Case 3 : 07-cv-01538 Document 1 Filed 09/10/2007 Page 1 of 31 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS ^:^.. DALLAS DIVISION VULCAN LEE, Individually and On Behalf No. of All Others Similarly Situated, 3 O'7 CVI538- M Plaintiff, V. JURY TRIAL DEMANDED // , nq o HEELYS, INC., MICHAEL G. STAFFARONI, MICHAEL W. HESSONG, PATRICK F. HAMNER, ROGER R. LL^_S. D1IST C L COURT ADAMS, RICHARD E. MIDDLEKAUFF, NORJLHERN DIST R I's ( Of TEXAS SAMUEL B. LIGON, WILLIAM R. F I LE D THOMAS, CAPITAL SOUTHWEST CORPORATION, CAPITAL SOUTHWEST VENTURE CORPORATION, BEAR, SEP 1 0 200T STEARNS & CO. INC., WACHOVIA CAPITAL CLERK, l ISTRICT COURT MARKETS, LLC, J.P. MORGAN By SECURITIES INC. and CIBC WORLD Deputy MARKETS CORP., Defendants. COMPLAINT - CLASS ACTION 1. This is a securities class action against Heelys, Inc. ("Heelys" or the "Company"), certain of its directors, its controlling shareholder and its investment bankers (collectively, the "Defendants") for violations of the Securities Act of 1933. Plaintiff brings this action individually and on behalf of all other purchasers of Heelys' stock issued pursuant or traceable to the Company' s Registration Statement filed with the Securities and Exchange Commission ("SEC") by Heelys in connection with the Company's December 2006 initial public stock offering ("IPO") 2. Heelys designs, markets and distributes footwear which comes with a removable wheel. The Registration Statement and Defendant ' s pre-IPO marketing and promotional Case 3:07-cv-01538 Document 1 Filed 09/10/2007 Page 2 of 31 campaigns represented that Heelys users could "seamlessly" switch from walking or running to skating (aka "heeling") by shifting weight to their heels. Heelys targets its wheeled footwear - which costs approximately $60 a pair - at the six to fourteen year-old age group. Operating solely as a distributor, Heelys has its footwear manufactured by third party suppliers in Asia and sells to independent retailers and national chains in the United States and internationally. Heelys itself manufactures nothing. Eighty percent of its products are shipped directly from the factory to the retailer. Sales revenue is recognized immediately upon shipment from the third-party suppliers. To increase brand awareness and sales of their wheeled footwear known as "Heelys," in the months leading up to the December 2006 IPO, Defendants caused Heelys to be featured in numerous television and print spots, including on television networks CNN and CNBC, on television shows such as "So You Think You Can Dance," "Good Morning America," "Radical Sabbatical, Livin' Large," "CSI: Miami" and "Invent This," in magazines and newspapers such as Time, People, The Wall Street Journal, In Style, Newsweek and Sports Illustrated and the World Book Encyclopedia and in McGraw Hill school textbooks. Heelys were also featured in the Miramax film "Spy Kids 2" and in music videos and television specials featuring pop artist Usher. As a result of this aggressive marketing campaign, the then seven- year-old Company's sales exponentially increased in the months leading up to the IPO. Heelys sold 3.9 million pairs during the first nine months of 2006 alone, more than five times the 697,000 pairs sold in all of 2004. The Company achieved $117 million in sales revenues during the first nine months of 2006, more than 260% of the $44 million in sales achieved during all of fiscal 2005. Essentially, Heelys went into the IPO having recently reported huge sales on the Company's single product that had never before been so widely sold. -2- Case 3:07-cv-01538 Document 1 Filed 09/10/2007 Page 3 of 31 4. The Company's Registration Statement on Form S-1 (Registration No. 333- 137046) (first filed with SEC on September 1, 2006 and declared effective on December 7, 2006 after several amendments and iterations) represented that the Company's 2006 "product placement activities enable[d the Company] to build awareness of [Heelys'] products and ... brand in a cost-effective manner." However, rather than providing adequate safety warnings, Heelys' users were featured in promotional ads needing no protective gear whatsoever. In fact, demonstrational videos on the Company's own website featured Heelys users in action "crashing and burning," tripping, falling, jumping off railings, flying into pools, wearing no protective padding and no helmets. When questioned about these depictions, Heelys responded that the videos featured highly trained professionals who did not need protective gear. In fact, of the ten youths pictured on the front cover of the IPO Prospectus wearing/riding Heelys, three were clearly wearing safety gear, three were clearly wearing none, and four of the photos were inconclusive. Moreover, Heelys' advertising, marketing and promotional materials failed to disclose that reports of broken bones, skull fractures and other serious injuries suffered by Heelys users had exponentially increased in the months leading up to the IPO as sales of Heelys increased. In fact, while the Heelys website said that the Company highly "recommend[ed]" the use of protective gear "when the wheels [were] in the shoes," the Company's bottom line - as stated on its website - was that "protective gear is not required" when using Heelys. Instead, as represented in the Company's IPO Registration Statement and Prospectus (collectively, the "Registration Statement"), Heelys were marketed to children, preteens and teenagers alike as "stylish" shoes that reflected "individualism," "independence" and "freedom" and permitted the -3- Case 3:07-cv-01538 Document 1 Filed 09/10/2007 Page 4 of 31 user to "seamlessly" switch back and forth between walking, running and skating, without missing a beat, much less stopping to don wrist guards, knee pads, elbow pads and helmets. 6. In the December 2006 IPO, the Company and certain of its senior executives and directors sold $155 million worth of Heelys stock at $21 per share. The Registration Statement filed by defendants in connection with the IPO was misleading in that it represented that Heelys had a viable, well-established business plan and that its tremendous revenue growth and resulting profits were based on sound business and stable sales practices. Moreover, the Registration Statement failed to disclose the staggering number of injuries suffered by Heelys' users in the months leading up to the IPO. 7. At the time of the Heelys IPO, Consumer Product Safety Commission ("CPSC") had received more than two million injury reports related to Heely's use between 2001 and 2006. Beginning in the Spring of 2007, following the IPO, it would be disclosed that doctors from Ireland to Singapore had, in the months leading up to the IPO, reported treating hundreds of additional injuries -- including head injuries, dislocated elbows and fractures -- suffered by children wearing Heelys. Between September 2005 and December 2006 alone, one death and at least an additional 64 roller-shoe injuries were reported to the CPSC. Sixty-seven children were treated for injuries from wheeled shoes at Temple Street Children's University Hospital in Dublin, Ireland, over one ten-week period during the summer 2006. Doctors in Singapore reported that 37 children had been treated for similar injuries at a hospital there during a seven- month period in 2004 - adding that none were wearing protective gear. Balancing on the wheels was reported to be tricky, especially for novices. In the Irish study, most injuries were in new users and occurred when children fell backward while trying to transfer their body weight. As a -4- Case 3:07-cv-01538 Document 1 Filed 09/10/2007 Page 5 of 31 result, in June 2007, the American Academy of Orthopedic Surgeons (the "AAOS") issued new safety advice that mandated the use of helmets, wrist protectors and knee and elbow pads for children using wheeled shoes. Disclosure of the unacceptably high safety risk associated with the use of Heelys was material as it would have multiple detrimental effects on Heelys' sales (and profits) - each of which was borne out in the months following the IPO. Parents of many younger children would refuse to let them continue using their Heelys and cease making additional purchases. Older youth would reject the fashion statement that wrist guards, elbow pads, knee pads and helmets make. Certain retailers fearing potential legal exposure would refuse to carry Heelys in their stores. By the end of the week of August 5, 2007, following warnings by the CPSC, the AAOS and other industry safety watchers, Heelys sales had decreased 37% on a year-over-year basis - the third week in a row marking such declines. 9. By the end of the second quarter of 2007, retailers were holding more than a years' backlog in inventory and the unsold inventory at Heelys' own distribution center had grown 175% year-over-year from the second quarter of 2006. On August 8, 2007, Defendants were forced to significantly downgrade the Company's revenue and earnings guidance for the second half of 2007, admitting that retailers were sitting on huge unsold inventory and refusing to place additional orders, causing the Company's stock price to plunge 45% in a single trading session on more than six-times the average daily trading volume over the preceding month. 10. When the truth about the dangers associated with use of Heelys reached the market on August 8, 2007, ratings of the Company's common stock were slashed and Heelys' stock price plummeted to less than $13 per share. Plaintiff and the other members of the Class -5- Case 3:07-cv-01538 Document 1 Filed 09/10/2007 Page 6 of 31 who acquired Heelys stock in or traceable to the IPO have suffered tens of millions of dollars in damages as a result of their purchases of Heelys' shares. JURISDICTION AND VENUE 11.