Signs emerged in March that the retinal imaging specialist Optos (OTCPK:OPOSF) might be approaching a pothole in the road. The 90% drop in profits announced by the company this morning, however, was rather a larger pothole than anyone had foreseen.
The resulting fall in the company’s share price – 16% to a two-and-a-half year low of 134.75p on the London stock exchange – attests to the unexpected nature of this news. Things might not be as dismal as they first appear; outright device sales are strong and the firm’s own accounting practices make its financial situation look worse than it is. But competition is growing and it could take time for confidence in the company to recover.
The six months to March 31st saw Optos score profits of just $700,000, compared with $6.9m in the same period in 2012. This was in spite of a strong sales result in certain areas: for example, the company shifted 400 of its new Daytona imaging devices in the first half, bringing the total installed worldwide to 729.
John Savin, an analyst at Edison Group, points to a quirk in Optos’ accounting to explain the situation. As well as selling its machines to customers, Optos also leases them, for three to five years, and does this in one of two ways: a finance lease, at the end of which the customer will own the system, and an operating lease, which is a straight rental agreement.
Mr. Savin told EP Vantage that Optos had been pushing to move its customers from operating leases to finance leases when the original agreement expires. This makes little difference to the customer, but a big difference to Optos’ accounts. In the case of an operating lease, Optos records each year’s income when it is delivered. With finance leases, though, Optos records all the income due under the contract up front, in one go.
As a large number of operating leases have come up for renewal in the last couple of years, there has been a wave of these transfers – the same amount of money was coming in, but the income was reported earlier. “You’d be effectively reporting three years of sales in one go,” Mr Savin said.
It’s A Trap
The trouble arose from the shrinking base of customers who could be moved from one type of contract to the other. “The challenge they had was, could they sell enough Daytona systems, or find enough new people on finance leases, to make up the gap?” They did not quite do it, he said.
This was due to a number of factors – software glitches slowed the launch of the new Daytona machine, while the continuing poor economic situation in Europe has also militated against sales. Europeans tend to be more reluctant to take on leases than U.S. or Japanese customers, preferring to buy outright, and they were “less willing to go out and buy a $75,000 machine,” Mr Savin said.
The company is not reliant only on Daytona to drive future sales. It has a new product that performs scanning laser ophthalmoscopy, allowing doctors to evaluate the underlying structure of the retina. This device should be ready for launch in September 2014.
The bad news is that Optos is starting to see competition. “A company called Heidelberg Engineering has a product called Spectralis, which can do this laser scanning of the eye already,” Mr Savin noted. Heidelberg is a serious competitor, he said, and has been promoting its system aggressively.
“The fundamentals of Optos are really good,” Mr Savin said. “They’ve got a big installed base, they’re getting sales in the marketplace, they’ve got a good product. They’ve got into a trap because of the accounting standards.”
But Optos has also lowered its full-year guidance, acknowledging that there is more disappointment to come. Recording three years’ worth of revenue can make a business look great – but when that the first year expires, the gloss wears off. Sales growth needs to recover quickly to rebuild confidence.