Earlier this month, the company officially announced a settlement agreement with Apple under which GT will wind down sapphire materials production and exit from the market as a producer of sapphire materials. The company will refocus its business as an equipment supplier, manufacturing and developing sapphire growth systems and processes.
Below you can read an accounting of their relationship with Apple as provided to the court:
Background of Relationship with Apple
At the outset of negotiations, Apple had offered GTAT what would have been the company’s largest sale ever: an order for 2,600 sapphire growing furnaces. In that scenario, GTAT would operate the furnaces on Apple’s behalf, but Apple would own the furnaces. Apple’s size and prominence make it the ultimate technology client to land. The deal with Apple was viewed as a potential game-changer for GTAT.
After months of extensive negotiations over price and related terms, Apple offered a transaction with a different structure: Apple would no longer buy furnaces from GTAT; instead, GTAT would borrow money from Apple to purchase furnace components and assemble furnaces that would be used to grow sapphire for Apple. Under the new structure, Apple would act as a lender and would have no obligation to purchase any sapphire furnaces, nor did it have any obligation to purchase any sapphire material produced by GTAT. At the same time, GTAT would be precluded from doing business with any other manufacturer in or supplier to the consumer electronics market.
Under Apple’s new proposal, GTAT was to acquire 2,036 sapphire furnaces using a prepayment from Apple of up to $578 million (however, the last $139 million tranche has not been received by GTAT). Apple’s prepayment was calculated based on the cost to GTAT of the furnaces and related equipment used to produce sapphire material. GTAT would then manufacture sapphire according to Apple’s specifications and repay the Apple loan using either cash or completed sapphire material as the currency for the repayment.
If this business transaction worked as contemplated, GTAT would earn income only if Apple purchased sapphire material in excess of loan repayment obligations. Due to losses associated with the development of the technology in accordance with Apple’s requirements, including new issues associated with manufacturing 262kg boules and changes in product specifications, GTAT ended up bearing the costs of more than 1,300 temporary and permanent personnel, utilities, insurance, repairs, and raw materials with minimal revenue output. The total cost incurred by GTAT pursuant to the project with Apple has so far amounted to approximately $900 million.
If Apple decided not to purchase sapphire material, GTAT would still be required to repay the full amount of the prepayments in cash. If that eventuality transpired and GTAT did not have the cash needed to repay the loan, Apple could foreclose on the 2,036 furnaces and related equipment. These obligations were secured through a structure that Apple intended to be “bankruptcy remote” and would shield Apple from risk. With the very limited exception for pre-existing orders, GTAT was restricted under the Apple Agreements from selling and marketing its furnaces for consumer electronics applications.
In October 2013, GTAT had invested months negotiating a sale contract with Apple while being effectively unable to pursue other opportunities with other customers.
Based on the nature of the negotiations, GTAT believes that the key terms of the various agreements presented by Apple were not negotiable. The following terms are illustrative of the terms governing the transaction:
● GTAT committed to supply millions of units of sapphire material. Apple, however, has no obligation to buy any of that sapphire material.
● GTAT was required to form a wholly-owned subsidiary, Debtor GT Advanced Equipment Holding LLC (“GT Equipment”), in October 2013 to implement a structure under which GTAT Corp. would be obligated to buy and assemble furnaces for Apple, but the cash and furnaces would then be “round-tripped” through GT Equipment, referred to in the deal documents as a “bankruptcy remote entity,” using a sale and leaseback between GTAT Corp. and GT Equipment.
● Apple was obligated to procure, construct and lease the Mesa facility to GTAT Corp.
● The pricing for sapphire was the lesser of (i) the price agreed between the parties, (ii) the “not to exceed” price listed on a schedule, (iii) 95% of the lowest price offered by GTAT to any of its customers or (iv) 99% of the quoted price in a bona fide offer to Apple from another qualified source. There was no pre-established formula to adjust the pricing to account for specification or process changes.
● Apple took a security interest in the entity referred to in the documents as the “bankruptcy remote entity,” which was designed to own the furnaces.
● GTAT was prohibited for a number of years from conducting any sapphire business with companies in the consumer electronics space or any direct and indirect supplier to such a company without Apple’s express consent.
● If there was excess capacity at the Mesa facility, GTAT Corp., with Apple’s consent, was able to use such facility to produce sapphire material for other parties, provided that GTAT Corp. paid Apple an unspecified amount for use of the facility for such business
● If GTAT discloses any aspect of the agreements with Apple, it is liable for breach of confidentiality to Apple for $50 million per occurrence as liquidated damages; Apple is not liable for any liquidated damages if it violates confidentiality.
● GTAT must accept and fulfill any purchase order placed by Apple on the date selected by Apple. If there is any delay, GTAT must either use expedited shipping (at its own cost) or purchase substitute goods (at its own cost). If GTAT’s delivery is late, GTAT must pay $320,000 per boule of sapphire (and $77 per millimeter of sapphire material) as liquidated damages to Apple. To put this figure in perspective, a boule has a cost of less than $20,000. Apple, however, has the right, without compensating GTAT, to cancel a purchase order in whole or in part at any time and reschedule a delivery date at any time.
● GTAT must pay $640,000 per boule that it sells to a third party in violation of the exclusivity restrictions in the contract. Apple has no obligation to buy boules exclusively from GTAT.
● GTAT must pay $650,000 per month for any sapphire furnace that is used in violation of GTAT’s exclusivity obligations to Apple. To put this figure in perspective, furnaces provided as part of the transactions with Apple were provided at a one-time total cost of approximately $200,000 per furnace. Apple has no exclusivity obligations to GTAT.
● GTAT is prohibited from modifying any equipment, specifications, manufacturing process or materials without Apple’s prior consent. Apple can modify any of these terms at any time and GTAT must immediately implement Apple’s modifications.
● If Apple exercises a Termination Event, and becomes a “lessee” of the furnaces and related equipment in the Mesa Facility, the rental amount Apple would pay to GT Equipment is $50 per month, as compared with the $9.9 million monthly rent payment that GTAT Corp. is deemed to pay to GT Equipment under its lease with GT Equipment.
● Apple has an “exclusive right of negotiation,” which basically requires GTAT to negotiate exclusively with Apple for thirty days if it seeks to sell substantially all assets or its sapphire business or it receives an expression of interest from a third party. If GTAT violates this provision it must pay Apple $1 billion. Apple has no corresponding obligation to GTAT.
● Apple cannot be liable to GTAT for any design defects or consequential damages from product flaws occurring at the Mesa Facility, which Apple owns, unless GTAT proves that the causes of those defects or flaws were solely Apple’s fault.
● The 14 separate agreements reflecting transactions among GTAT Corp. and its subsidiary, GT Equipment, have cross-termination provisions.
● GTAT Corp. was required to maintain certain key personnel.
● The SOW had a term of 7 years, with automatic 1 year extensions unless either party provided notice of termination.
● GTAT sends the sapphire material it produces to Apple’s suppliers in Asia. Those suppliers further process the sapphire material into an end product. If there is a question about whether the sapphire product GTAT ships to Asia is defective, the question is resolved by a committee of three parties, comprised of GTAT, Apple and one of the two vendors in Asia, with each party getting one vote on whether GTAT was at fault or not.
● If Apple terminates the SOW (as defined herein) for cause, then GT Equipment must immediately repay the intercompany loan from GTAT Corp. By contrast, if GTAT Corp. terminates the SOW for cause, there is no acceleration of the loan obligations.
When GTAT’s management expressed concerns to Apple regarding the deal terms during the contract negotiations, Apple responded, in substance, that similar terms are required for other Apple suppliers and thus would be required for GTAT as well. At the same time, however, Apple expressed its commitment to sapphire technology and its intention to work collaboratively with GTAT. In GTAT’s business judgment, based on facts and circumstances known to GTAT in October 2013, the deal with Apple offered significant opportunities for it, and GTAT elected to proceed. 20.
At the closing of the Apple transaction, GTAT also took on substantial new debt. Specifically, on or about October 30, 2013—the day before the agreements with Apple were signed—GTAT terminated its revolving credit agreement with Bank of America and paid off all outstanding debt owed to Bank of America at that time. This was necessary to permit Apple to take a lien on all of the assets of both GTAT Corp. and GT Equipment.
As permitted by the Apple agreements, GTAT also borrowed an additional $214 million by issuing additional convertible notes in 2013 and raised $71 million through a concurrent common stock sale.
Pursuant to the Apple Agreements, Apple Becomes Involved in the Sapphire Growth and Fabrication Processes
Apple was intimately involved in key aspects of the sapphire growth and fabrication processes.
A specialized facility is required to house over 2,000 sapphire furnaces and the related fabrication equipment. In addition, due to the nature of sapphire growth, a stable and uninterrupted power infrastructure and supply of process cooling and emergency cooling water is required because interruptions in power or cooling water can render the sapphire-growth material unusable, causing millions of dollars in losses.
Apple selected the Mesa Facility and negotiated all power and construction contracts to design and build out the facility with third parties. GTAT had no direct communications with the Apple subcontractors that were building out the Mesa Facility. The first phase of the Mesa Facility was not operational until December 2013—which was only 6 months before GTAT was expected to be operating at full capacity in order to meet its “Minimum Supply Commitments” (as defined in the SOW). The parties had originally anticipated that a facility for the sapphire growth and fabrication project would be ready much earlier in 2013.
Additional unplanned delays continued to surface, because the Mesa Facility required a significant amount of reconstruction, including reconstruction of floors roughly the size of multiple football fields. The build-out of the Mesa Facility, delays in available power, and power interruptions, further delayed the ramp-up of sapphire growth and fabrication by approximately three months. This was critical lost time for GTAT.
Further complicating GTAT’s build-out of sapphire-growth furnace and fabrication areas, driven by the compressed timetable, there were over 1,200 construction workers engaged in the build-out of the Mesa Facility—a difficult situation given the need to be producing at full capacity by summer 2014.
The quality and reliability of the power infrastructure, as noted earlier, is critical to the sapphire growth process. After much discussion, it was determined that implementing power back-up for the furnaces was too expensive and, therefore, non-essential. That decision was not made by GTAT. On at least three occasions, power interruptions occurred, leading to significant delays and losses of whole production runs of sapphire boules. GTAT’s losses to date resulting from power outages at the Mesa Facility exceed $10 million. These power interruptions also adversely affected GTAT’s ability to develop and optimize the process for growing sapphire material to Apple’s specifications because GTAT lost important data every time a boule was damaged by a furnace run affected by interruptions of power or water.
In addition, Apple sent a significant number of employees to the Mesa Facility and the Salem Facility, including supply chain, manufacturing, and quality engineers. These Apple employees were involved on a full-time basis in GTAT’s sapphire growth and fabrication processes. As much as 30% of GTAT’s R&D and manufacturing team’s time was spent interacting with Apple’s employees.
Many of the processes associated with cutting, polishing, and shaping sapphire (this is the “fabrication process”, in contrast to the “growth process” that takes place in the furnaces) were new, given the unprecedented volume of sapphire being grown at the Mesa Facility. GTAT did not select what tools to use and what fabrication processes to implement at the Mesa Facility. GTAT had no direct contact with suppliers of cutting and polishing equipment to specify and in some cases develop such tools.
GTAT believes that it was unable to achieve its planned fabrication cost and production targets because many of the tools did not meet their performance and reliability specifications. Over time, a majority of the selected fabrication tools had to be replaced with alternative tools, resulting in additional capital investment and operating costs to GTAT and months of lost time in production. The fabrication cost was approximately 30% higher than planned, requiring nearly 350 additional employees and significantly higher consumption of diamond wire and other wear items than originally planned. GTAT was required to absorb these additional costs.
The final prepayment of $139 million had not been made as of the Petition Date.
When GTAT initially entered into negotiations to sell sapphire furnaces to Apple, it had no sense that, having borrowed hundreds of millions of dollars to pay for the components of more than 2,036 sapphire furnaces, it would end up being unable to meet its cost and production targets for reasons that it believes were beyond its control as well as unforeseen difficulties in scaling its technology to 262kg boules to meet evolving product specifications.
Unfortunately, these chapter 11 cases are not just a dispute between two parties. GTAT has numerous creditors at various levels of its corporate structure. Notably, GT (GTAT’s parent company) is obligor under more than $430 million in convertible notes, a significant portion of which was required to be used to finance GTAT’s consummation of the Apple transactions. In addition, trade creditors hold approximately $145 million in claims against certain GTAT entities. Finally, GT’s public shareholders have seen their investment lose much of its value.
In light of the interests of GTAT’s creditors and other stakeholders, and given the severity of the losses incurred as a result of the transactions with Apple and the terms of the Apple Agreements, GTAT had little choice but to commence these chapter 11 cases.
As recently as a few weeks before the Petition Date, GTAT senior management made a detailed presentation to Apple senior management in charge of the sapphire growth project and advised them that GTAT was losing substantial amounts, that certain specifications needed to be reviewed and that unless pricing was revised and the final prepayment was made in September that it was projected to run out of cash in a few weeks. While Apple responded with various proposals, after intense negotiations, none of Apple’s proposals solved the economic issues in an effective manner, and GTAT believed that acceptance of such proposals would have exposed GTAT to further risk.
You can read the full document at the link below...
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