OPTO CIRCUITS One-offs, forex loss impact results:Edelweiss

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􀂄 Healthy top line growth, but one-offs dent margin
Opto Circuits' (OPTC) Q2FY11 top line was broadly in line, but EBITDA and net profit
came below expectations, primarily owing to jump in SG&A and employee expenses
(owing to integration of its recent acquisitions) besides forex losses of INR 82 mn.


Both invasive and non-invasive segments grew at a healthy pace Y-o-Y (up 62%
and 20%, respectively) though the sequential decline in invasive revenues (-2.6%)
was a tad disappointing. EBITDA margin declined to 31.9% on account of higher
staff costs (up 49% Q-o-Q, 45% Y-o-Y) and SG&A (up 37.7% Q-o-Q, 70.5% Y-o-Y).
Rise in employee costs was on account of integration of recent acquisitions of N.S.
Remedies (India) and Unetixs (US) besides fresh hires at OPTC’s new Malaysia
facility. Jump in SG&A costs was driven by higher promotional expenditure which
the company pegged at ~INR 50 mn. Excluding this expense, we estimate the
EBITDA margin would have been ~33.4%. Tax rate fell sharply to 2.9% from 10%
in Q1FY11, led by scale up in operations in the Vizag SEZ.

􀂄 Proposed acquisition of Cardiac Science
OPTC has announced that it intends to acquire NASDAQ-listed Cardiac Science
(CSCX) for USD 2.3/share and expects to spend a total of ~USD 85 mn on this
acquisition. CSCX had revenues of USD 156.8 mn and net loss of USD 76.9 mn in
2009. It develops, manufactures and markets advanced diagnostic & therapeutic
cardiology devices and systems, which primarily include automated external
defibrillators (AEDs). We believe the acquisition is a strategic fit for OPTC’s noninvasive
product portfolio and do not see funding as a material concern given
OPTC's negligible debt/equity of 0.1. However, CSCX had initiated voluntary field
correction for its key products, AEDs, in November 2009 and post a warning from
the USFDA in Feb 2010 it had to replace ~24k AEDs in the US market. To date,
CSCX has set aside ~USD 32 mn for product recall/update. So far OPTC has not
clarified on its future liability, if any, for this product recall. We await further
disclosures from management on the same and will thereafter revisit our estimates.

􀂄 Outlook and valuations: core business growth on track; maintain ‘BUY’
We believe OPTC’s core business growth remains on track and expect recent
acquisitions to enhance its product portfolio and drive revenue growth. OPTC’s
new manufacturing facility in Malaysia is expected to commence full-fledged
operations Q3FY11 onwards and will facilitate it to serve Asian markets faster,
besides providing tax-exemption for 10 years. We await clarity from the
management on its strategy for its proposed acquisition CSCX, particularly details
on the future product liability (if any) and the expected time to turnaround the
acquisition. Thus our current estimates do not incorporate CSCX. We have
lowered our FY11 and FY12 earnings estimates by 3.5% and 2.1% respectively
owing to higher SG&A costs. We maintain our ‘BUY’ recommendation.