Applied Materials Profit Drops,
Forecasting an Industry Slump
By DEAN TAKAHASHI
Staff Reporter of THE WALL STREET JOURNAL
July 13, 1998
SAN FRANCISCO -- About 70,000 people will gather here this week for the annual convention of companies that make semiconductor-manufacturing equipment. But nobody feels like celebrating.
The high-tech tool makers are in the midst of their worst downturn in more than a decade, and their second slump since 1996. Equipment makers have shed thousands of employees in the past six months, and further cuts are likely.
On Friday, Applied Materials Inc., the No. 1 equipment maker, provided more evidence of the market's deterioration, predicting profit of 15 cents to 18 cents a diluted share for the third quarter ending July 26, down from earlier guidance of 20 cents to 23 cents. Perhaps more ominous, Applied said it now expects orders of $600 million to $675 million, well below earlier estimates of $850 million to $1 billion.
The Santa Clara, Calif., company, which had already announced plans to trim 1,000 of its 15,000 workers through attrition and a voluntary severance program, said its customers are delaying orders, rescheduling equipment deliveries and reducing spending on manufacturing services. Applied shares closed at $29.50, up 50 cents, in Nasdaq Stock Market trading Friday, and slid after the announcement in after-hours trading to 27, according to Instinet Inc.
Two Slumps Compared
Amid all the bad news, some people are now wondering whether companies that survived the industry's worst slump in the mid-1980s will make it through this one.
"When you're in the bottom of the valley, it's a lot harder to see the peaks," says Asuri Raghavan, chief executive officer of GaSonics International Inc., a San Jose, Calif., equipment maker. "But to me, this downturn is worse than 1985."
It certainly is different. Equipment makers, which produce machines that typically cost more than $1 million for factories that often cost more than $1 billion, closely follow the fortunes of the chip makers that buy their products. In the mid-1980s, both were coping with excess production capacity, partly because of Japan's move into the memory-chip market.
This time, there are far more players, including South Korean companies that produce memory chips and their competitors in Taiwan. Manufacturing capacity is building up in more countries, triggering a glut of chip supplies and plunging memory prices. Asian economic and currency devaluations crises have further hurt demand, while Intel Corp.'s prices for microprocessor chips have been hurt by the rise of low-end personal computers that require cheaper components.
"Food Chain" Consequences
So chip makers have slowed building new factories and buying equipment. Strategic Marketing Associates, a research firm in Santa Cruz, Calif., is predicting about $25 billion in factory cancellations this year. Another firm, Dataquest Inc., predicts semiconductor-equipment revenues will decline 17.3% in 1998, coming on the heels of a 7% decline in 1997.
"It's terrible for the whole food chain right now," says Mihir Parikh, chief executive of equipment maker Asyst Technologies Inc., Fremont, Calif., which cut about 10% of its staff in the past quarter.
James Morgan, Applied Materials' chief executive, says he was surprised by the drop in sales to the Japanese, whom he thought would try to gain market share by spending in advance of the South Koreans. Even the new Taiwanese entrants have begun to pull back on expansion plans, shutting off another avenue for equipment companies to offset declines in other markets, he said.
Papken Der Torossian, chief executive of Silicon Valley Group Inc. in San Jose, says that some Korean chip makers have taken the unusual tack of asking to get machines on credit, financed with no money down. So does Brad Mattson, CEO of Mattson Technology Inc. in Fremont.
"Our customers want us to become bankers, financing millions of dollars in sales," Mr. Mattson says. "We're willing to be flexible to gain some market share now, but we aren't qualified to become bankers."
Sudden Downturn
This bust seemed to come up suddenly. In fact, times were so good a couple of years ago that this week's trade show, known as Semicon West, was expanded to include exhibits in both San Francisco and San Jose. This year, attendance is expected to be down 10%, according to the Semiconductor Equipment and Materials Institute, the trade group that organizes the event.
"We're going to the show, but mostly to show our faces and keep our place in line," says Curt Wozniak, CEO of chip tester Electroglas Inc. in Santa Clara, Calif. "But for a lot of the time we'll just go commiserate with the other vendors about how bad things are."
Memory makers were hurt in 1996 by a major downdraft of sales, but the industry had appeared to be on the mend. In this second quarter, however, earnings warnings have come from equipment leader Applied Materials as well as Electroglas, KLA-Tencor Corp., ASM Lithography NV, FSI International Inc., Kulicke & Soffa Industries Inc. and Integrated Process Equipment Corp. Lam Research Corp., Fremont, Calif., is conducting its second round of layoffs this year; at GaSonics, 8% of the staff was cut and all other workers are taking every other Friday off.
Besides job cuts, equipment makers are curtailing the number of people they send to training sessions at the conference. Watkins-Johnson Co., a veteran equipment maker in Silicon Valley, cut an employee sabbatical program earlier this year.
Bright spots are few and far between. Novellus Inc. expects to announce that, working withInternational Business Machines Corp., it has developed technology for using copper instead of aluminum to connect transistors in ultrafast microprocessors. But that business will take off gradually and won't compensate for the effects of the downturn, says Rick Hill, chief executive of Novellus in San Jose.
Timing Hurts Investments
The timing of the downturn is painful in part because equipment makers have been investing in research necessary for a major retooling of chip factories, estimated to cost the chip industry about $15 billion. Chip makers are slowing plans to shift to larger 12-inch silicon wafers that yield more chips. After spending $25 million to $50 million to develop each piece of equipment to handle the bigger wafers, vendors may not see a return on the investment for eight years.
During the show, eyes are certain to be focused on Intel, which reports its second-quarter earnings Tuesday.
Though analysts still expect Intel to spend about $4 billion on new equipment, the level isn't as big as last year's expansion. Some equipment makers have speculated that the industry giant could shift from its time-honored tactic of using identical equipment in each factory to a more opportunistic approach of bringing in newer models of machines as they are introduced.
But Paolo Gargini, director of technology strategy at Intel, said it hasn't found equipment offering enough of a productivity gain to change what it calls its "copy exactly" tradition. "It is wishful thinking on their part that we are changing our direction," he said.
The industry's overall direction probably won't change much soon. Dataquest sees return to growth of 2.9% in 1999, though it is calling for a 39% jump in 2000. GaSonic's Mr. Raghavan assumes the rebound will come when software advances such as voice recognition take off and demand more memory and faster microprocessors, in turn requiring better equipment. "There are a lot of people out there talking doomsday, but I don't think this is doomsday," he says.
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