vancouversun.com/Apple iPhone glass supplier seeks to seal documents in bankruptcy hearing

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SHAFAQNA –  GT Advanced Technologies Inc., the Apple Inc. supplier that filed for bankruptcy this week without saying why, asked a court to seal documents in the case, citing agreements it doesn’t want discussed in public.

GT Advanced is seeking to avoid the risk of incurring $50 million in damages per violation “under certain confidentiality agreements involving a third party,” the company said in a filing today in U.S. Bankruptcy Court in Manchester, New Hampshire.

After ruling on routine motions to allow GT Advanced to continue operating during its reorganization, U.S. Bankruptcy Judge Henry Boroff cleared the courtroom to consider the request to seal. Only attorneys for the debtor, Apple and the U.S. Trustee, the Justice Department’s bankruptcy watchdog, were allowed to remain.

Earlier in the hearing, Luc Despins, a lawyer for Merrimack, New Hampshire-based GT Advanced, told Boroff he couldn’t give some details about the case in open court or about the confidentiality agreement.

The company has said it’s suffering a “severe” liquidity problem. Another GT Advanced lawyer, James Grogan, told the judge that its net operating loss could reach $152 million by the end of the year.

Apple last November signed a deal to make a prepayment of about $578 million to GT Advanced to build furnaces for making synthetic sapphire, which can be used in mobile-device screens. When Apple introduced new iPhones last month, though, the smartphones didn’t include the material.

The next hearing in the case is set for Oct. 21.

GT Advanced reoriented its operations from supplying materials and equipment for solar panels and chips to making synthetic sapphire for Apple so that iPhone screens could be tough and scratch resistant. GT Advanced even lined up $578 million in prepayment loans from Apple to pay for the equipment to produce the material, which wasn’t included in the latest version of iPhones.

Even before stunning investors with the bankruptcy filing on Oct. 6 and triggering a 93 per cent drop in shares, signs of trouble began to emerge in August. While GT Advanced Chief Executive Officer Thomas Gutierrez said he was “very positive about our sapphire materials business,” the company said a 1.4 million-square-foot Mesa, Arizona, factory wouldn’t be fully operational until early 2015.

GT Advanced said in a U.S. Securities and Exchange quarterly earnings filing that month it had “incurred significant costs” during the first six months of this year as it worked to convert the plant to produce the material.

“The Mesa operation is operating at a per-unit and total cost structure substantially above the targeted cost structure for the facility,” the Merrimack, New Hampshire-based company said at the time. It cautioned that “if we are unable to remedy these production inefficiencies,” a whole slew of things could happen, including defaulting on its deal with Apple.

GT Advanced unveiled a multiyear agreement on Nov. 4 to provide Apple with sapphire, the second-hardest substance on Earth after diamonds. GT Advanced shares jumped 21 percent on the news. While Apple never said publicly what it planned to use the glass for, the Cupertino, California-based company agreed in late 2013 to the prepayments to help GT Advanced set up the Arizona facility.

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Synthetic sapphire isn’t a common replacement for glass, owing to its higher manufacturing costs, and has traditionally been used for watches. Vertu Ltd., a maker of luxury mobile phones, was the first to adopt sapphire for its screens, while Apple has been using the material only for its Touch ID fingerprint readers.

Drop Tests

Apple had originally planned to use sapphire for the screen of its latest iPhone models before switching back to Corning’s Gorilla Glass because of concerns that there wouldn’t be enough supply, said a person with knowledge of the plans. The iPhone 6 and 6 Plus became available in September, selling more than 10 million units during their opening weekend, a record.

The sheets of sapphire produced by GT Advanced kept failing technical benchmarks, including drop tests, according to people familiar with both companies who asked not to be identified because the information is private. Weaknesses caused during the process of cutting and grinding is the main difficulty in sapphire and isn’t a problem limited to GT Advanced, the people said.

Jeff Nestel-Patt, a spokesman for GT Advanced, declined to comment, while Apple said it was surprised by the bankruptcy filing.

“We are focused on preserving jobs in Arizona following GT’s surprising decision and we will continue to work with state and local officials as we consider our next steps,” Chris Gaither, a spokesman for Apple, said in a statement.

Technical Challenges

Synthetic sapphire is grown as a crystal in factories in a process that takes as long as 18 days to produce 100 kilograms (220 pounds). Its physical properties mean that the larger the piece, the more prone it is to splitting from the edges when microscopic cracks are introduced during the cut and grind process, the people said. Those challenges mean that a key test — dropping the sapphire from a height — reveals weaknesses and reduces yield, or the amount of material that can be used in final products.

Apple was so keen on making the arrangement with GT Advanced work that it had been working closely with the company, trying to overcome the technical challenges and to become cash- flow positive, a person familiar with the effort said.

Sapphire Furnaces

While GT Advanced had enough furnaces to equip 10 million iPhone 6 Plus smartphones per production cycle, its yield rate was about 40 percent, according to LEDinside, a subsidiary of the Taiwan-based market-intelligence firm TrendForce Corp.

“The problem cannot be solved before product release,” Roger Chu, research director of LEDinside, wrote in an e-mailed statement.

Manufacturing large amounts of sapphire wasn’t GT Advanced’s business prior to its relationship with Apple. GT Advanced had mainly sold raw materials and equipment to the solar industry, and the acquisition of Crystal Systems Inc., a manufacturer of furnaces used to grow crystals, in 2010 put them into the sapphire-material business.

The company’s “sapphire business was traditionally based on designing and selling advanced sapphire crystallization furnaces, which are used to produce sapphire,” GT Advanced Chief Operating Officer Daniel Squiller said in an affidavit filed as part of the bankruptcy. “As a result of a series of transactions with a key customer in 2013, the GTAT Group’s sapphire business model shifted from being primarily an equipment manufacturer to also being a sapphire materials manufacturer.”

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In other words, GT Advanced went from manufacturing the tools to making the products.

Borrowed Time

Total revenue from sapphire reached 62 percent during the first six months of the year, he said. In August, GT Advanced reported a second-quarter net loss of $86 million, about double the prior period and compared with a profit of $12 million a year earlier.

GT Advanced ended the second quarter with $333 million in cash and cash equivalents, and CEO Gutierrez said in August that the company was on track to end the year with about $400 million in cash. Instead, it finished the third quarter with about $85 million, according to a court affidavit.

“As you know from prior history, this business really starts to generate cash once the order flow and the revenue flow starts to move,” the CEO said on Aug. 5.

Strings Attached

While Apple agreed to help fund GT’s expansion through a series of installments, it also attached technical and performance metrics, according to GT Advanced’s regulatory filings. A fourth payment of almost $140 million was due to be paid by Apple this month, according to GT Advanced.

“There can be no assurance that we will successfully meet the metrics in order to receive the fourth prepayment installment,” the company said.

GT Advanced was set to begin repaying the money in January, either as cash or a credit against Apple purchases of sapphire material.

“Without significant sapphire revenue from Apple, we would still be required to repay in cash (on a quarterly basis) significant amounts of the prepayment amount beginning in 2015, which would limit our ability to invest in or operate other portions of our business, including our equipment operations, or to repay indebtedness at the time of maturity of such indebtedness,” GT Advanced said.

The repayments could exhaust all of the company’s cash and if GT Advanced defaulted, Apple would have the right to take ownership of manufacturing equipment. Apple could also cancel advance payments and demand repayment earlier if GT Advanced failed to generate sapphire material “to specification prior to an agreed upon date or we are unable to comply with certain financial requirements,” the filing said.

Moreover, accelerated prepayments would probably also force GT Advanced to default on its existing debt, the company said in filings.

“This is one very massive undertaking that we’ve taken on,” CEO Gutierrez said of the sapphire project in August.

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