Opto Circuits Management Call
The Management certainly came across as transparent and more than willing to discuss each and every point we raised. Judge for yourselves. Wishing a Happy Puja/Dussehra to you all. 1. MRI+multi-parameter monitor and OEM manufacturing deals-just announced a) Some of these off-the-record developments discussed last time, have panned out. Can you tell us more about the deal? What is unique about this deal/product? Opto Circuits has signed a strategic long term agreement with a European manufacturer and distributor of medical equipment. The agreement involves the supply of private label patient monitoring systems by us to the partner integrating Criticare’s modular anesthetic gas delivery products (in their product) for several key markets, both in the United States and Europe. b) This should be a significant driver of revenue growth? What will be the near-term and medium-term impact? What kind of margins can we expect here? Opto Circuits retains the rights for the Indian market. This is a strategic long term deal with the manufacturer. This deal means that we are assured of some bulk quantities and do not have to go through the distribution route ourselves. The margins we will be thinner, but we are spared the higher working capital requirements for the same, which as you know can be considerable with longer credit cycles for distributors. c) Is this a game changer, will it lead to more pure OEM deals? It could be. There are some 3-4 more deals in the pipeline shortly involving Criticare’s modular gas delivery products. 2. This SEZ - OEM manufacture for Manufacturing biggies? a) What makes this work? There must be compelling cost advantages, but why would a big guy outsource manufacturing to a realtively small competitor? Aren't there pure OEM manufacturers in China, Taiwan able to offer better deals? The SEZ project is for manufacturing the full range of products around Opto Circuits technology. The above deal is only incidental. The European manufacturer needed our modular anesthetic gas delivery product for their patient monitoring systems. They saw some of the advantages in getting their entire product manufactured here, and hence the deal. Opto Circuits has the EOU tax exemption extended till 2011 as you know. We have now got land at both Mysore and Hassan SEZs. The SEZs will be used as the manufacturing base for all our technology products. We will also offer co-location space/facilities to all our vendors and major customers just like other manufacturing hubs. b) This is perhaps not a pure OEM manufacture deal? It involves technology transfer (Criticare). We answered that. Yes. c) Do you forsee more deals like this, or pure OEM deals in future Its possible that we get more deals like the one just announced. But we are not in it for pure OEM manufacturing, not at the moment anyway. 3. You have mentioned in the past a $1Bn target by 2015. Going by the developments, you have successfully raised money, things look to be on track. a) What are the top 3 milestones/successes Opto Circuits is looking to achieve in that drive in the next 2-3 years is it -USFDA approval for DIOR/DES Stents (BMS stents are in the process) -large-scale manufacturing for medical equipment biggies -dominating Indian market for Invasives? As we explained before Criticare revenues are set to double. The investments made in Criticare are beginning to show. We have a slew of products coming out. Opto Circuits now has a complete range of products for addressing the full needs of patient monitoring in all environments –ICU, CCU, OT. We are able to address opportunities which we earlier could not because of a limited range –examples are big worldwide tenders from bodies such as the WHO. Opto Circuits is one of the shortlisted vendors. In the coming 2 years the invasive products from EuroCor will be a big driver of growth. Opto Circuits is the first with CE approval for DIOR (drug eluting balloon) and Magical –BMS stent+DIOR (which is a superior technology to the DES stent). Sales are dependent on clinical data from tests, acceptance with doctors, there are major market development efforts/costs involved. More the tests data, the easier to find major acceptance, easier to sell. Competitors on this technology are atleast 2 years away from approval, so we are very hopeful that these may prove to be real disruptive products, as they offer significant benefits over existing technology. b) What's your view on the Indian Invasive market? Do you not want to dominate the home market? The Indian Invasive market for cardiac surgeries is about 80,000 stents a year currently. Last year we did about 12000 stents. We are slowly finding good acceptance along with the big players. Opto Circuits has ties with most major hospitals. There are other initiatives on to tap the tertiary care market directly in non-metro environments. Two such pilots may be pushed through in the next 3-4 months. We have plans to scale this in a big way depending on the response and success of these pilots. 4. US (and European) Market Penetration - will it lead to margin expansions? a) MediAid (~17% sales) margins have suddenly shot up from ~4% in FY08 to over 10%? What are the reasons, and is this sustainable; Sorry. Missed this as the discussion was more free-flowing than stuctured. We will get this answered, soon. b) Criticare (~18% sales) margins are at 18%. Is the integration exercise all over? When can we expect better margins here? >Most of it is over. We have shifted all back-end design and manufacturing to India. There is a core team of about 20 front-end core design team in the US. Some operations are still continuing for specific vendors because of contractual obligations, and will gradually be shifted out. We get a 30% cost advantage directly by just shifting operations. Margins should climb to Opto’s levels of 25-26% pretty soon. c) Eurocor (~13% sales) margins are ~27%; Is it going to get better with more acceptance of DIOR/DEB. Any breakthroughs are expected in the invasive segment? This is likely to get better from here on. As we explained earlier a lot is dependent on our ability to spend on trials, test data, sponsored workshops, getting key doctors on board, and we have limited resources. We are doing what we can. There should be big additions to topline probably within 6-9 months. About higher margins we will have to see what we can command at that point of time, its an evolving scenario. d) What’s your sense on currency risks? Euro running away vs the Dollar scenario. Are you hedging any? Opto Circuits has a natural hedge built-in in its operations. Raw materials import is substantial. As long as the dollar remain in the 40 plus range, we should be okay. As for the Euro, we manufacture the invasive range entirely in Germany (in Euros), and sell in Euros. 5. Equity Dilution - QIP/fresh allotment of warrants to promoters? With the additional 2.14 cr shares issued Equity paid up shares has gone upto 18.29 Cr; that’s another 11-12% equity dilution coming on top of the earlier dilutions. While promoter stake is probably maintained through the fresh allotment of warrants, retail investors are surely looking at much lower EPS growth. b) What's Opto Circuits Management's thinking on this? How do you balance Value Creation vs Equity dilution for common shareholders. What in your opinion is a prudent D/E limit for Opto? This is the first time Opto Circuits has diluted equity to the extent of 11-12%. All previous equity dilutions have been minor. We had to do this to finance our growth. Last year we did the Criticare acquisition for Rs.300 Cr, which was substantially larger compared to all our earlier acquisitions. If you see Criticare has already added Rs. 145 Cr to the top line. We are very sure this is going to double in the next 24 months – there are a slew of products coming out, some of them with unique positioning. You have seen the recent announcement, and some more announcements are just around the corner. c) Why wasn’t raising additional debt a better option, given that D/E can still probably be within 1.5, even if the entire Rs.400 Cr was taken on Raising further debt was certainly possible, and was considered. That kind of money through debt on top of our existing high cost debt, would have meant we would be fully leveraged. We didn’t want to be in a situation where should another suitable opportunity arise, we are unable to tap that. Raising the money through equity dilution at this time means we are fully funded for now, we can retire some of the high cost debt, strengthen the balance sheet, and therefore retain the flexibility to leverage a stronger balance sheet, should the need arise. d) So is there a suitable opportunity Opto Circuits is already eyeing, have you identified something? No. There is nothing on the horizon at the moment. As we said, we like always to keep our options open. d) How much of the debt are you going to repay in FY 10? A substantial portion will be paid off as this is high-cost debt. It will definitely be more than 50%, probably much more. 6. Opto Circuits Rs. 400 cr QIP money raised - utilisation? Would you give us a sense on how this Rs 400 cr is going to be utilized? How are you allocating this capital? Mysore SEZ, paying off debt, Other Capex /Subsidiary Capex, R&D, trials, test data, sponsored workshops, etc. A large portion will be used to retire the high cost debt. And the rest, for all above as mentioned. 7. With the Criticare and EuroCor subsidiaries, staying ahead at the product innovation game is an imperative. Fighting infringement calims/ other under-cutting tactics from biggies may be a reality soon as the USFDA approval for Stents come through. a) Are you looking to take the biggies head on? Or is there a calibrated strategy here? Are you adequately prepared for this? As we said before, this is an evolving scenario. We are going about this in a step-by-step approach. We have limited resources, we are finding innovative ways to marshal these limited resources and extract the maximum we can. We will watch how it goes and develop our strategies flexibly. b) Opto Circuits has only some 20+ strong design team at EuroCor and Criticare; Especially EuroCor is that enough to battle the product innovation game with the biggies? What are the plans on scaling up? News flow out of EuroCor has been pretty muted since DIOR! You see we have to find innovative ways to do things here. Instead of maintaining a bloated in-house teams, Opto Circuits makes extensive use of local universities in Germany. We sponsor studies/projects at the universities, we have tie-ups with the National Laboratory. and other major institutions. Sometimes we have been able to get major studies done at a fraction of the cost that it would have otherwise involved. c) The allocations for R&D must be steadily going up. It stands at 12% of Opto Circuits Revenues today? Is this a sustainable level? or this will taper down? Well there were initial push costs. Requirements down the line would not be as high. These are not standard and may fluctuate from case to case, product to product. We do not have enough data to make a case for what levels they will stabilize on, yet. 8. It is quite evident that Opto Circuits has some sustainable competitive edge. But find it difficult to put a finger on it/translate it effectively for new believers in Opto Circuits. a) What is Opto Circuits doing better than its competitors, including smaller competitors. What are the competitors doing better than Opto Circuits? There are many things that contribute to our success –technology, product quality, flexibility in strategizing, diversifying over different segments. We are probably the only company worldwide to have a major presence in both Invasive and non-Invasive segments. Coming to specifics. Let’s come to product quality first. While you might think Sensors are easy to manufacture, it’s pretty hard to match the stringent quality requirements. As an example if a sensor measurement is 98, it can only have absolute tolerance of 2. It can either be 96 or 100. There are no percentage tolerances, here. There have been instances of Chinese manufacturers trying to enter this market for long but they have never been able to match the required quality. On the other hand Opto Circuits has never had an instance of a single sensor being sent back by our major OEM like Philips over the last 12 years. We go back in the sensor technology to 1982, that’s a full 27 years of design and quality experience backing us. We started on this from scratch, its our complete design, unlike many others who just pick up the design from a design shop. We are exclusive suppliers to two majors Philips and GE. We are rated very high on a scale of 9 on 10 in vendor qualification lists by these OEMS. They take our products ship-to-stock, directly without any requirement of acceptance tests, for a critical market such as the US. There have been instances where a Chinese manufactured product caught fire in the patient hand and people got sued for it. Major distributors will just not take the risk with unproven vendors, even if they do manage to get FDA approvals, say. This has been our bread-and-butter business for many many years. Form over 70% dependence on this segment we have quickly progressed to a situation where we have only a 20-25% contribution today from this segment. We believe we have tremendous headstart over others here, we have full control over design/quality, and we have great pricing ability. Next, if we move from Sensors to Patient Monitors, these products are based on proprietary technology. With the Criticare acquisition we have attained good traction. Criticare is a very respected name in its niche for the last 25 years. We have complete control over the technology, design and ability to innovate new products. We have a networked product line coming up, where a nurse station can control upto 16 patient monitors through a single console networked over wi-fi, where only alarm conditions for each patient (if any) are flashed, with an escalation software process in place. That is going to be a big productivity boost. We have modular monitor products which are plug and play, and can move with the patient as he is moved from CCU to ICU or OT, or anywhere else, it can also plug into a laptop! Imagine this over the normal scenario of moving the whole patient monitoring system from place to place. We have a IP-protected sensor technology coming up, where Patient monitoring systems will only work with Opto sensors and will not work with compatible sensors. We have developed a low cost patient monitor for developing markets like Bangladesh. We have developed the NanoSAT, small and lightweight pulse-oximetry product for mobile/emergency requirements. This is the kind of complete flexibility and control over technology to innovate that we have. The proprietary technology is patented. To put things in perspective while Opto Circuits earlier had 4 patents awarded, the Criticare stable has 28 patents awarded and another 19 filed. It’s not an easy market to penetrate. There are only 5-6 players worldwide here. The Patient Monitors segment accounts for over 40% of sales today. We have talked about the EuroCor promise before. If we have been followers in the other segments, with EuroCor Invasive products, we should have the first-mover advantage, and possibly to disruptive effect. This is again completely proprietary technology which works to our advantage. The Invasive product segment accounts for about 25% of our sales today. Opto Circuits is a much smaller player compared to the market dominating big manufacturers. But we have our place, the market is huge, our products have earned respectability and we have tremendous headroom to grow. Opto Circuits has been consistently bringing in new product lines through careful acquisitions at very reasonable prices and at a fraction of the time and cost it would have otherwise taken. The expanded product line helps us utilize our distribution workforce much more optimally and allows us to address opportunities that were not open before. 9. You have maintained that nothing much can be done about high debtor days. These will remain in the ~170-180 days range for next 2-3 years, atleast till Opto products develop more Brand pull a) Since historically bad loans have been almost negligible, couldn’t some cheap source of financing (based on sundry debtors) be possible to ease working capital requirements No, this is not amenable to cheaper source of financing. Mainly because this is distributor reputation led. We might have a very big distributor in Turkey, but he carries no weight with local banks. And we have a huge number of smaller distributors. We have explored this option and have found that it works out actually to be atleast 200 basis points costlier, and in case if there is something that is carried over for more than 6 months, it gets worse. Yes, you are right in saying that Opto Circuits is in a way financing its products business, but that’s the dynamics of the game right now for us. We factor this in our margins, and we have managed creditably so far. We make very decent margins, we pay our dividends, we have managed our capex from our operating cash flows, and still manage a decent Free Cash flow at 5-6% of sales. You see GE has its own financing arm, they bundle a whole lot of products together with longer credit cycles to handle this aspect of the business and therefore they are able to show better management on this front. Yes if you are a Johnson and Johnson you can command 30 days. You can arm-twist the distributor into accepting a whole bundle of products because he can’t do without 4 to 5 indispensables- if you want this, you got to take this whole lot - works for them. But things have become better since when we last talked. This year our target is to bring it down to 150 days, and eventually to about 120 days. We are able to command cash and carry terms for some of our niche products like the DIOR. The OEM bulk deals will ensure better control than we have over distributors. Some of the other unique products will command better terms. b) Working Capital requirements are at 75% of Sales. Can you share any actions that you may have taken to reduce working capital requirements? You see one of the reasons of burgeoning debtor days has been our acquisitions. Each new acquisition added its product lines and a set of fresh distributors. The larger number of distributors each year added more working capital requirements. We have been able to rationalize some of the distribution force, introduce more direct sales, etc. 10. Final Question – Dividends Are we going to get the dividends by way of ECS this time, as promised? Extremely sorry to have missed this one. How could I? We will get this answered, soon.
|
