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THE DAY AHEAD: Chatting with Applied Materials

COMMENTARY -- Applied Materials' outlook for the current quarter shows a few short-term wild cards for the chip sector, but investors may be well advised to think about the big picture.

Chip equipment giant Applied Materials (Nasdaq: AMAT) closed out a whopper of a year and brought in fourth quarter earnings of 77 cents a share on sales of $2.92 billion. Orders of $3.6 billion were in line with expectations.

The outlook, however, may have confirmed a few fears about slowing growth in the chip sector -- at least in the short term. Applied Materials CFO Joe Bronson projected earnings of 75 cents a share to 78 cents a share for the fiscal first quarter on sales of $2.9 billion to $2.95 billion, about flat sequentially. First Call Corp. consensus projected earnings of 80 cents a share for the first quarter.

As for guidance for fiscal 2001, Applied was upfront -- it's too early to tell. Projecting the second quarter of 2001 was also a bit of a stretch. CEO James Morgan said it was "too early to even project the second quarter." But over the next two years or so, Applied Materials expects to post revenue of about $20 billion, double current annual sales.

Morgan and Bronson outlined a few of the short-term wild cards. The biggest is earnings shortfalls from telecommunications companies and a slowdown in telco capital spending. A lot of chips go in those network upgrades, and Applied supplies the gear to make those semiconductors. "Both are clouding the outlook for the second half," said Morgan. In addition, slowing economic growth in the U.S. and abroad clouds the picture.

Simply put, you could see choppy trading in shares of Applied and its main rivals Novellus (Nasdaq: NVLS), Lam Research (Nasdaq: LRCX) and KLA-Tencor (Nasdaq: KLAC). (See product comparison at WitSoundview)

But Applied Materials' long-term picture looks just fine, especially when you consider the chip equipment maker is trading at the low end of its 52-week range (chart). In an interview with ZDII, Morgan outlined the long-term issues:

  • 300mm fabs: The transition to 300mm fabs is expected to spark a boom in equipment sales, but semiconductor companies have a big job ahead to switch. Morgan said the adoption rates will take some time. The transition to 200mm fabs took three to five years to complete. You can expect a similar timeline for 300mm. Morgan said Applied will see a revenue pop from the 300mm transition in the "latter half of 2001."

    "This is a significant transition," said Morgan. "One or two companies will go forward with it and then others will follow."

    Does it make sense for a chip company to go 300mm now? Yes, because semiconductor companies need the latest innovations to keep up, but there will be struggles getting these plants up and running.

  • Memory outlook: Memory prices have fallen, but DRAM makers are investing to boost capacity. In Applied's latest quarter, memory accounted for 20 percent of sales, up about 5 percent sequentially. That bump was fueled by one big order. "We're expecting a shortage in 2001," said Morgan. "Memory makers haven't been investing, and it showed this quarter." Memory has accounted for as much as 40 percent of sales in previous years, he said.

  • Copper: Like the transition to 300mm fabs, copper usage in chips could be a big boost to Applied. Morgan said copper usage is beginning to pick up, but it will take time. Some 200mm fabs are transitioning to copper. Copper, however, won't totally replace the use of aluminum in chips. In five years, the industry may be half copper, said Morgan.

  • The information age chip cycle: Morgan said the best thing about Applied's business in the New World order is the diversification of its business. Games, PCs, wireless phones and other gadgets all need leading edge technology. "All chips even on the consumer level have leading edge technology," said Morgan. "Silicon has gone from 10 to 20 to 25 percent of electronics."

    Can the information age demand for chips smooth out those notorious swings in the semiconductor sector? Morgan said it's possible, but another factor is worldwide capacity spending based on economic, not governmental, factors. "The diversification of applications is smoothing out chip cycles, and economic-based expansion has curbed overcapacity," said Morgan. "We should have more rational ups and downs. I'm excited about the next five years." TDAIN