In re Restoration Robotics, Inc. Sec. Litig.

417 F.Supp.3d 1242

IN RE RESTORATION ROBOTICS, INC. SECURITIES LITIGATION

Case No. 5:18-cv-03712-EJD

United States District Court, N.D. California, San Jose Division.

Signed October 18, 2019

ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS; GRANTING DEFENDANTS' JOINDER MOTIONS

Re: Dkt. Nos. 45, 47, 49, 50

EDWARD J. DAVILA, United States District Judge

This class action arises out of Defendants' alleged violations of Section 11 and 15 of the Securities Act of 1933 ("the Act") during its initial public offering ("IPO") of Restoration Robotics, a company dedicated to robotic hair restoration.

Lead Plaintiff Edgardo Guerrini purchased Restoration Robotics common stock pursuant to the "Offering Materials," see infra I.A., issued in connection with Restoration's IPO.¹ Plaintiff alleges violations of Section 11 and 15 of the Act and argues that the Offering Materials contained materially false or misleading statements regarding Restoration's marketing function, the functionality of the ARTAS System (Restoration's hair transplant technology), and the ARTAS System's sales and continuing revenue. See Consolidated Amended Complaint ("Compl.") ¶¶ 3, 15, 19, 129, Dkt. 36. Plaintiff also claims Defendants violated Item 303 of SEC Regulation S-K by failing to disclose known trends or uncertainties that existed at the time of the IPO.

The Complaint names multiple defendants:² (1) Restoration Robotics; (2) Individual Defendants Ryan Rhodes (the Chief Executive Officer "CEO"), Charlotte Holland (Chief Financial Officer "CFO"), Frederic Moll (Chairman of the Board), Jeffrey Bird (Board member), Gil Kliman (Board member), Emmett Cunningham, Jr. (Board member), Craig Taylor (Board member), and Shelly Thunen (Board member); (3) Venture Capital Sutter Hill Ventures, L.P., Clarus Lifesciences II, L.P., Clarus Ventures II, LLC, Alloy Ventures 2002, L.P., Alloy Ventures 2005, L.P., Alloy Ventures 2002, LLC, Alloy Ventures 2005, LLC, Interwest Partners IV, L.P., and Interwest Management Partners IX, LLC; and (4) Underwriter Defendants National Securities Corporation, Roth Capital Partners, LLC, and Craig-Hallum Capital Group LLC. Id. ¶¶ 21–43.³

I. BACKGROUND

A. Factual Background

Company Overview. Restoration Robotics is a medical technology company that "develop[s] and commercializ[es] a robotic device, the ARTAS System that assists physicians in performing many of the repetitive tasks that are part of a follicular unit extraction surgery, a type of hair restoration procedure." Compl. ¶ 51, Dkt. 36. The ARTAS System is an all-in-one device comprised of a patient chair, a robotic arm, an integrated vision system, artificial intelligence algorithms, and a series of proprietary end effectors, which have a needle and punch to secure hair follicles from a patient's scalp. Id. ¶ 52. It is designed to "robotically assist[ ] a physician through many of the most challenging steps of the hair restoration process." Id. ¶ 54.

In April 2011, Restoration received clearance to market and sell the ARTAS system in 61 countries. Id. ¶ 56. To sell the system domestically, Restoration relies on a direct sales and marketing team. This team is composed of Regional Sales Managers ("RSMs"), Clinical Trial Managers ("CTMs"), and Practice Success Managers ("PSMs"). Id. ¶ 66. RSMs are "responsible for coordinating with executing the direct sales of the ARTAS Systems." Id. ¶ 67. CTMs provide "high quality, comprehensive training and education to physicians on the use of the ARTAS System and on how to build their hair restoration practices." Id. ¶ 68. PSMs work alongside physician clients to help "build awareness and market the ARTAS procedure and increase ARTAS brand-awareness." Id. ¶ 69. This system is meant to prioritize profits by working collaboratively with physician customers to increase the number of ARTAS procedures performed. Id. ¶ 73. Internationally, the Company sells the ARTAS System to independent, third-party distributors who then sell the systems to end-users. Id. ¶¶ 118–19. As an inducement to buy the system, Restoration promised doctors high quality patient leads. Id. 78–80.

Revenue Structure. Restoration generates revenue from the ARTAS system in three ways: (1) systems, (2) procedure based, and (3) service-related fees. Id. ¶ 59.

First, "systems" is the sale of the actual ARTAS system, which is a one-time revenue at an average price of $225,000 to $240,000. Id. ¶ 61. Domestic sale revenue is recorded upon delivery to customers. Declaration of Gavin M. Masuda in Support of Restoration Robotics Defendants' Motion to Dismiss ("Masuda Decl."), Ex. A at 61, Dkt. 48. International sale revenue is recorded upon shipment to an international distributor. Id. Second, "procedure based" revenue is earned anytime there is a procedure; physician-customers must "pay in advance on a per-follicle basis for the follicles to be harvested, and on a per procedure basis for Site Making." Compl. ¶ 62. Outside of the United States, physician-customers pay in advance on a per procedure basis for both follicle extraction and site making. Id. Third, Restoration generates "service-related fees" from post-warranty maintenance on the ARTAS Systems pursuant to "service and support contracts offered by the Company." Id. ¶ 64. Because the purchase of an ARTAS System is a one-time occurrence, Restoration depended mainly on "procedure-based" revenue. Id. ¶ 59.

Internationally, the revenue system functioned a bit differently. Plaintiff alleges that, at the end of the quarter, Restoration increased sales to foreign distributors to boost quarterly sales numbers. Id. ¶¶ 118–23. In these foreign sales, the products did not go directly to the physician-consumer; instead, a distributor purchased the system and then allowed it to lay dormant in their warehouses. Id. This resulted in "warehousing," which resulted in limited "procedure based" profits and oversaturated foreign markets, ultimately causing "system" revenue to decrease. Id. ¶¶ 145–58. In response, Restoration announced a pivot to a U.S.-centric model in May 2018. Id. ¶ 161.

Pre-IPO. Plaintiff uses three confidential witnesses ("CWs") to support its allegations. Id. ¶ 44. CW 1 was a PSM, employed by Restoration before the IPO. Id. ¶ 45. CW 2 was a PSM employed after the IPO. Id. ¶ 48. And, CW 3 was an RSM employed before and after the IPO. Id. ¶ 49. According to CW 1 and 2, Restoration was unable to provide doctors with the promised patient leads and marketing support. Id. ¶¶ 80–82. Those that Restoration did identify as potential leads often had "no idea" how they ended up on Restoration's list. Id. ¶ 82. This problem was so widespread, it resulted in a number of internal complaints among the PSMs and physicians. Id. Ultimately, because patient leads were not provided, physicians allowed their ARTAS System to lay dormant, resulting in a significant drop in procedure-based revenue. Id. ¶¶ 85, 93.

Beyond the lack of patient leads, doctors also reported discontent with the amount of time and expense required to use the ARTAS System. Id. ¶¶ 97–99. Allegedly, the system had widespread product issues that resulted in lower follicle yields, which further caused doctors to abandon the system. Id. Specifically, the needles used for the procedure suffered from a material defect that caused the machine to damage a patient's already limited number of donor grafts, lowering harvest yields and increasing costs to physicians, leading to more abandonment of the system. Id. ¶ 140. According to CW 1, thirteen percent of doctors in her region had abandoned the system. Id. ¶ 100.

Finally, before the IPO, device sales stalled because interested doctors were waiting for the new product (the ARTAS iX). Id. ¶¶ 112, 152. Representatives were told to avoid mentioning this during sales for fear of stagnation of sales. Id. ¶ 167, 169. Sales of the original ARTAS System were slowing because of this potential new product—doctors did not want to buy an out-of-date system. Id.

The IPO. On September 1, 2017, Restoration filed its Registration Statement with the Securities and Exchange Commission ("SEC"). Id. ¶ 5. After several amendments, the statement became effective on October 11, 2017. Id. ¶ 6. On October 13, 2017, Restoration filed a Prospectus pursuant to Rule 424(b)(4) with the SEC, commencing the public offering of 3,575,000 Restoration shares of common stock priced at $7.00 per share, raising over $23 million in net proceeds. Id. ¶ 128. The Registration Statement and the Prospectus, together the "Offering Materials," form the basis of this action. Id. ¶ 7. The Offering Materials contained disclosures regarding Restoration's sales and marketing strategy, the quality and design of the ARTAS System, and ARTAS system sales and continuing revenue. Id. ¶¶ 130–46.

Post-IPO. Following the IPO, the Company's stock traded consistently below its offering price of $7.00 per share. Id. ¶ 13. Plaintiff identifies three significant events: first, on January 5, 2018, Restoration announced Chris Aronson was replacing long-time Vice President of Global Sales Brent Nixon, causing the stock price to drop 14%. Id. ¶¶ 163–64. Second, on May 14, 2018, Restoration announced its first quarter earnings for 2018, which showed a loss and caused the share price to drop 14.42% (falling to $3.68 per share). Id. ¶¶ 150–51. Third, on November 5, 2018, Restoration announced quarterly earnings for the third quarter of 2018 of $4.8 million, based on the sale of 11 ARTAS iX Systems. Despite an increase in total system sales, procedure-based revenue dropped to $1.28 million. Id. ¶ 152. Analyst Roth Capital Partners, and other analysts, lowered their price target to $4 per share. Id. ¶ 153. The share price decreased to $1.13 per share as of November 29, 2018. Id.

B. Alleged Material Misstatements/Omissions

Plaintiff alleges the Offering Materials contained 10 materially false, misleading, and incomplete statements concerning the Company's marketing function, the quality and...