By Daisuke Wakabayashi
Shortly before 7 a.m. Pacific time on Oct. 6, the chief
executive of GT Advanced Technologies Inc. called an Apple Inc.
vice president with bad news: GT, which was to supply Apple with
superhard sapphire screens for its new iPhones, had filed for
bankruptcy 20 minutes earlier.
The filing surprised Apple, because the companies had been
negotiating changes in their contract to ease GT's financial
strain, according to a letter Apple later sent to GT's creditors.
Executives of the companies had planned to meet the next day at
Apple's headquarters.
A year earlier, Apple and GT had hailed a $1 billion plan to
build an Arizona factory that would produce 30 times as much
sapphire as any other plant in the world.
Instead, the alliance turned into a rare--and public--misstep
for Apple, whose strict management of its global supply chain has
helped it become the world's biggest company by market value. From
the making of the first iPhone in 2007, Apple repeatedly has pushed
its suppliers to achieve the improbable, while driving hard
bargains on price and time to market.
The Apple-GT marriage was troubled from the start. GT hadn't
mass-produced sapphire before the Apple deal. The New Hampshire
company's first 578-pound cylinder of sapphire, made just days
before the companies signed their contract, was flawed and
unusable. GT hired hundreds of workers with little oversight; some
bored employees were paid overtime to sweep floors repeatedly,
while others played hooky.
GT's meltdown underscores the promise and peril for Apple
suppliers. An Apple deal can generate billions in revenue. But it
also means adapting to huge fluctuations in demand, at razor-thin
profit margins and little room for error.
"This is not easy money," said an executive of a longtime Apple
supplier in Asia.
GT Chief Operating Officer Daniel Squiller told the bankruptcy
court that Apple had turned his company into a captive supplier,
"bearing all of the risk and all of the cost." GT couldn't make a
profit at Apple's "dictated pricing," he said.
Apple put blame for the deal's failure "squarely at the feet of
GTAT's own management," according to the letter to GT's creditors,
which Apple allowed The Wall Street Journal to review. "We never
wavered from our commitment to make the project successful."
The Cupertino, Calif., company turned to GT while seeking to
solve a big problem with iPhones: scratched or broken screens.
Sapphire is one of the hardest materials on earth, now typically
produced synthetically, in furnaces that reach more than 3,600
degrees Fahrenheit. It also is expensive--more than five times the
cost of glass.
Apple consumes one-fourth of the world's supply of sapphire to
cover the iPhone's camera lens and fingerprint reader. Early last
year, the company began looking for a much larger supply, to cover
the iPhone's screen.
GT made furnaces for producing sapphire. According to Apple's
letter to the creditors, GT told Apple in March of last year that
it was developing a furnace that could produce a sapphire cylinder,
known as a boule, weighing 578 pounds, more than twice as large as
what were then the biggest boules. The larger boule would yield
more screens, reducing costs.
GT said in its bankruptcy filings that Apple expressed interest
in buying 2,600 of the new furnaces.
Around early summer, Apple switched gears and asked GT to make
the sapphire. Apple didn't want to pay GT's typical 40% margin for
the furnaces, a person close to GT's operations said.
Apple also was having trouble finding a sapphire manufacturer.
An executive at another company Apple approached last year said it
couldn't make a profit producing sapphire at the price Apple
wanted.
Apple offered to lend GT $578 million toward building 2,036
furnaces and operating a factory in Mesa, Ariz. Apple would buy and
retrofit the factory for an additional $500 million and lease it to
GT for $100 a year.
GT was intrigued, because the agreement would provide more
consistent revenue than equipment orders. Moreover, GT's business
making equipment for solar cells had fallen on hard times. GT's
2013 revenue was down 66% from two years earlier.
On Oct. 31 of last year, GT and Apple signed an agreement, a few
days after the first 578-pound boule emerged from a GT furnace. The
cylinder was cracked so badly that none of the sapphire was usable,
people familiar with Apple's operations said.
GT said the quality would improve, and Apple was encouraged by
GT's track record of making successively bigger furnaces, the
people said.
GT quickly set out to hire 700 staffers. Hiring moved so quickly
that at one point in late spring, more than 100 recent hires didn't
know who they reported to, a former manager said. Two other former
workers said there was no attendance policy, which led to an
unusual number of sick days.
GT managers in the spring authorized unlimited overtime to fill
furnaces materials to grow sapphire. But GT hadn't built enough
furnaces yet, so many workers had nothing to do, two former
employees said.
"We just kept sweeping the floors over and over," one of the
former employees said. "I just saw money flying out the door."
Producing sapphire proved to be the biggest problem. It took
roughly 30 days and cost about $20,000 to make a single boule. The
people familiar with Apple's operations said more than half the
boules were unusable.
GT stored unusable cylinders in rows in an area of the Mesa
factory that employees labeled the "boule graveyard," people close
to GT's operations said.
Mr. Squiller, the GT operations chief, told the bankruptcy court
that GT lost three months of production to power outages and delays
building the facility.
Apple was responsible for building the facility to GT's
specifications and providing power. Apple told the creditors that
GT failed because of "mismanagement," not power interruptions.
Apple's comments were "purposely misleading, out of context or
inaccurate," GT said in a brief statement for this article. "There
is no point in engaging in a point-by-point debate on each
issue."
Late this April, Apple withheld the final $139 million it was
supposed to advance GT, saying it hadn't met the contract's output
or quality requirements.
GT said in its bankruptcy filing that Apple repeatedly changed
specifications for the sapphire. The filing said GT spent $900
million--more than twice the $439 million Apple provided--to get
the factory up and running.
On June 6, GT Chief Executive Thomas Gutierrez met with two
Apple vice presidents in Cupertino to explain the production
problems, according to Apple's letter to the creditors. He
presented a document titled "What Happened," listing 17 problems,
including improperly stocking the furnaces and creating problems by
inadvertently changing a furnace design.
Mr. Gutierrez said he was there to "fall on his sword," the
Apple letter said. After the meeting, GT decided to stop producing
578-pound boules and make 363-pound cylinders to get the formula
right.
When a boule was suitable, GT used a diamond saw to carve
14-inch thick bricks in the shape of Apple's two new phones: the
iPhone 6 and iPhone 6 Plus. Those bricks would be sliced lengthwise
to make screens.
Manufacturing wasn't the only problem. In August, one of the
former workers said, GT discovered that 500 sapphire bricks were
missing. A few hours later, workers learned that a manager had sent
the bricks to recycling instead of shipping. Had they not been
retrieved, the misfire would have cost GT hundreds of thousands of
dollars.
By that point, it was apparent that sapphire wouldn't be used
for the screens on the new iPhones, which went on sale Sept. 19.
Yet Apple still was eager to get as much sapphire as possible, the
people familiar with its operations said. Apple's letter said it
only received 10% of the sapphire that GT originally promised.
The people close to GT's operations said contractors for Apple
applied quality standards inconsistently, sometimes accepting
bricks that had been rejected a few days earlier.
In the first week of September, GT told Apple that it was having
significant cash-flow problems. It asked Apple to pay the final
$139 million loan installment and asked Apple to pay more for
sapphire deliveries starting in 2015, one of the people familiar
with GT's operations said.
On Oct. 1, Apple offered to give GT $100 million of the $139
million loan installment and delay the repayment schedule, the
people familiar with Apple's operations said. Apple also offered to
raise the price it paid for sapphire this year, to discuss raising
it for 2015 and to relax exclusivity agreements so GT could sell
furnaces to other customers, they said. The companies agreed to
discuss the offer in person Oct. 7 in Cupertino.
Then came the early-morning Oct. 6 call, when GT chief Mr.
Gutierrez told Apple that his company had sought bankruptcy
protection. The people close to GT's operations said executives
hadn't told Apple about the bankruptcy plan because they feared
Apple would try to thwart them.
GT shares collapsed 93% on the news, wiping out roughly $1.4
billion in market value.
Write to Daisuke Wakabayashi at Daisuke.Wakabayashi@wsj.com
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