Risk & Compliance

SEC Charges Bring Long Fraud Saga to a Close

Five years after GT Advanced Technologies went bankrupt, the company and its ex-CEO, facing overwhelming evidence, cop to SEC allegations.
David McCannMay 8, 2019

On May 3, 2019, the Securities and Exchange Commission charged GT Advanced Technologies (GTAT) and its former CEO, Thomas Gutierrez, with multiple violations of the Securities Act. The company had gone bankrupt in 2014, surprising many observers, although there had in fact been prior predictive signals that the company was deeply troubled.

GTAT and Gutierrez, who have settled the case with the SEC, allegedly profited from the offer or sale of securities through materially false statements; filed misleading current reports with the SEC; and failed to keep accurate accounts and effective internal controls.

The charges stem from an October 13, 2013 agreement under which GTAT was to provide Apple with sapphire glass for its products. The deal called for Apple to make four advance payments totaling $578 million, subject to GTAT meeting certain required standards.

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When GTAT failed to meet the requirements in April 2014, Apple withheld a $139 million payment and gained the right to accelerate repayment of $306 million that had been advanced to GTAT.

The terms of the Apple agreement were outlined in the risk factors section of GTAT’s public filing for the second quarter of 2014:

“If we do not operate our facility at or near capacity or we are unable to manage certain expenses with respect to these sapphire material operations, we may continue to have negative margins and our ability to meet our delivery and/or payment obligations under the arrangements with Apple would be significantly impacted, which would have a negative impact on our business and may impair our ability to operate our business and satisfy our obligations to Apple and others (including holders of our 2017 and 2020 convertible notes).

It is evident from this disclosure that Apple did not have an obligation to purchase products from GTAT if the established conditions and operational targets weren’t met. More importantly, it’s also evident that GTAT would be required to repay Apple if Apple decided against purchasing GTAT products.

However, GTAT proceeded to avoid its performance obligation to repay by claiming that Apple had breached the agreement. In making this claim, GTAT avoided recognizing the debt owed to Apple as current. Had the debt been recognized as current, it would have had an immediate impact on GTAT’s status as a going concern.

Despite the knowledge that GTAT would not be able to meet the standards required by Apple, Gutierrez made false and misleading statements to investors and the public about the company’s performance, according to the SEC.

He reported in the Q2 2014 earnings release that GTAT was expected to hit performance targets and was set to receive Apple’s fourth installment payment in October 2014. He even went so far as to say, “We remain confident about the long-term potential of the sapphire materials business for GT.”

Yet in the same earnings release GTAT updated its guidance for fiscal year 2014, disclosing that revenue would be on the lower end of the previously provided guidance range of $600 and $700 million. At the same time, fully diluted non-GAAP earnings per share was updated from $0.12 to $0.18.

It’s interesting that GT Advanced Technologies reported that its sapphire segment accounted for 75% of its revenue in the quarter. Revising revenue guidance downward when three-quarters of revenue comes from one segment could indicate trouble.

GTAT’s ability to obtain funding was important for the company’s survival. Apple pulling out of the agreement had significant and swift material consequences for GTAT. Only two months after the Q2 2014 earnings release, GTAT filed for bankruptcy protection under Chapter 11. By early October 2014, the company’s stock had lost roughly half of its value, and then lost a further 90% after the bankruptcy filing.

As discussed in our previous blog post, GT Advanced Technologies: Non-GAAP Signals, other warning signs were evident in the Q2 2014 earnings release. In general, GTAT began relying more on non-GAAP numbers when reporting financial results.

To evaluate reliance on non-GAAP metrics, Audit Analytics previously analyzed the number of non-GAAP words in GTAT’s press releases. The number rose steadily from 28 such words in a Nov. 4, 2013 release to 61 words on Aug. 4, 2014.*

Generally speaking, a company may overly emphasize non-GAAP metrics when trying to divert investors’ attention away from deteriorating GAAP results.

Overuse of non-GAAP metrics, or unusual non-GAAP numbers, such as capitalized expenses that GTAT disclosed, is a significant red flag. Adding these types of items to the non-GAAP disclosures indicates that a company does not believe the item is material to an evaluation of the company’s performance.

Of note, in the non-GAAP section of GTAT’s Q2 2014 earnings release, one of the lines reconciling GAAP and non-GAAP incomes was related to “production ramp-up costs.” The costs, according to GTAT, mostly consisted of “costs in connection with production inefficiencies and inventory losses as a result of the qualification of sapphire growth and fabrication equipment and the establishment of related production processes.”

One interpretation of GTAT’s non-GAAP “production ramp-up costs” disclosure is that the company was experiencing difficulty scaling the technology to meet Apple’s requirements.

As previously disclosed in the company’s rick factors, GTAT’s inability to meet its obligations to Apple would halt further payments and push company into imminent insolvency.

Difficulties that would hinder the company’s ability to fulfill performance obligations and receive necessary payments to keep the company solvent are material to evaluating GTAT’s performance. However, GTAT added the capitalized expenses to its non-GAAP disclosures, indicating that the information was not material, when in fact it was a key piece of information regarding the company’s performance.

As GTAT experienced significant challenges with production and inventory, it should not have been surprising that Apple ceased payment. Subsequently, it should not have been a surprise that GTAT filed for bankruptcy.

While the bankruptcy filing did surprise many at the time, GTAT had previously exhibited a number of qualitative red flags that should have served as warning signs to investors. In a short period of time at the beginning of 2014, GTAT’s finance chief resigned, the company was unable to file its annual report on time, and it recorded an out-of-period adjustment to correct tax errors.

The SEC accepted a settlement offer from GT Advanced Technologies and Thomas Gutierrez. The commission also ordered Gutierrez to pay more than $143,000 in connection with the charges, consisting of disgorgement of $15,510, prejudgment interest of $2,993, and civil penalties of $125,000.

GTAT has since exited bankruptcy and is now privately held.

* To evaluate reliance on non-GAAP metrics, we used a simple algorithm that counted the number of “non-GAAP” words in a press release. We searched 8-Ks using the following algorithm: “non” within 5 characters of “GAAP.” Some companies tend to present extensive amounts of non-GAAP data while using the “non-GAAP” string only once. Other companies may avoid using the “non-GAAP” string altogether by using descriptions such as “non-core” or “adjusted.” Therefore, the frequency of the word “non-GAAP” may not necessarily capture all the instances of extensive reliance on the non-GAAP disclosure. Instead, the metric measures extensive reliance on non-GAAP language.

Olga Usvyatsky is vice president of research and Nicole Hallas a research analyst for Audit Analytics. This article is republished here by permission.

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