Somnomed Limited (ASX: SOM) yesterday reported a full-year revenue increase of nearly 40%, to $25.9 million on the back of increased sales of its medical devices which are designed to treat the milder forms of sleep apnoea. However, the company also reported a substantial reduction of NPAT to $215,000, due to slightly decreased gross profit margins and increased general administration expenditure.
Recently, the company has just announced that the retail share purchase plan was heavily oversubscribed, and shareholders are already finding their applications were heavily scaled back. While the demand for shares demonstrates that the smart money is holding tight to SomnoMed, the recent capital raising was unfair.
That's because, 270,000 shares are reserved for the chairman and other directors. Given that the shares currently trade at above $1.85, that's a quick $94,500 paper profit for them. On top of that certain privileged institutions were issued 3.7 million shares to bag a quick profit of about $1.3 million – all at the expense of the neglected retail shareholders. I'll be voting against the issue of discounted shares to board members – they ought to have to scramble for discounted shares like the rest of us.
Just 1 million shares at the discounted price of $1.50 were set aside for retail shareholders. As it turns out, about 500 shareholders applied for shares, meaning that on average they would receive 2,000 shares each. The total paper gain for all these retail shareholders was about $350,000.
Back to the results, the gross profit margin fell from 66.3% to 64.9% and general administration costs grew by 58% – from 18.7% of revenue to 21.1% of revenue. Marketing costs grew in line with revenue.
These additional administration expenses were primarily due to "the consolidation and costs involved in the establishment of medical departments, additional sales staff in all regions, new premises in Holland, reporting system upgrades and increased marketing & promotional costs."
On top of that, the company also had administrative expenses relating to the expansion of the European business, "through the acquisition of complimentary or vertically integrated businesses in Germany, Sweden and France, as well as the costs of preparing to enter the markets of Finland, UK, Ireland, Spain and Portugal."
Strategically, the company is concentrating on marketing its products to medical doctors, who actually prescribe treatments for sleep apnoea (as opposed to the dentists, who fit the company's mouth-guards). All things considered, the company is in a strong position to make headway against its main competitors such as ResMed Inc. (CHESS) (ASX: RMD) and Fisher & Paykel Healthcare Corp Ltd (ASX: FPH). These much larger companies offer a more comprehensive treatment for sleep apnoea called Continuous Positive Airway Pressure (CPAP) that requires patients to attach themselves to a machine each night.
Although this is useful in severe cases, I could also imagine it being quite inconvenient in many situations. For example, partners may be disturbed by the machines and it would be somewhat annoying to travel with them. In comparison, the SomnoDent mouth guards are quite portable and can improve patient compliance. That's why doctors may recommend the COAT system over the CPAP system in some circumstances. Even if SomnoMed grows to be 10% of the current size of industry leader ResMed, that will still make it close to a 10-bagger for current shareholders.
The company's continued investment in the business will be welcomed by shareholders, who should be pleased with the news that SomnoMed sold 43,438 units in FY 2014, an increase of over 20% on FY 2013. At this stage in the development of the company, SomnoMed's focus is to continue to grow sales without sacrificing the underlying net profit margin. When all is said and done, economies of scale will improve the business, as will vertical integration.
The company is forecasting better growth for FY 2015, announcing the expectation of 55,000 device sales and revenue of $32.5 million, which would be increases of 26.5% and 25% respectively.
I don't pay much attention to EBITDA because depreciation is a real expense for SomnoMed and the company's figure of $1.05 million apparently excludes other real expenses such as share and option expenses, as well as losses on foreign exchange and disposal of fixed assets. If you would like an even less relevant "earnings" figure, the company helpfully reported $3.3 million in "underlying EBITDA" – a figure that excludes the reinvestment that will remain essential to the company's growth plans for many years to come.
The bottom line is that the company is energetically pursuing its goal of making its continuous open airway therapy a frontline treatment for sleep apnoea. This is an excellent strategy because populations in developed countries are both ageing and increasingly overweight. As a result, the number of patients suffering from disruptive sleep disorders such as sleep apnoea is likely to increase.
