness of the
Company's operations and/or intimate knowledge of the false financial statements filed by the
Company with the SEC and disseminated to the investing public, the Individual Defendants had
the power to influence and control and did influence and control, directly or indirectly, the
decision-making of the Company, including the content and dissemination of the various
statements which plaintiff contends are false and misleading. The Individual Defendants were
provided with or had unlimited access to copies of the Company's reports, press releases, public
filings and other statements alleged by plaintiff to be misleading prior to and/or shortly after
these statements were issued and had the ability to prevent the issuance of the statements or
cause the statements to be corrected.
206. In particular, each of these defendants had direct and supervisory involvement in
the day-to-day operations of the Company and, therefore, is presumed to have had the power to
control or influence the particular transactions giving rise to the securities violations as alleged
herein, and exercised the same.
114
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 38 of 39
207. As set forth above, Organogenesis and the Individual Defendants each violated
Section 10(b) and Rule 1 Ob-5 by their acts and omissions as alleged in this Complaint. By virtue
of their positions as controlling persons, the Individual Defendants are liable pursuant to Section
20(a) of the Exchange Act.
208. As a direct and proximate result of the Individual Defendants' wrongful conduct,
plaintiffs and other members of the Class suffered damages in connection with their purchases of
the Company's securities during the Class Period.
WHEREFORE, plaintiffs pray for relief and judgment, as follows:
A. Determining that this action is a proper class action, designating plaintiffs
as Lead Plaintiffs and certifying plaintiffs as a class representative under Rule 23 of the Federal
Rules of Civil Procedure and plaintiffs' counsel as Lead Counsel;
B. Awarding compensatory damages in favor of plaintiffs and the other Class
members against all defendants, jointly and severally, for all damages sustained as a result of
defendants' wrongdoing, in an amount to be proven at trial, including interest thereon;
C. Awarding plaintiffs and the Class their reasonable costs and expenses
incurred in this action, including counsel fees and expert fees;
D. Awarding extraordinary, equitable and/or injunctive relief as permitted by
law, equity and the federal statutory provisions sued hereunder, pursuant to Rules 64 and 65 and
any appropriate state law remedies to assure that the Class has an effective remedy; and
E. Such other and further relief as the Court may deem just and proper.
115
Case 1:04-cv-10027-JLT Document 58-4 Filed 12/22/04 Page 39 of 39
JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury.
Dated: December 22, 2004 MOULTON & GANS, P.C.
By: Is! Nancy Freeman Gans Nancy Freeman Gans, BBO #184540 33 Broad Street, Suite 1100 Boston, MA 02109-4216 Telephone: (617) 369-7979 Facsimile: (617) 369-7980
Liaison Counsel and Local Counsel for Plaintiffs and the Class
MILBERG WEISS BERSHAI) & SCHULMAN LLP
Steven G. Schulman Elaine S. Kusel Peter Sloane One Pennsylvania Plaza New York, NY 10119 (212) 594-5300
Lead Counsel for Plaintiffs and the Class
LAW OFFICES OF MICHAEL A. SWICK PLLC
Michael A. Swick One William Street, Suite 900 New York, NY 10004 (212) 584-0770
Attorney for Plaintiffs and the Class
116