Bright Spots Amid the Chip Equipment Gloom

But the mood was grim at Semicon West, the semiconductor equipment industry's confab in San Francisco Monday and Tuesday. Last Friday, chip equipment vendor Applied Materials (AMAT) warned that its earnings for the current quarter will come in several pennies below the Street's estimates. And other equipment vendors have reported similar weakness in the wake of a general slowdown in chip sales, especially in Asia.

And if the chipmakers aren't selling much these days, Applied and its peers, which control the very chemistry of the chip-making business, aren't going to make much until things recover.

Many analysts see that as just part of a long slump that won't start be reversed till the fourth quarter of this year at the earliest. And so the sense of woe in the equipment sector is pervasive. Visitors to Semicon West describe the mood as a general malaise, with old-timers counseling younger executives to hold on for the inevitable sector return.

One industry observer claims the problem is not so much Asia/Pac worries, but rather the tremendous pricing pressure in PCs that has put the squeeze both on chip firms and on the equipment companies from whom they buy. "With the pricing pressure, there's a big focus on depressed margins," he says. "People are selling chips cheaper, but it's not improving overall demand."

Amid the general gloom at the show, one visitor found reason for hope. According to Ron Leckie, analyst with equipment research firm Infrastructure, if the chipmakers are not beefing up their chip foundries at home and in Asia, they are nonetheless investing in methods to keep generating cutting-edge products with their existing fabs. That's the only way, in fact, the chip companies can move forward at a time of tightened budgets.

Leckie says Etec Systems (ETEC), which sells machines that help Intel and others make the masks they use to conduct photolithography -- a chip-making process -- should see good sales of new mask-making equipment despite the downturn.

That's because semiconductor firms need to create chips with smaller feature sizes. "Basically, a lot of the oversupply in chips has been for large chips, at .5 micron and above," and so vendors need Etec's equipment to build out chips with line widths of .3 and below, says Leckie. And Leckie says privately held Tronix of Phoenix, Ariz., is also important in the mask sector.

Equipment that helps chipmakers move from 200 millimeter wafers to 300 millimeter wafers, will also be important, as it will allow them to achieve smaller feature sizes on their chips. "People say the Japanese are holding off on spending, but many believe that behind the scenes they're working on moving to 300 millimeter," says Leckie.

Another important area is speeding up productivity, says Leckie, and here Etec's new products will be important, along with wares from PRI Automation (PRIA) and Mattson Technology (MTSN). And Leckie says tools that let engineers determine how many usable chips they will get from a wafer -- called the "yield" -- will be very important in a time when firms are trying to maximize resources. Look to KLA-Tencor (KLAC) and privately held IDS Software of Foster City, Calif., to provide yield detection products.

Does the importance of these vendors' wares mean they have a shot at recovering sooner than others in the equipment sector? Leckie agrees with the popular contention that chip equipment stocks generally won't see real strength in earnings until the middle of next year. However, he thinks companies providing electronic test equipment could well bounce back sooner, given that their equipment is generally needed before production resumes in general.

Companies in this segment, such as Kulicke & Soffa Industries (KLIC) and Teradyne (TER), could show some signs of improvement as early as four to six weeks from now, he says. On Tuesday, Teradyne reported second-quarter revenue of $406 million, up from $289 million last year, and 46 cents in earnings per share, in line with the Street's expectations.