Applied Materials Israel is a strange bird in Israel's high-tech environment. In contrast to Israeli development centers established by US corporations through mergers and acquisitions, Applied Materials Israel is a business group that brings together all of Applied Materials Inc.'s (Nasdaq:AMAT) process diagnostics and control (PDC) systems.
The group is not a foreign development center that operates according to the classic model of such centers in Israel, which receive dictates and instructions from head office. Applied Materials Israel is an independent group that handles respectable development activity, and is responsible for all aspects of business.
Nor is this development business negligible. The PDC group employs 1,000 people in Israel, not including foreign workers, of whom 600 are R&D staff, assisted by 120 students.
"We're not a development center in Israel, but a business group with a development center," says Applied Materials VP and process diagnostics and control product business group general manager Gilad Almogi. "Almost no foreign company is without some kind of unit in Israel, but among all this activity, only a few companies manage part of their business activities from Israel. In a sense, our model resembles that of an Israeli company, handling all aspects of the business.
"Nonetheless, we're not an Israeli company listed on Nasdaq, but the Israeli division of an American company. We're happy to be part of a leading company with large financial and managerial capabilities, while on the other hand, we're an entity capable of influencing its own fate and quality. In other words, success and failure are in our hands. We're not an entity that might get a fax one day ordering us to fold because India is cheaper. We're a group that is measured by business criteria and will survive so long as it can continue growing."
Applied Materials came to Israel in the early 1990s, after deciding that Israel was a good place to which to move its development activities. It set up a development center at Atidim with 100 employees. An important milestone was reached in 1996 when it paid $285 million to acquire Opal Technologies and Orbot.
Applied Materials acquired the two companies when it decided to enter the metrology and inspection business. Opal Technologies and Orbot, located next to each other, handled different aspects of metrology and inspection. Applied Materials paid $110 million for Orbot, a private inspection systems company. It paid $175 million for Opal Technologies, a public company that developed electron microscopes for spotting defects. Opal Technologies had $30 million in cash at the time of the acquisition, which reduced the actual acquisition price to $145 million.
Five years later, Applied Materials acquired a third company, Oramir Semiconductor Equipment, for $27 million. Oramir developed a device for completely cleaning silicon wafers, by removing remaining contaminants left over from the manufacturing process.
Good times before the great crunch
Over the years, Applied Materials' Israeli connection was not only expressed in its activity, but also by the presence of Israelis in its senior management. In 1980, when Applied Materials was in severe difficulties with only $70 million in sales, three engineers from Bell Laboratories joined the company. The three men were responsible for Applied Materials' rehabilitation and for moving it forward. One of them was Dan Maydan, a former scientist at the Soreq Nuclear Research Center, who served as president of Applied Materials from 1994 until May of last year.
Applied Materials is considered a world leader in semiconductor fabrication solutions. Its current market is $2.83 billion. After three hard years during which sales plummeted, Applied Materials saw better days in 2004: it posted a profit of $1.35 billion on $8 billion in revenue, compared with a loss of $149 million on $4.47 billion in revenue in 2003. Revenue in 2004 was 78% higher than in 2003.
The main reason for the company's recovery is the significant improvement seen in the semiconductor industry this year, according to Semiconductor Industry Association (SIA) figures. Global semiconductor sales are expected to show a rise of 28% in 2004 to $214 billion from $166.4 billion in 2003.
The phenomenal growth in the semiconductor industry is not expected to continue in 2005. Semiconductor sales for the fourth quarter of 2004 are already flat, compared with the third quarter, and the SIA says global semiconductor sales will probably remain unchanged in 2005, compared with 2004. Gartner Group says spending on semiconductor equipment will rise 61% in 2004, but fall 15% in 2005. Gartner Group predicts that all major semiconductor equipment sectors will probably shrink in 2005, except for automated inspection equipment, which will grow by 3% in 2005 and 30% in 2006. Gartner Group says the market is in a slowdown, although the slowdown is expected to be shorter than the previous one in 2001.
Applied Materials jealously guards the results of its business units, including those of the PDC group in Israel. However, Applied Materials president and CEO Mike Splinter declared during the year that the past year was not a bad one for the PDC group. It is estimated the PDC group has annual sales of just under $400 million, and has contributed several billions of dollars to Applied Materials' top line over the years. The press has reported in the past that Applied Materials Israel's expenditures amount to $100 million a year, which means that it is a particularly profitable division.
The diagnostics and control market, in which Applied Materials Israel operates, is estimated at $2 billion a year. The largest company in the sector is KLA Tencor (Nasdaq:KLAC), which has traditionally specialized in this filed. Other competitors are Hitachi (NYSE:HIT; TSE:650) and a number of fairly small companies. KLA Tencor, which employs several hundred people at its Israeli branch, has a current market cap of $9 billion. It posted a profit of $243 million on $1.5 billion revenue for its 2004 fiscal year, ending in June.
"Development is not sterile"
One of Applied Materials Israel's greatest successes is SEMVision, launched in 1998. This machine is based on an electron microscope that quickly reviews defects spotted by the testing machines. SEMVision quickly and automatically identifies and photographs defects at a high resolution so that the source of the defect can be understood. Since its launch, Applied Materials has improved SEMVision, launching next-generation versions. SEMVision G2 FIB was launched last year. Applied Materials added to the original machine an ion beam that makes it possible to drill down through a silicon wafer to the location of a defect. SEMVision G2 FIB combines a SEM system with an FIB system, which analyzes defects in silicon wafers by slicing precisely and comprehensively analyzing the shape and composition of the material.
Another Applied Material machine is ComPlus, which inspects for defects in silicon wafers, using a system of laser dispersal from many different angles and picture processing that improves the picture from the angles. The system is based on Applied Materials' Enlarged Grayfield technology, which combines high output with sensitive inspection level.
"We have very extensive development activities," says Almogi. "Development is the dominant part of the group's activity. It is routinely integrated with production activities and customer relations. It isn’t sterile development. Our development staff has close interaction with production and the field. We're not an abstract entity that develops a machine that is sold to someone else. Development is instilled throughout the enterprise."
"Globes": What is the development staff working on now?
Almogi: "The development staff is currently working on the next generation of process diagnostics and inspection machines. We focus on developing products based on technologies, which are currently active, as well as products in areas where we don’t have activity at present. I'm talking about a range of inspection machines for the entire manufacturing process, which give feedback to the process manager on how to improve the production process and how to respond. Hard-to-spot defects are a tenth of a micron in size, and machines must image processes at very high resolution at very high speed.
"Our team is multidisciplinary. There is no one discipline in our team that much larger than any other. All professions taught in engineering faculties end up here: mechanics, robotics, physics, electronics, and others."
How are all the fields coordinated?
"Most development managers have many years experience, who have a comprehensive perspective. Our engineers are exposed to different professions and can work in multi-disciplinary environments."
"All enterprises miss something"
Does the know-how accumulated here spread to other places in the company?
"Our machines go all over the world. Since we make process inspection equipment and Applied Materials makes manufacturing equipment, there is a great deal of cooperation and movement of know-how, not so much about the insides of the machines, but about the significance of machines. We learn from each other."
Have you had any failures?
"I don’t think there's any enterprise that hasn’t missed something. I don’t think we've had anything exceptional."
Who initiates new developments? You or the company's headquarters?
"As I said, the activity in Israel isn’t a development center, but a group that has all the features of a business. We're responsible for process diagnostics at Applied Materials. We bear the overall responsibility. We're also responsible for increasing our market share and revenue, as well as expanding into new areas. Naturally, Applied Materials' management approves and monitors our activities, but in companies like ours, each group is expected to develop its business. Unlike a development center that gets orders from the company's management, we don’t get orders. We must identify market needs, understand what's important, and decide where to invest the money."
Where are the bulk of your current sales?
"Over the years, there has been a strengthening transfer of production to a range of areas in Asia. In the 1980s, Japan was dominant and Taiwan was the leader in the 1990s, as well as a number of significant players in Korea, China, and several other countries. An increasing proportion of our sales are now in Asia."
Are sales made directly?
"Applied Materials has sales and support units all over the world. There is no semiconductor fab without the support of an Applied Materials sales unit, which handles integration with the customer. The work is very closely coordinated with us, and we're involved in the entire sales process and maintaining contact with the customer. We help airlines make a good living as we maintain close ties with the customers. Part of the company's worldview is that there must be a direct relationship with the customer, to be close to him and understand him."
What are the chances that Applied Materials will make more acquisitions in Israel?
"We believe in our development capabilities in our areas of expertise. We've proven in the past and we'll prove in the future that we can develop products. Applied Materials constantly examines acquisitions and rules nothing out."
You don’t sound enthusiastic about opportunities for growth through acquisitions.
"Nothing in life is easy. People who work in development know that it's not easy, and everyone who works in acquisitions knows that isn’t easy either. We consider each thing on its own merits. I have great faith in our development capabilities."
What are the chances that part of the group's activities will be transferred to cheaper countries?
"It's very fashionable to talk about developments in cheaper countries. Just like the talk a few decades ago was about blue-collar work leaving, the fear now is that white-collar jobs will leave. We're not a development center, but a business group. You don’t wake up one morning and move a business group. As a company, we're constantly operating according to economic considerations, buying things where it's cheap. Therefore, even if in the future some activities are outsourced, that does not mean we're moving our activities overseas.
"In a pure development center that does not handle complete activities, the cost of labor per hour is a consideration. If the cost of labor in Israel is $50 per hour and in India it is $10, there is always a risk that the development center will close. Unlike us, development centers are much more dependent on their foreign companies."
How much do Chief Scientist grants influence decisions?
"In general, for every dollar the Chief Scientist gives, a company investing in Israel adds $8-9. The Chief Scientist's development grants might greatly influence a company's decision where to set up business, but the decision is primarily based on the quality of labor in the country where the company wants to do business. There are few investments by the state that give a return as fast as investments by the Chief Scientist do. Technology investments by the Chief Scientist can bear fruit within four to five yeas. In my opinion, the current level of Chief Scientist investment is insufficient to expand development in Israel."
What do you think other development centers should do become more central to their companies?
"Obviously that is first and foremost a decision by the corporation. But I think that the important thing is to change the attitude that Israelis are great at development but poor at operational management to a situation of confidence that it's possible to manage a complete business in all its aspects."
Did you expand significantly in Israel during 2004?
"In the past year, Applied Materials grew from revenue of just under $5 billion in 2003 to $8 billion in 2004. This was a good year for growth in revenue and profits. Our group had a record year in terms of revenue."
What about manpower?
"We didn’t grow significantly in terms of people. We operate in a cyclical industry, and we strive not to inflate fixed costs and manpower, just as we strive not to lay off people when the industry is declining."
What about 2005?
"The electronics revolution is continuing. There are a lot of drivers in our industry. I think that demand for chips is growing, and will continue to grow in the long term. There will be rises and falls en route, but in the long term, demand for electronic products and chips will only grow."
Published by Globes [online], Israel business news - www.globes.co.il - on January 4, 2005