Does ADE Pass the Test?

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One of the benefits of subscribing to one or more of The Motley Fool's newsletters is that, besides the official recommendations, members are presented with other promising stocks that can serve as starting points in the search for investments. In Motley Fool Hidden Gems, several stocks make it onto a Watch List every month. Likewise, Rule Breakers readers are treated to a list of interesting stocks that constitute the "Rule Breakers Universe." It occurred to me that a company that manages to make both lists may be worth examining closely. And one such company is ADE (Nasdaq: ADEX).

ADE is a semiconductor equipment company that manufactures tools used for inspecting and measuring silicon wafers, magnetic data storage devices, and optical mechanisms. One of its new products, called WaferSight, measures the shape, flatness, and thickness of silicon wafers. Using ADE's equipment, manufacturers are able to give their wafers the kind of inspection that would make J. Lo's paparazzi blush. These tools are needed to prevent wafers that are shaped like potato chips (at least on a microscopic scale) because irregularly shaped wafers yield fewer semiconductor chips than flat wafers do. ADE dominates this inspection market and expects strong growth to continue. In what was good news for the company, the Gartner research firm earlier this year forecast that 300-millimeter wafer demand would more than triple by 2010.

While most of ADE's revenue comes from silicon wafer inspection equipment, ADE is expanding its business into computer hard drives and semiconductor devices. Its tools are helping hard-drive manufacturers such as Seagate Technology (NYSE: STX) and Western Digital (NYSE: WDC) fend off the flash memory onslaught by expanding storage capacities with perpendicular recording technology. Another ADE product, the film inspection tool, is used to monitor semiconductor manufacturing processes and is capable of finding minuscule defects after film deposition. Lastly, ADE's NanoXam tool is used during chemical mechanical planarization processing to control copper dishing and erosion. In short, ADE should benefit from the increasing penetration of copper interconnects in dual-core semiconductor chips, as well as from the shift to 65-nanometer line widths.

Like most other semiconductor equipment manufacturers -- Hidden Gems pick FormFactor (Nasdaq: FORM) excluded -- a downturn in capital equipment spending by chip manufacturers has caused ADE's sales this year to dip below last year's levels. So goes life when you do business in a cyclical industry. Nevertheless, the drop appears to be limited to the company's wafer-inspection business. Sales of other products saw healthy increases for the six-month period ending Oct. 31.

Early indications are that the coming year should see improvement. During ADE's second-quarter conference call, management stated that it has seen a strong pickup in quote activity because of a rise in customers' capacity utilizations. With strong growth prospects, perhaps the Hidden Gems crew will someday promote ADE from the Watch List to formal recommendation status.

For related semi-Foolishness:

• First and Second ADE
• A Silicon Surprise
• Screening for Superior Stocks
• Nano Greasing the Skids for Intel

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Fool contributor Dan Bloom has no financial interest in any stock mentioned in this column.