Could SEC Charges Have Been Predicted for GT Advanced Technologies?

Note: This article was first available to subscribers of Accounting Quality Insights by Audit Analytics on Bloomberg, Eikon, FactSet, and S&P Global.

Key Points:

  • SEC fined former CEO of GT Advanced Technologies (GTAT) over $140,000 in connection with making false and misleading statements to investors
  • Former CEO reported false positive performance outlook despite the knowledge that the company was unable to meet terms of supply agreement with Apple
  • GTAT filing for bankruptcy after reporting results for Q2 2014 was a surprise to many analysts, but certain red flags, including use of non-GAAP metrics, showed signs of trouble before the bankruptcy

On May 3, 2019, the Securities and Exchange Commission publicly issued an Accounting and Auditing Enforcement Release announcing charges against GT Advanced Technologies Inc. (GTAT) and its former Chief Executive Officer, Thomas Gutierrez.

The SEC complaint alleged that GTAT  had violated multiple sections of the Securities Act, including obtaining money in the offer or sale of securities through materially false statements, filing misleading current reports with the Commission, and a failure to keep accurate accounts and effective internal controls.

The charges stem from an October 13, 2013 agreement between GTAT and Apple Inc. [AAPL] in which GTAT was to provide sapphire glass for Apple products. The agreement involved four payment installments totaling $578 million as payment in advance for Apple’s purchase of goods, pursuant on GTAT meeting certain required standards. When GTAT failed to meet the requirements in April 2014, Apple withheld a $139 million payment and could have accelerated repayment of $306 million that had been advanced to GTAT.

The terms of the Apple agreement were outlined in the Risk Factors section of the Q2 2014 filing:

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, and, more importantly, that GTAT would be required to repay Apple if Apple decided against purchasing GTAT products.

However, GTAT proceeded to avoid its performance obligation to potentially have to repay Apple by claiming that Apple had breached the agreement. In making this claim, GTAT was also avoiding recognizing the debt owed to Apple as current, because, 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, GTAT’s then-CEO, Thomas Gutierrez, made false and misleading statements to investors and the public about the Company’s performance. Mr. Gutierrez deceptively 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, even going so far as to say “We remain confident about the long-term potential of the sapphire materials business for GT.”

Despite this positive sentiment from Mr. Gutierrez, in the same earnings release GTAT updated its guidance for fiscal year 2014, disclosing revenue would be on the lower end of the previously provided guidance range of $600 and $700 million, while fully diluted non-GAAP earnings per share was updated from $0.12 to $0.18. It is interesting to note that, at the time, GTAT reported that their sapphire segment accounted for 75% of the revenue in the quarter; revising revenue guidance downward when three-quarters of revenue comes from one segment could be an indicator of trouble.

The ability of GTAT to obtain funding was of key importance for the Company’s survival. Apple pulling out of the lucrative 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 of non-GAAP references in GTAT’s 8-K current reports almost doubled between August 2013 and August 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, are a significant red flag. Adding these types of items to the non-GAAP disclosures indicates that a company does not believe that the item is material to the 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” that, 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 GTAT was experiencing difficulty scaling the technology to meet Apple’s requirements. As previously disclosed in the Company’s Risk Factors, the inability of GTAT to meet its obligations to Apple would halt further payments and push the Company into imminent insolvency. Difficulties that would hinder the ability of the Company to fulfill performance obligations and receive necessary payments to keep the Company solvent are material information to evaluating GTAT’s performance. However, GTAT added the capitalized expenses to their non-GAAP disclosures, indicating that the information is 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, as GTAT explicitly needed the funding to survive and 75% of revenues came from the segment supplying the products to Apple.

While the bankruptcy filing surprised 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 CFO resigned, they were unable to file their annual report on time, and they recorded an out-of-period adjustment to correct tax errors.

The SEC accepted an Offer of Settlement from GT Advanced Technologies and Thomas Gutierrez. The SEC also ordered Thomas Gutierrez to pay over $140,000 in connection with the charges, consisting of disgorgement of $15,510, prejudgment interest of $2,993 and civil penalties of $125,000.

GT Advanced Technologies has since exited bankruptcy and is now privately held.

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1. 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-K’s 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 “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.