SECURITIES EXCHANGE ACT OF 1934
Release No. 49541 / April 8, 2004
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 1987 / April 8, 2004
ADMINISTRATIVE PROCEEDING
File No. 3-11455
In the Matter of GERBER SCIENTIFIC, INC., Respondent. |
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ORDER INSTITUTING CEASE-AND- |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), against Gerber Scientific, Inc. ("Gerber," "Company," or "Respondent").
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, which Respondent admits, Respondent consents to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
III.
On the basis of this Order and Respondent's Offer, the Commission finds1 as follows:
RESPONDENT
Gerber, a Connecticut corporation with its headquarters in South Windsor, Connecticut, is a provider of sign making and specialty graphics, apparel and flexible materials, and ophthalmic lens processing goods and services. During the relevant time, Gerber conducted its business primarily through four subsidiaries: Gerber Scientific Products, Inc. ("GSP"); Spandex PLC; Gerber Technology, Inc.; and Gerber Coburn Optical, Inc. ("Gerber Coburn"). Gerber uses a fiscal year that ends on April 30. Its common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and is listed on the New York Stock Exchange.
SUMMARY
Gerber violated the antifraud provisions of the federal securities laws when it issued materially inaccurate financial information and failed to correct such information after discovering that it had made an error. While preparing its annual report on Form 10-K for fiscal year 2000, senior management learned that, for the fourth quarter, the Company had failed to record approximately $1.5 million of a $6.2 million decrease in the value of the inventory of the Company's GSP subsidiary. Notwithstanding this information, the Company did not disclose this mistake by correcting its previously issued press release reporting earnings for the quarter and year ended April 30, 2000, and then filed its annual report on Form 10-K with materially inaccurate financial statements and related disclosures. Without disclosure, the Company then sought to eliminate the error by improperly amortizing the $1.5 million error over its next four fiscal quarters.
In addition, the Company violated financial reporting, record-keeping, and internal controls provisions of the federal securities laws in connection with the $1.5 million error and also in connection with certain reserves.2 Gerber improperly (a) established reserves for contingencies that did not exist or, at best, were general or unspecified contingencies, (b) established other reserves in amounts for which it lacked support, (c) overstated earnings by using previously established reserves to reduce current period expenses, and (d) overstated operating income by using excess reserves for income tax contingencies to offset unrelated operating expenses. As a result, Gerber's financial statements filed with the Commission for periods at least as early as its fiscal year 1998 and as late as its fiscal quarter ended January 31, 2002 were materially misstated and not in conformity with Generally Accepted Accounting Principles ("GAAP").
FACTS
On August 27, 2002, Gerber filed its annual report on Form 10-K for its fiscal year ended April 30, 2002. In that Form 10-K, Gerber included restated financial statements for its fiscal years ended April 30, 2000 and April 30, 2001, and for the seven quarters ended January 31, 2002; and it also restated its retained earnings as of April 30, 1999. Among other things, the Company included a restatement for its failure to record $1.5 million of a $6.2 million charge to write down the value of the inventory of its GSP subsidiary as well as for the Company's improper establishment and use of various reserves.
Gerber's Failure to Record $1.5 Million of a $6.2 Million Charge for the GSP Inventory Overstatement
By late February 2000, Gerber's senior management was aware of a large discrepancy between the estimated value of GSP's physical inventory, and the value of that inventory reflected on the Company's books. As a result, Gerber senior management ordered an expanded annual review of GSP's inventory. The review was begun by GSP personnel and then completed by a special internal audit team formed to determine the precise amount of the discrepancy. By no later than April 25, 2000, the special audit team informed senior management that GSP's inventory was overstated by approximately $6 million.
On April 26, 2000, Gerber issued a press release disclosing that it would record a charge of approximately $6 million to write down the value of GSP's inventory. The Company reported that the charge equated to $.17 per share and that, before any restructuring charges, it expected earnings for the fourth quarter of fiscal year 2000 to be reduced to $.08 to $.12 per share and earnings for the year to be $1.16 to $1.20 per share. Prior to the release, analyst expectations for Gerber had been $.42 per share for the fourth quarter and $1.50 per share for the year.
By early May 2000, the special audit team informed Gerber senior management that the exact amount of the overstatement of GSP's inventory was $6.2 million. On May 25, 2000, Gerber issued a press release announcing its results for the fourth quarter and year ended April 30, 2000. Gerber reported net earnings of $1.7 million or $.08 per share, for the quarter and net earnings of $25.9 million, or $1.16 per share, for the year. Gerber gave the write-down as one of two principal reasons why its earnings for the quarter were lower than the prior year's fourth quarter earnings and stated that, without the write-down, per share earnings for the year would have been $1.34 and thus would have exceeded the prior year's earnings of $1.29 per share.
During GSP's budgeting process in June 2000, GSP management discovered that the Company actually had recorded only $4.7 million of the $6.2 million charge for the inventory overstatement. GSP management immediately informed Gerber senior management of the error. Had Gerber recorded the entire $6.2 million in the fourth quarter of 2000, reported net earnings would have been $725,000, or $.04 per share, for the quarter and $24.9 million, or $1.12 per share, for the year.3
Upon discovery of the error, Gerber did not correct its May 25, 2000, earnings release. It also did not initially inform its auditor of the error. Instead, on July 27, 2000, Gerber filed its annual report on Form 10-K that included financial statements that reported the same results that Gerber had reported in its May 25, 2000, press release. Those results did not include $1.5 million of the $6.2 million charge required to write-down the value of GSP's inventory. Although the financial results included only $4.7 million of the charge, the Company, in footnotes to the financial statements and other disclosures in the Form 10-K, misstated that it had recorded the entire $6.2 million charge.
Gerber amortized the $1.5 million error in $375,000 increments in each of the next four quarters (i.e., the four quarters of its fiscal year 2001) even though such amortization was not a permissible method under GAAP to account for the error.4 No later than August 2000, Gerber discussed the $1.5 million error with its auditor, and the auditor approved a different way of accounting for the error, which Gerber did not use.
Gerber's Improper Establishment and Use of Reserves
Gerber also restated its financial statements in August 2002 for the improper establishment and use of reserves. That conduct resulted in both overstatements and understatements of net earnings as well as in overstatements of the Company's operating income.
The Corporate Reserves
In approximately 1986, the Company established accounts receivable and inventory reserves on its corporate level books ("corporate reserves"). When Gerber established these reserves, it did not have accounts receivable or inventory held at the corporate level, and the corporate reserves were not established to provide for a specific contingency at any of the Company's subsidiaries.5 The corporate reserves remained at a relatively constant level, totaling approximately $4 million, until fiscal year 1998.
During fiscal year 1998, Gerber used $2 million of the corporate reserves to reduce a variety of expenses that it otherwise would have had to record for its Gerber Coburn subsidiary, including expenses related to a company that Gerber acquired during fiscal year 1998. During fiscal year 1999, Gerber used the remaining $2 million of corporate reserves to offset additional Gerber Coburn expenses.6 These uses of the corporate reserves were improper under GAAP and resulted in an overstatement of net earnings of 25.4%, or $.06 per share, for fiscal year 1998 and of 4.5%, or $.06 per share, for fiscal year 1999.
Reserve Recorded in Connection with the Sale of a Subsidiary
In March 1998, Gerber sold one of its subsidiaries. In connection with that sale, the Company recorded a "non-recurring special charge" in the amount of $25 million to write down the value of certain assets of the subsidiary. Part of that charge was used to establish a reserve of approximately $4.2 million ostensibly for unfulfilled customer obligations and other potential liabilities. When Gerber recorded the charge, however, the Company lacked support for the reserved amount.
During fiscal year 1999, Gerber used the reserve for approximately $1.2 million of costs related to the sale of the subsidiary. The Company, however, also used the reserve to offset $1 million of unrelated severance costs. Then, while it was preparing its annual report on Form 10-K for fiscal year 1999, Gerber and the purchaser of the subsidiary resolved their outstanding claims against one another.7 The resolution of the claims ended any basis for Gerber to maintain the reserve on its books. The Company reversed the remaining $2 million reserve balance into income for fiscal year 1999, which increased Gerber's reported income for that year. Establishing a reserve without support for the amount recorded and using a reserve for purposes unrelated to the purpose for which the reserve was established are improper under GAAP. Gerber's establishment and subsequent uses of the reserve thus were improper under GAAP and resulted in an understatement of net earnings of 23.7%, or $.10 per share, for fiscal year 1998 and an overstatement of net earnings of 7.1%, or $.09 per share, for fiscal year 1999.8
The Income Tax Reserve
At all relevant times, Gerber maintained a reserve for income tax contingencies. At the start of each fiscal year, the Company estimated the amount of income tax expenses that it would incur for the current fiscal year and compared that amount to the amount of the reserve recorded on its books. It then recorded quarterly adjustments to the reserve so that the reserve would equal the amount of the anticipated income tax expenses for the year. During the 1990s, Gerber senior management determined that, in any year in which the outstanding reserve exceeded the anticipated income tax expense for the year, the Company would use the excess to reduce certain operating expenses for the year.9 Using the excess reserve in this manner is improper under GAAP and caused operating income to be overstated.10
For fiscal years 1999 through 2001, Gerber had excess reserves for income tax contingencies. For these years, Gerber used the excess to reduce operating expenses by $1.5 million in 1999, $2 million in 2000, and $0.8 million in 2001. As a result, Gerber's operating income for those years was overstated by 2.8%, 4.3%, and 4% respectively.
DISCUSSION
Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5 prohibit, among other things, the making of material misrepresentations or omissions, with scienter, in connection with the purchase or sale of any security. These provisions also make it unlawful to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. A statement is deemed material if there is a "substantial likelihood that a reasonable investor would consider it important" in deciding whether to purchase or sell securities or that a reasonable investor would have viewed disclosure of the omitted fact as altering the "total mix" of information available. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988).
Section 13(a) of the Exchange Act requires issuers of registered securities to file periodic reports with the Commission containing information prescribed by specific Commission rules. Rule 13a-1 requires the filing of annual reports on Form 10-K. Rule 13a-13 requires the filing of quarterly reports on Form 10-Q. Rule 12b-20 requires, in addition to information required by Commission rules to be included in periodic reports, such further material information as may be necessary to make the required statements not misleading. These reports are required to be complete and accurate. See SEC v. Savoy Industries, 587 F.2d 1149, 1165 (D.C. Cir. 1978).
Section 13(b)(2)(A) of the Exchange Act requires issuers to "make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer." "A company's 'books and records' include not only general ledgers and accounting entries, but also memoranda and internal corporate reports." Gibson Greetings, Inc., Exchange Act Release No. 34-36357, 60 SEC Docket 1401 (Oct. 11, 1995). Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP.
Gerber's Materially False and Misleading Statements Arising Out of the Failure to Record $1.5 Million of the Inventory Write-Down
Gerber materially misstated its financial statements when it failed to record $1.5 million of the $6.2 million decrease in the value of GSP's inventory in the fourth quarter of fiscal year 2000. Gerber's financial results reported in its May 25, 2000, press release and financial statements and related disclosures in the Company's annual report on Form 10-K for fiscal year 2000 were, therefore, materially inaccurate.11 After learning of the $1.5 million error, the Company failed to correct the press release,12 proceeded to file its Form 10-K with material misstatements, informed its independent accountant it would correct the error in the first quarter of fiscal 2001, failed to do so, and then sought to eliminate the error in a manner that contravened GAAP and hid its true impact. Gerber's actions after the discovery of the $1.5 million error were knowing or reckless and violated Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5.
Gerber's Inaccurate Periodic Reports and Inadequate Books, Records, and Accounts and Internal Controls
Companies registered with the Commission pursuant to Section 12 of the Exchange Act, such as Gerber, are required to comply with GAAP in financial statements included in its filings with the Commission.13 Gerber did not satisfy this requirement because of the misstatements discussed above, including the $1.5 million error and the above-described reserve errors. Those misstatements were due in part to the Company's failure to make and keep accurate books, records, and accounts and to maintain a system of internal accounting controls sufficient to provide reasonable assurances that the company's financial statements were prepared in conformity with GAAP. The inventory valuation system that gave rise to the need for the $6.2 million inventory write-down, the $1.5 million error, and the lack of support for the establishment and use of reserves reflect the inadequacy of the Company's books, records, and accounts and internal controls. As a result of the foregoing, Gerber violated Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1 and 13a-13.
IV.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions specified in Respondent Gerber's Offer.
ACCORDINGLY, THE COMMISSION HEREBY ORDERS THAT, pursuant to Section 21C of the Exchange Act, Gerber cease and desist from committing or causing any violations of, and committing or causing any future violations of, sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 10b-5, 12b-20, 13a-1, and 13a-13.
By the Commission.
Secretary
Endnotes