Back to the Lab for Photronics

Photronics, Inc. (PLAB) is an original equipment manufacturer (OEM) of photomasks used by the semiconductor manufacturing industry in the fabrication of IC devices and LCD displays. In the April quarter, the top and bottom-line results were slightly worse than expected.

The company has strong technical development capabilities and is experiencing growth in its 130nm and 90nm product lines. In the near term, this growth will not outshine a maturing legacy product and soft markets. Consequently, we rate shares of PLAB a Sell and taking our price target down to $5.00 from $10.00, which corresponds to a 11.4x multiple.

Increasing wafer sizes with shrinking geometries are raising demand for increasingly expensive IC photomasks. The company is expanding advanced technology node production capability with a second 65nm line. The company quickly captured an estimated 16% share of the flat panel photomask market and is expanding capacity with a new LAM plant. Photronics is restructuring operations, controlling costs and increasing operations in low-cost regions like China.

The manufacture of photomasks is increasingly turning to in-house facilities at more mature nodes. Consolidation within the industry continues, as semiconductor manufacturing companies acquire photomask production assets. PLAB is the last major independent merchant supplier.  The capital structure has considerable leverage with a debt-to-equity ratio of 41.7%, which will be lowered after the convertible bonds mature in December. Almost all of the debt is convertible subordinated notes, which if exercised, could potentially be dilutive to equity shareholders.

PLAB shares are trading at a 24.1x multiple of our fiscal 2008 earnings estimate (P/E). It appears that some of the generation 7 spending will be put on hold until 2008. Semiconductor manufacturing foundries have reported strong utilization rates recently. Near-term growth prospects could be limited, as management guided quite conservatively and the company transitions into new plants.

Vital Images' Target Bumped Up

Vital Images, Inc.'s (VTAL) software applies proprietary computer graphics and image processing technologies to a wide variety of data supplied by computed tomography (CT), magnetic resonance (MR), and positron emission tomography (PET) scanners.

After 2008, the distribution partnerships driven by the relationship with Toshiba are expected to resume making strong contributions and the company with the launch of ViTAL Enterprise is expected to win more direct enterprise deals.

The demand for its Vitrea 2/ViTALConnect software continues to increase as demonstrated by the growth in the installed base of customers. Further market penetration and higher sales are expected due to VTAL's initiatives to broaden access to Vitrea among radiologists and cardiologists.