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Chipmaking: "Long-Term Opportunity Is So Vivid Today"

Semiconductor equipment maker Applied Materials (AMAT) is holding up relatively well, despite the industry downturn. Though the company's near-term outlook is still a little rocky, analysts wax positive on long-term prospects. Indeed, the company's stock was recently upgraded by Needham & Co. (from buy to strong buy), Prudential (from accumulate to strong buy), and WF Van Kasper (from buy to strong buy).

But for now, the sales decline for semiconductor products has led to bloated inventories, which means decreasing prices and reduced investments by chipmakers in the new technology that AMAT provides. For the second fiscal quarter ended Apr. 29, the company posted a 13% decline in net sales, to $1.91 billion. Net income (excluding one-time items) of $269 million, or $0.32 per diluted share, was down 41% compared with the same period last year. Not surprisingly, the company's stock has skidded. Though up some 10% for the year, trading around $42.78, AMAT shares are well off the 52-week high of $94.50 set last July.

BusinessWeek Online Correspondent Alan Hughes recently spoke with James Morgan, chairman and CEO of Applied Materials, about the company and the state of the industry. Here are edited excerpts from their conversation:

Q: You've been with AMAT since 1977. Is this the worst downturn you've seen?

A: For us, no. We've been through some tough downturns, but the company has so much more opportunity at this time because of the transitions that have been taking place in the industry and also in the Information Age. In earlier [downturns], there wasn't that sense of long-term opportunity that is [so] vivid today.

If we're trying to provide information to everyone, then one of the keys is how do we connect the next billion people? To do that, you're going to need to develop a set of tools and so forth that will enable customers to provide the chips that will meet all these new applications.

[Also], I think one of the keys that [makes it different now] is that we lead in every submarket, like Korea, Taiwan, China, and Europe. We haven't always been the leader in the submarkets.

Q: What are you doing to get through the downturn and prepare for the upturn?

A: We're in a good, strong strategic position. We worked hard to get our pipeline in place, spending over a billion dollars. We have about $4.5 billion in cash, so we're in good shape. We're working really hard to put a strong e-business piece into our company. During the last downturn, we upgraded all our technology and servers, telecommunications, and PCs. Now we're trying to lay a set of e-business applications on top of that to optimize supply-chain management issues. So that's a big opportunity.

In general, you make sure you conserve your cash and manage your profitability, and get your costs in line. But [you] continue to make investments, particularly to get your products positioned and in R&D, you build your internal processes, develop better infrastructures close to the customer.

Q: Any plans for that cash, such as acquisitions?

A: No. We do acquisitions, but we can meet our $20 billion [2005 revenue target] without doing acquisitions.

Q: When do you think chipmakers will turn the capital expenditures faucet back on?

A: The demand is there. It's a question of when the CEOs are going to spend the money.... Only 10% of the people in the world have cell phones, and only 2% have a computer. And so the [CEOs] see the long-term [demand]. The question is how do they afford it in the short term.... In addition to that, customers are outsourcing more.... We continue to make it cost-effective to make chips more powerful, portable, and affordable. As we do that, it should expand the market.

Q: Now that most chipmakers have made the transition to smaller 0.13 micron semiconductors and to copper and silicon-on-insulator, do they need to buy new equipment?

A: They do. And one of the things we're working on is to move forward with nanotechnology for the next transition.

Q: Last time we spoke, you mentioned AMAT has always come out of downturns with increased market share and a stronger global position. What are your expectations this time?

A: You don't know until the business picks up. But if you look out, this gives us an opportunity to become maybe a $20 billion company in a few years. If you look at 2005, the basic market where we lead, wafer fabrication, is over $50 billion. And for a company that's $8 billion to $10 billion in size, you have plenty of room to grow.

I think we did a good job of restructuring the company in the last downturn and getting our products when that grew in the past few years, we've kind of outgrew our competitors.

Q: Commercials for Applied Materials have been appearing on television. Why did you embark on a global advertising campaign now, especially given that your sales aren't directed toward consumers?

A: We see that there's a huge general interest in where the technology comes from that makes all the other steps possible. Previously [people] just thought about applications, whether it's a phone or a PC or whatever. Then you see the "Intel Inside" or the Cisco networks and people think of...the infrastructure. Now, since they kind of understand that, there seems to be a real increase in interest in [who] makes that possible, i.e. the people that make the equipment that makes chips.

[This campaign] is targeted at raising the confidence of our customers that we're going to be there long term and we've got a global investor base. We've seen this, particularly with the downturn in advertising, as a chance to get our story out.

Q: AMAT has always gotten high marks from analysts for having a top-notch management team. Would that optimism remain should you decide to step down?

A: We have a strong office of the president and we have several product-group heads that know how to run a multibillion [company]. We have a strong, deep management team.

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