4Q02 Semiconductor Capital and Equipment Spending Scenarios

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1 Forecast Analysis 4Q02 Semiconductor Capital and Equipment Spending Scenarios Abstract: Economic conditions have softened, and the outlook is uncertain. The demand recovery is stalling. How will it play out? Several scenarios are possible for the industry's recovery. By Klaus-Dieter Rinnen, Jim Hines, Bob Johnson, Takashi Ogawa, Mark Stromberg and Jim Walker Strategic Forecast Statements In 2002, the semiconductor equipment industry is realizing a second year of sharp contraction, most likely 33 percent, based on a guarded spending environment. The quarterly revenue picture shows a near-term slowing in equipment demand, but a slide back in sales revenue could start in the fourth quarter of 2002, extending into the first half of 2003; the first quarter of 2003 will have negative revenue growth, but the second quarter could see a first, renewed strengthening. Given short lead times, turns business is a reality for many equipment segments today, but workforce reductions added to equipment manufacturing capacity reductions this year and last limit vendors' capability to respond to sudden, large orders, which then limits the volume of upside turns business that can be realized in the short term. Our current forecast is for nearly 15 percent growth in 2003, close to our downside forecast from mid-2002; a likely back-end loading of shipments provides a risk factor and will further test companies' stamina. Given improvements in supply-side fundamentals, Gartner Dataquest holds increasing optimism for 2003: Solid improvements in end-user electronics demand should rapidly lead to an increased need for new capacity. Our more optimistic outlook for the annual revenue picture is based on the significant number of shells and only partially completed fab projects, combined with short equipment lead times. Publication Date:November 20, 2002

2 2 4Q02 Semiconductor Capital and Equipment Spending Scenarios Forecast Overview Big Picture Backdrop Continued spending constraints during 2002 (we estimate a nearly 32 percent decline in capital spending in 2002 after a nearly 30 percent decline in 2001) have improved the supply-side fundamentals for the semiconductor industry. This is the good news. But macroeconomic issues remain the overarching issue, impacting end-user demand for electronics. Given a weaker end-user demand outlook and increased risk, Gartner Dataquest has modified its forecast. Here is a brief synopsis of the major changes in our equipment forecast: Annual growth for 2002 has been revised downward, from negative 27 percent to negative 33 percent, for wafer fab equipment. Annual growth for 2002 was revised downward, from negative 18 percent to negative 26 percent, for packaging and assembly equipment. The anticipated growth pause in the sequential quarterly equipment revenue picture has developed into a second downward leg. We had anticipated a second dip in our downside forecast. It is now our most likely scenario with a quarterly contraction in the fourth quarter of 2002 and the first quarter of Our forecast guidance for 2002, issued in September of this year, already alerted clients to this move. Annual growth for 2003 for capital spending has moved to the downside of our midyear forecast; we now anticipate most likely growth of 7 percent. Annual growth for 2003 for wafer fab equipment has moved to the downside of our midyear forecast; we now anticipate most likely growth of 15 percent. Annual growth for 2003 for packaging and assembly equipment has moved to the downside of our midyear forecast; we now anticipate most likely growth of 24 percent. We still anticipate shell-filling activity during 2003, but new fab announcements are likely to be delayed by about six months into Based on these changes, we are pushing out the onset for the next downcycle into 2006 for the most likely scenario. The upside scenario holds to our previous timing for the next downcycle onset in In the macroeconomic picture, the outlook is for some strengthening in 2003, yet uncertainty is high. Downside risk is considerable. After the strong rise in the fourth quarter of 2001 and the first quarter of 2002, the U.S. recovery has succumbed to downside pressures, resulting in slow growth. Hopes have faded for Europe to provide added stimulus to the U.S. recovery pattern in In fact, the situations in Japan and Europe have become more alarming and provide significant downside risk for global economic growth in More government stimulus is needed, but obligations under an agreement to adopt the euro shackle governments'

3 capability to react. The prospect of an Iraqi conflict with its impact on energy prices and local instability adds to the uncertainty for We are still forecasting improvements in the macroeconomic environment to lead to a phased recovery in the electronic equipment food chain in Our concern for all of 2002 has been with the speed of the recovery as well as the speed with which it reaches the manufacturing end of the electronic equipment food chain. While the latter concern is lessening, the former is still very much alive. Consumer spending has been the beacon for the industry, but for how much longer? Corporate spending remains sluggish, while a silver lining is appearing on tomorrow's horizon. Once again, it appears improvements are just another six months out a not unfamiliar story for this downcycle. Corporations in 2002 have been driven by balance sheets, not by income statements. How long can the industry continue on this path before impacting employee productivity? Overall, end-user demand is still slow and below the enthusiastic expectations from the start of the year because PC sales are sluggish in While there is an absence of a driving "killer application" and a catalyst such as Y2K to incite an end-user spending spree, the temporal expanse of depressed spending is creating pent-up demand. Its release will be more at a corporation's discretion, but competitive elements could exert pressure on corporations once the wave starts. With it, we anticipate a continuation of the phased recovery pattern we proposed in the beginning of 2002, albeit at later points than we had anticipated heading into this year. Semiconductor demand and manufacturing have been improving in the quarterly picture in Semiconductor demand looks positive in the annual comparison with In unit terms, we anticipate growth of about 14 percent compared with Given continued average selling price (ASP) pressure in 2002, semiconductor revenue is likely to be up only slightly but still positive. A portion of the improvement can be attributed to the industry shift from an inventory liquidation of historically unprecedented levels to inventory replenishment. However, the quarterly revenue pattern continued to exhibit positive sequential growth for every quarter of this year so far, even after the inventory replenishment had run its course. Clearly, this is a different story compared with last year. Softness is anticipated for the fourth quarter of 2002 and the first quarter of In fact, the "back to school" effect was largely a nonevent, and holiday sales in some world regions in 2002 provided only meager improvement. Companies' unwillingness to hold any inventory was a factor in this. It is not just-in-time business but more like "just the day after" business. With the aforementioned focus on balance sheets, companies are willing to draw inventory below safety levels and replenish it afterward. If demand exceeds conservative expectations, companies could be scrambling for components and potentially lose business. However, the gloomy business sentiment and demand picture encourage such action and argue for subsequent low risk. On the flip side, this argument would encourage a somewhat rosier picture for the first quarter of The first quarter 3

4 4 4Q02 Semiconductor Capital and Equipment Spending Scenarios typically is soft due to inventory overhang from the holiday season, which might not be the case next year. Still, the industry should not expect a pop as in the first quarter of The constellation of events was much more dramatic in 2002; a more-muted underpinning, if our argument holds true, could come to pass in An important factor for semiconductor industry growth in 2003 besides gradual improvements in the end-user demand picture is that fab utilization overall has been improving in Given the prospects of slow device demand in the fourth quarter of 2002 through the first quarter of 2003 and a limited capacity appreciation based on increased quarterly equipment spending levels during 2002, there will be some softening in utilization. However, we judge it to be limited and temporary. We therefore believe that any upturn in demand will map through to a need for new capacity more rapidly than at any stage during this downcycle. Because of strengthening chip demand entering 2002, order momentum for capital equipment was initially positive in the first half but has again turned negative in the second half. The capital spending tally has moved to the downside: After a slew of cutback announcements, it stands at negative 32 percent for Foundry spending has proved most volatile this year, with beginning-of-the-year increases and late-year cuts. While foundry expenditure is expected to decline more than 13 percent, this decline is significantly weaker than the overall market decline of 32 percent. For 2003, news on capital spending paints a dire picture. We judge that current announcements are not a good reflection of final spending for the next year but are very much impacted by the lack of any visibility and a high level of perceived uncertainty for With some improvements in demand, capital spending should actually grow by high single digits. Yes, this reflects some optimism, but improvements in the supply-side fundamentals encourage that optimism. Forecast Scenario Commentary General In this section, Gartner Dataquest introduces its forecast scenarios for both wafer fab and packaging and assembly equipment. Along with the forecasts, we have compiled a list of trends that influence these forecasts. The most likely case is the scenario that has the highest probability to occur. In this scenario, the industry will live through a contracting revenue pattern in the fourth quarter of 2002 through the first quarter of 2003; growth should turn positive again in the second quarter of 2003, opening prospects for double-digit annual growth in All other cases are constructed as variations on the basic assumption set that underlies the most likely case. The best case refers to a scenario in which the current second dip is shorter and less deep. Recovery begins in the first quarter of 2003 and has strength beyond what we assumed in our most likely scenario. On the other hand, the worst case refers to a scenario in which

5 5 the recovery is delayed or which lacks strength, resulting in a slow and extended growth pattern in the near term but an accelerated growth pattern in the intermediate term. For each forecast scenario, we have arrayed a set of assumptions that lead us to forecast independent sequential quarterly growth patterns. It is important to recognize, for example, that the best-case scenario will not necessarily have the best sequential growth rate, and vice versa, the worstcase scenario does not necessarily have the worst growth in any quarter listed. Therefore, sequential quarterly or annual growth rates for the worst-case scenario can exceed those of the best-case scenario. All data refer to equipment revenue. Wafer Fab Equipment Market Changes Compared With Previous Forecast In July 2002, Gartner Dataquest provided its previous version of this forecast (see "Midyear 2002 Semiconductor Manufacturing Market: Review of Fundamentals" [SCEM-WW-FR-0129] and the other Focus Reports that comprise the series). Significant changes to that forecast are as follows: Annual growth for 2002 was revised downward to negative 33 percent for wafer fab equipment. The anticipated growth pause in the sequential quarterly equipment revenue picture has developed into a second downward leg. We had anticipated a second dip in our downside forecast. It is now our most likely scenario with a quarterly contraction in the fourth quarter of 2002 and the first quarter of Our forecast guidance for 2002, issued in September of this year, already alerted clients to this move. Annual growth for 2003 for wafer fab equipment has moved to the downside of our midyear forecast; we now anticipate most likely growth of 15 percent. We still anticipate shell-filling activity during 2003, but new fab announcements are likely to be delayed by about six months into Based on these changes, we are pushing out the onset for the next downcycle into 2006 for the most likely scenario. The upside scenario holds to our previous timing for the next downcycle onset in Industry Trends This section details trends in the wafer fab utilization, silicon consumption and equipment segments. Wafer Fab Utilization Overall trend Worldwide utilization crossed over the 75 percent level in the second quarter (the low was about 59 percent in the third quarter of 2001) and increased to nearly 80 percent by the third quarter of However, we expect it to decline again in the fourth quarter to about 75 percent before beginning a slow increase through the first half of Total utilization should end 2003 at almost 90 percent for all production, setting up demand for additional capacity expansion through 2004.

6 6 4Q02 Semiconductor Capital and Equipment Spending Scenarios Leading-edge utilization At or below 0.18 micron, utilization peaked at 94 percent by midyear 2002 but then is declining as new capacity comes in line and demand for production decreases. Leading-edge utilization should drop to the high 80 percent range in the first quarter of 2003 before resuming its upward trend. By the end of 2003, leadingedge utilization should be firmly at about 95 percent. Capacity changes New fab construction remains slow overall. Our tally of fab closures has increased since January. The new estimate is about 51 permanent fab closures during 2001 and This compares with 35 closures at the start of Fab attrition could bring supply and demand into closer balance this year. In addition, we are seeing slow increases in overall capacity as limited buys are preparing 300- millimeter (mm) fabs for expansion once demand returns. 300-mm picture Most 300-mm fabs have moved from pilot production levels into low-volume manufacturing. Companies are again cautious on 300-mm fab investments, having proven processes and are now waiting for increased demand to drive further expansion. Significant potential new capacity is in existing 300-mm fabs to carry necessary expansions through 2003 and well into 2004 before new greenfield construction is needed. Foundry Following a strong start in the first half of 2002, demand for foundry wafers began to wane in July, causing overall foundry fab utilization to dip to 66 percent in the third quarter from a peak of 70 percent in the second quarter. Continued weak demand is expected in the fourth quarter of 2002, which is likely to bring foundry utilization into the low 50 percent range. Silicon Consumption Recent trends Demand in the second quarter grew ahead of our mostrecent forecast (dated July 2002). In the second quarter, 125-mm and 150-mm demand again showed high quarterly growth, driven by LCD driver, analog and digital bipolar devices. Demand for smaller-size wafers (below 100 mm) weakened during the second quarter. On the other hand, 200-mm demand rose in the quarter, partially driven by the increasing demand from the DRAM sector. With increased fab activities by several chip vendors, 300-mm demand shows steady growth. In the second quarter, it was expected to increase 23 percent to 26 percent over the first quarter. Overall, we estimate that demand has grown sequentially by 26 percent in the second quarter. For the third quarter, we estimate that overall silicon demand declined slightly over the second quarter. This estimate is reinforced by a recent release by Semiconductor Equipment and Materials International (SEMI) of its quarterly silicon wafer shipment statistics. Utilization Utilization has improved into midyear We estimate 8-inch utilization was about 85 percent to 90 percent in the second quarter and declined slightly in the third quarter. Suppliers are increasing output via personnel; however, capital investments (while somewhat elevated over the bottom in the first quarter of 2002) remain slow. Second-quarter equipment order momentum, as judged by SEMI's

7 worldwide equipment statistics, shows returning strength, but followthrough remains to be seen, given the high degree of uncertainty in the market for Forecast evaluation Demand was strengthening ahead of our most likely forecast until the third quarter. We are now forecasting strong growth of more than 20 percent for 2002, which is ahead of chip unit growth. However, since midyear, silicon demand has entered into a stagnation phase, as we suggested in July. The stagnation is in response to a device unit recovery, which is weaker than the industry expected. We forecast a sustainable resumption of growth in silicon demand to start in the second half of Until then, we expect more silicon shipment adjustments. Equipment Bookings Worldwide bookings turned again in July 2002 and are declining. Since the lows of 2001, monthly bookings for wafer fab equipment had appreciated by more than 100 percent until June 2002, returning to levels equivalent to those seen in August and September of 1999 during the most recent upcycle. However, capital spending cuts in the third and fourth quarters so far exert downward pressure on the bookings momentum. Starting as early as July, the industry has witnessed a renewed shrinkage in bookings. The decline should be temporary. Bookings for the third quarter receded by 10 percent to 20 percent and are expected to decline at a slower rate in the fourth quarter. Billings Building on solid gains in shipment revenue in the second quarter of this year, we believe that revenue grew about 5 percent to 10 percent in the third quarter significantly below our more-bullish expectation earlier in the year. Combined with a further softening in the fourth quarter, our latest most likely revenue estimate for 2003 has slipped below our worst-case estimate from midyear. In our midyear forecast, we anticipated a pause in the first half of This pause is occurring earlier and is likely to be deeper. Reported billings represent Staff Accounting Bulletin 101 (SAB 101) revenue, which for U.S.-based companies will typically lag shipment numbers by one to two months. Thus, the impact of a bookings decline in the second half of 2002 will be cushioned through SAB 101 accounting. Focus The equipment focus remains on technology for 130-nanometer (nm) and first 90-nm as well as 300-mm investments. Sentiment Buyers are much less excited than they were at the start of Commitment has softened with renewed push-outs and cancellations. Many projects have been delayed by three to six months. Major equipment growth cannot be expected until semiconductor unit demand is on more solid footing. Lead times are short, encouraging lastminute orders by customers, requiring same-quarter turns and increasing market volatility. However, recent workforce cuts by some major equipment makers decrease vendors' potential to support a turns business. The mismatch between customer needs and expectations and 7

8 8 4Q02 Semiconductor Capital and Equipment Spending Scenarios vendor capabilities could create possible hiccups if demand returns more strongly than anticipated. Forecast Range Tables 1 through 3 provide quarterly and annual revenue, sequential, and year-over-year growth forecast scenarios for the wafer fab equipment market. Table 1 Worldwide Wafer Fab Equipment: Revenue Forecast Scenario (Billions of Dollars) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002) Table 2 Worldwide Wafer Fab Equipment: Sequential Growth Forecast Scenario (Percent) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002)

9 9 Table 3 Worldwide Wafer Fab Equipment: Year-Over-Year Growth Forecast Scenario (Percent) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002) Additional Drivers and Inhibitors The following drivers and inhibitors could affect the wafer fab equipment forecast scenarios: Drivers Chip sales have been positive on a sequential basis for every quarter in For the third quarter, revenue grew about 8 percent sequentially. Overall, revenue is anticipated to eke out slightly positive growth in the annual comparison. Unit demand has accelerated more strongly, likely at 14 percent, because ASPs remain depressed. For 2003, we anticipate chip revenue to grow about 12 percent (for further details, see "Semiconductor Forecast: 4Q02 Update" [SEMC-WW-DA-0063]). If demand builds ahead of our projections, the industry's need for more capacity could arise earlier, leading to accelerated spending. Leading-edge utilization is high, albeit receding from the highs earlier in the year. With more leading-edge designs being implemented, utilization could rapidly appreciate, sponsoring a need for more equipment. Longer lead times for the latest technologies, especially for steppers, could be an issue as demand grows. Recent workforce cutbacks at major equipment vendors could result in a delay in their response time to any abrupt changes in the demand picture. This could trigger double-ordering, artificially increasing demand. Given reduced capacity at vendors and any abrupt change in equipment demand, the industry might face equipment shortages that would bring increased equipment price stability and appreciation to the market. Inhibitors ThetalkaboutadoubledipinthequarterlyGDPgrowthpatternhas not subsided. Final sales are slow, and political uncertainties impose

10 10 4Q02 Semiconductor Capital and Equipment Spending Scenarios significant risk to growth. The question is whether the industry will experience more of a normal seasonal pattern in the second half of The jury is still out. Component buying certainly has not been stellar. But the big question is how strong end-user sales will and can be. With a focus on balance sheets, nobody wants to hold inventories. With industry overcapacity and short lead times, sales are turning increasingly into real-time business transactions, with little warning to suppliers. This has increased market volatility and yet decreases the industry's visibility of demand. We expect this situation to continue into 2003, severely impairing any visibility to end-user demand and renewed capacity needs. Corporate spending remains slow. Corporate buyers do plan to increase spending in the next six months, as Gartner Dataquest's third-quarter survey shows, but will it materialize? We had hoped for somewhat of a return as early as the fourth quarter of 2002, but such a return is likely muted, if at all visible. Concern about the timing of a revival of corporate spending and its strength creates continuing high uncertainty. As mentioned, there is no catalyst for spending, and profitability is a "must" before any meaningful upward movement will occur. A weaker-than-anticipated demand climate could add to previous issues, again causing corporate spenders to remain "on the sidelines" longer or to move more slowly than anticipated. Foundry spending remains volatile. We had cautioned in our earlier forecast that if conditions in the second half of 2002 were not as we expected, foundry spending could again become volatile. It did. We anticipate further volatility in the first half of Lengthening lead times and SAB 101 issues could dampen the current slide back in shipments and might obscure its severity. However, on the restart, SAB 101 might prolong the time between booking and official revenue recognition, leading to a later and more protracted ramp. Packaging and Assembly Equipment Forecast Assumptions Changes Compared With Previous Forecast As noted earlier, Gartner Dataquest published its previous version of this forecast in July 2002, with renewed guidance in September. Significant changes to that forecast are as follows: We have lowered our most likely annual forecast from negative 18 percent to negative 26 percent. While the sequential order pattern has consistently improved over the last few quarters, this momentum stalled in the July time frame. We now anticipate that back-end equipment revenue for the fourth quarter of 2002 will be sequentially negative over the third quarter.

11 Factory utilization rates are reaching break-even run rates, with integrated device manufacturers (IDMs) now at 70 percent to 75 percent. For semiconductor assembly and test services (SATS) companies, rates are at 65 percent to 70 percent and will remain in this range for the fourth quarter. Some major orders are still being announced. However, these orders are predominantly for advanced packages. Kulicke and Soffa recently received a major order from Advanced Semiconductor Engineering (ASE) for 350 Maxum Ball Bonders for use in ASE's high-lead-count ball grid array (BGA) lines. Fourth-quarter SATS revenue is expected to be negative on a sequential basis over the third quarter. Demand is shifting to the latest advanced package types more strongly than originally anticipated. Therefore, the majority of new designs are for array packaging. Flip-chip technology is also enjoying increasing demand. Various quad flat no leads (QFN) packages are also becoming more prevalent, as the telecommunications market continues to shift out of small outline IC (SOIC) into these new, smaller packages. All the major SATS companies are offering QFN-type products (chip scale packages [CSPs]). Demand for power management and discrete devices remains comparatively strong. The buying focus remains on technology, specifically for flip chip, CSP and system-in-a-package (SIP). Industry Trends This section details trends in the packaging and assembly utilization, substrate consumption, and equipment segments. Packaging and Assembly Utilization Overall trend Factory utilization rates are reaching break-even run rates, with IDMs now at 70 percent to 75 percent. For SATS companies, rates are at 65 percent to 70 percent and will remain in this range for the fourth quarter. Leading-edge utilization Some SATS companies are reporting tight capacity in fine-pitch wire bonding and flip chip. This appears to be customer-specific, however. The overall flip-chip segment still has some capacity, but it will continue to tighten as the first half of 2003 begins. For CSPs, especially those that are lead-frame-based, capacity is tight, and we anticipate this segment to drive investments in fine-pitch wire bonders along with the BGA. The capital investments that are occurring are concentrated in the leading-edge side of the business. Capacity changes Lead-frame-based, more-mature packages remain in excess. Leading-edge capacity is tight and is the major focus of investments. Negotiations continue for industry consolidation and joint ventures, especially with Japanese IDM divestitures to SATS companies as Japan struggles to adopt the outsourcing model. 11

12 12 4Q02 Semiconductor Capital and Equipment Spending Scenarios Substrate Consumption Recent trends Demand is stable, but price erosion has continued, with prices dropping by 10 percent or more in the third quarter at some SATS companies. Some laminate-based package prices are now becoming competitive with lead frames. Utilization Substrate suppliers have seen increased orders, which is consistent with the continued migration to array packaging. Forecast evaluation There will be a rapid transition to laminate-based substrates as the recovery gains momentum. Equipment Bookings Significant orders for advanced, fine-pitch and low-loop wire bonders by major SATS packaging subcontractors occurred throughout the first three quarters of This drove the back-end North American book-to-bill ratio, as defined by SEMI, above parity between February and July. However, the ratio fell below parity in August and September. Billings Billings have continued to grow, but they are likely to pause and dip into the negative realm during the fourth quarter. Focus The focus is on chip-scale, wafer-level, flip-chip and 3-D packaging capacity. Sentiment Buyers are much less excited than they were midyear. Selective spending is occurring, especially in the advanced packaging area. Major equipment growth cannot be expected until semiconductor unit demand is on more solid footing. To put it simply, the macroeconomic environment must improve. Forecast Range Tables 4 through 6 provide quarterly and annual revenue, sequential, and year-over-year growth forecast scenarios for the packaging and assembly equipment market.

13 Table 4 Worldwide Packaging and Assembly Equipment: Revenue Forecast Scenario (Billions of Dollars) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002) Table 5 Worldwide Packaging and Assembly Equipment: Sequential Growth Forecast Scenario (Percent) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002)

14 14 4Q02 Semiconductor Capital and Equipment Spending Scenarios Table 6 Worldwide Packaging and Assembly Equipment: Year-Over-Year Growth Forecast Scenario (Percent) 1Q02 2Q02 3Q02 4Q Best Case Most Likely Case Worst Case Q03 2Q03 3Q03 4Q Best Case Most Likely Case Worst Case Q04 2Q04 3Q04 4Q Best Case Most Likely Case Worst Case Source: Gartner Dataquest (November 2002) Additional Drivers and Inhibitors The following drivers and inhibitors could affect the packaging and assembly forecast scenarios: Drivers Capacity utilization rates will increase from just below 50 percent entering 2002 and exceed 80 percent by year-end New designs utilizing flip-chip technology and SIP will continue to be adopted faster in the fourth quarter of Dual in-line memory modules (DIMMs) will begin to make a transition to 3-D stacking and SIP. Inhibitors The availability of lead-free components, especially from U.S. suppliers, could slow growth if demand increases for environmentally friendly electronic equipment. Package design software could limit the demand for increasing thermal and electrical requirements of new silicon/package combinations. A slower transition and growth of laminate-based array packages could result if new designs continue to use traditional lead-framebased packages. Severe economic uncertainty forces consumers to pull in the reins, killing macroeconomic demand.

15 Gartner Dataquest Perspective After getting on its recovery path in 2002, the U.S. economic recovery has been disappointing in speed and strength. Adding the threat of war and weakness in other global economies, the economic outlook has a high degree of uncertainty and risk. Markets can take risk it can be priced in but they cannot take uncertainty. Consequently, economic uncertainty sponsors a deep pessimism running through the industry and the stock markets. Today's environment is a "show me" environment, as Cisco called it in the vendor's latest earnings call. Uncertainty discourages any risk taking. Who could blame anybody for a highly conservative stance, given the disappointments the industry has endured this year and the poor visibility projected for next year? This explains why Wall Street and industry forecasts for 2003 capital spending are mostly negative. This view is also captured in our downside scenario. As mentioned, however, we see some silver lining that promotes guarded optimism for Gartner Dataquest has reduced its outlook for next year. Our outlook for end-user demand is tempered by conservatism as well. On devices, we have reduced revenue growth expectations from 22 percent to 12 percent. But our wafer fab equipment forecast is more bullish, noting 15 percent annual growth in Our outlook on the supply fundamentals is what instills some optimism in our forecast. On the supply side, the capacity situation has been coming under control; leading-edge capacity is tight as companies watch spending closely. Our estimates show that the semiconductor industry will enter 2003 significantly underinvested. In addition, ample unfinished projects are available. In fact, we estimate that as much as 200 millions of square inches (MSI) (quarterly capacity) of "nonequiped" fab capacity exists, which will allow rapid moves on equipment once demand picks up. So, when we combine all these factors, we believe there will be motivation and location to put new equipment in Gartner Dataquest Recommendations Our recommendations are largely unchanged from July Equipment vendors have already seen significant acceleration in order momentum. Still, companies must prepare for a rather sudden lull. Although we do not necessarily forecast a steep contraction, it will be important to identify true demand and not be lured by wishful thinking. The several transitions ahead could be swift and turbulent, but 2003 will see the first market expansion since The range of operational flexibility remains large, however, and vendors need to be ready to react appropriately in case the market volatility continues longer than expected. Gartner Dataquest recommends the following: Equipment vendors must be prepared to endure a second downleg in the quarterly revenue picture. 15

16 16 4Q02 Semiconductor Capital and Equipment Spending Scenarios This document has been published to the following Marketplace codes: SEMC-WW-DP-0212 As for equipment, given short lead times, turns business is a reality for many equipment segments today. This adds to the lack of visibility of the semiconductor equipment customers and makes for a rather choppy and unpredictable order pattern. We advise vendors to be prepared for sudden order movements, with both positive and negative impacts on quarterly sales. With demand returning, positive posturing for new orders and some first tentative steps by customers, suppliers face a dilemma about how to prepare for what could come and how to avoid excess inventories or increasing lead times. Careful inventory management is important. Vendors should not plan for high levels of capacity technology purchases but should instead focus on longer-lead-time items and technologies. This strategy offers less risk and a better chance for sales. A high degree of manufacturing efficiency and flexibility will be required in the next few quarters, on both the upside and the downside. Cautious planning is advisable. Demand assessment is difficult because of the fluid climate in the industry. We advise vendors to carefully evaluate factors that advance purchases of their tools. New tool introductions or price increases can impact near-term demand, either slowing or accelerating it. Companies need to plan carefully and distinguish between true demand and artificially inflated demand. Assessing competitive positions should not be based on market share results but on new account wins. SAB 101 revenue can be misleading. For equipment customers, this is the best time to buy equipment because lead times are short, and purchasing terms and support are best. Key Issue How will market conditions affect semiconductor manufacturing, procurement and cost models? For More Information... In North America and Latin America: In Europe, the Middle East and Africa: In Asia/Pacific: In Japan: Worldwide via gartner.com: Entire contents 2002 Gartner, Inc. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice