News and New Products

Has the Chip Industry Learned Anything?

By Jeff Chappell -- Electronic News, 10/25/2004

Well the first week of the calendar Q3 earnings season is behind us, and while there were few surprises in the wake of an autumn marked by a slew of negative preannouncements, there are a few interesting observations to be gleaned.

First off, the industry definitely seems to be inclined to react faster to market conditions this time around.

Many chipmakers still enjoyed healthy revenue growth last quarter; and some, like Broadcom for example, were downright surprising. And yet, to a company, chipmakers agree we are in the grips of an inventory correction at the very least, and guided down for Q4.

And judging by the pain felt in the process and test equipment realm, they are reacting fast to the inventory problems. In fact, chipmaker Freescale Semiconductor and litho light source supplier Cymer – which easily holds the lion's share of this market – both announced job cuts well ahead of any future red ink.

A close look at one of the major critical subsystems and component suppliers to the capital equipment industry, Advanced Energy Industries, which reported Thursday, shows just how much the chip industry is pulling in its capital growth. As a supplier of such things as mass flow controllers for process gases, AE sells to both chipmakers and equipment vendors.

In Q3 the Fort Collins, Colo.-based company posted revenue of $93.6 million, up 36 percent year over year, but down 14 percent sequentially, producing a net loss of $1.1 million, or 3 cents per share. The company expects the downward trend to continue in Q4, anticipating revenue to drop to between $82.5 million and $85 million, with a loss of 15 cents to 20 cents per share.

In fact, lest you think Freescale and Cymer are isolated incidents, the near-term picture is bleak enough that AE said it plans to cut 200 jobs among its Fort Collins workforce over the next nine months.

It's a perfect example of the whipcord metaphor everyone likes to utilize in describing the semiconductor supply chain. Applied Materials Inc., the world's largest equipment supplier and consequently AE's biggest customer, accounted for 28 percent of AE's Q3 revenue, about $26 million, compared to 31 percent in the prior quarter. That translates to a 22 percent sequential drop in revenue from Applied Materials for AE.

Goldman Sachs Inc. financial analyst Jim Covello, who covers the semi cap equipment market, suggested in a research note that the overall Q3 drop in business at was driven by a falloff in shipment levels at Applied and other major semi OEMs during the quarter as well as a work-down in subcomponent inventories at equipment companies, in turn driven by the weaker than expected shipment outlook.

This is almost certainly the case; as chipmakers grapple with inventory woes and consequently cut back on capital spending and capacity additions, equipment vendors pull in their business with their suppliers and so on up the supply chain. Another equipment subsystems and components supplier reporting last week, MKS Instruments, while remaining healthy and in the black, also saw orders drop and push-outs from process equipment manufacturers, and expects that to continue in Q4.

Keeping an Eye on ATMI

While chipmakers try and react quickly to the inventory glut, it is obviously incumbent upon equipment and materials suppliers to do the same, and be prepared for shifts in the market that are a matter of if, not when.

Of course the industry has heard a lot of marketing chatter from equipment company managements about being more agile and being able to respond more quickly to market conditions. In the wake of the blood bath that was 2001, managements have suggested that they have plans and business models in place to remain profitable in the face of industry cycles, be they supply driven or demand driven.

Essentially, equipment suppliers have pledged not to get caught with their financial pants down once again. Time will certainly tell.

But it would seem that perhaps some have learned their hard lessons along with their customers. Cymer is one case in point; Teradyne, which enjoyed a relatively healthy Q3 given the state of the market, also said that it was making moves to cut operating costs already in light of falling orders.

Along these lines, two companies reported last week that will bear watching in the quarters ahead: ATMI and Mattson Technology. Neither could be considered a bellwether company; ATMI provides specialty process materials, and Mattson is a dry strip and thermal process tool vendor, a relatively small company compared to the likes of Applied Materials, Novellus, etc.

But both ATMI and Mattson are prime examples of the phenomenon that was the 1999-2002 cycle. Both companies rode high and were subsequently hammered during the downturn; at the worst of it, some observers questioned if Mattson could survive as an independent company. Both have made drastic measures, such as divesting or selling off non-core businesses, in order to remain viable and return to profitability, which both companies managed to do, albeit it was a long time in coming.

In Q3 ATMI posted revenues of $64.4 million up 52 percent year over year and 6 percent sequentially. The company's management said that its wafer-start driven business model, built around its materials business, is mitigating its exposure to the semiconductor inventory glut, particularly now that its non-core businesses, such as its smart card venture, no longer figure in the picture. While it expects wafer starts to drop off 7 percent to 10 percent this quarter, it anticipates wafer starts to start growing again in Q1 2005.

"While we, like the rest of the industry, have some exposure to capital equipment push-outs and reductions in wafer starts, those declines for the most part represent trailing edge technologies," Doug Neugold, ATMI President and COO, said in a statement. "In ATMI's case, this is offset by the growth in emerging technology nodes -- 130nm and below -- where we realize more than 30 percent of our business. Our customers are aggressively ramping these processes, a trend we expect to continue."

Cyclically Flexing Mattson

Meanwhile, Mattson reported Q3 net sales of $68 million, up 108 percent year over year and 13 percent sequentially. It posted net income of $10.2 million, or 22 cents per diluted share, once again a gain year over year and sequentially.

These are great numbers, sure but not spectacular. What's notable about Mattson's Q3 earnings report, however, was the fact that its net bookings stood at $74.1 million, up 90 percent year over year and 8 percent sequentially. Granted, Mattson guided equipment orders down 15 percent to 25 percent for the current quarter, but it is nevertheless in rare company; the vast majority of tool vendors large and small saw orders drop off already in Q3.

While part of this obviously comes from market share gains, Mattson also cited its business model. For sometime now, the company's senior management has been touting what it calls a cyclically flexible enterprise model.

The company began discussing this model, under which it aims to remain profitable in terms of an operating income during all points of an industry cycle going forward, back in early 2003, when it sold off its wet clean business to former rival SCP Global. To do that, the company said it plans to concentrate on its core competency, thermal processing and dry strip, and utilize lean manufacturing principles where feasible.

"Our business model continues to result in improving financial performance," CEO David Dutton said in a statement about Mattson's Q3 earnings. "This is our fourth consecutive quarter of increasing profits, and that performance is accompanied by growth in bookings, gross margins and revenue."

Will ATMI manage to see revenue growth rebound so quickly with wafer starts in Q1? Will Mattson be able to stay ahead of the game with its cyclically flexible enterprise model? Will others be prudent enough to manage this inventory correction with a minimum of pain and misery? What will happen if macroeconomic factors turn this supply-driven downturn into a demand-driven one that lasts several quarters?

Again, ultimately time will be the judge. But it will certainly be interesting to watch over the next two weeks as the rest of the industry's earnings reports come in, and see if there are any further layoffs, particularly from chipmakers, and if any other equipment vendors managed to see orders grow in Q3.

Further down the road, into early next year, it will be interesting to see who learned their lessons and managed to stay in the black, at least on an operating income basis, and who wallows in red ink once again within the supply chain.