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Pro Medicus (ASX:PME) 1H FY2020 First Half Results Analysis

2020-02-12T23:32:58+00:00

Over the years, Ethical Equities has written plenty about Pro Medicus (ASX:PME). We received more feedback on that one stock than any other.

Importantly, Ethical Equities is now archived as a website, and exists as a column within A Rich Life, a new periodical covering arts, culture, philosophy and ethical investing.

Happily, if you're interested, you can therefore read coverage of the Pro Medicus (ASX:PME) 1st Half FY 2020 Results on that new website.

- Claude

That Time I Got Lucky, Anatomy Of My Pro Medicus (ASX:PME) Investment

2019-10-08T22:00:57+00:00

An Ethical Equities Supporter has requested I do more case studies of investments I've made in the past, which I think is good for learning, so here is the first one.

The Process

I came across Pro Medicus because I have two beliefs about the long term future.

Software is eating the world
Healthcare is the best defensive industry

So I was looking for companies that were working in software and healthcare.

I also look for:

Insider buying
High Insider ownership
Profit and dividends.

Pro Medicus in 2013

Made $5 million in profit, market cap of <$50 million.

However, on an underlying basis, only made about $1 million in profit.

The big profit was because it sold its part of its Amira business (which it bought in 2009), for a multi-million dollar profit.

It sold the software, but it kept the team of software developers that built the software -- they were now working on software for the visualisation of large radiology files: Visage 7.

https://www.youtube.com/watch?v=idCQOUHv7Q4

Pro Medicus in 2014

In October 2013, PME made its first sale of Visage 7, worth $4 million.

Then, in April 2014 it announced a 6 year deal worth $20 million. This was the inflection point.

In July I bought shares. In August it reported profit of $1.5 million (ie, an improvement on the year before, backing out Amira proceeds). It had a market cap of about $90 m, plus over $20 million in the bank.

If you adjust for the cash, it was trading on EV to Earnings of about 46 times -- so it was definitely not cheap on the past metrics. It announced another deal in November, worth $8m. CEO said gross margins on these deals would be around 80%.

Importantly, both founders were involved in the business, and insiders were buying shares in the business, despite already controlling over 60% of the shares.

The CEO was willing to take time to explain the business to a little-young-nobody like me. My research indicated that both founders sourced some of their energy for life and work activities, from pride and passion. This is important because if majority owners are motivated only by money then they will not share the spoils of success fairly with minority shareholders.

Looking to the numbers; forward gross margins of around $25m had been won in the space of 1 year of launching Visage 7, while the company's entire enterprise value was around $100m.

It was clear if the company kept winning Visage contracts then it was extremely cheap. While I did of course perform a discounted cash flow valuation, the undervaluation this was extremely obvious, given the material gross profit uplift caused by each new contract, and the fact that the company was profitable already. The only it needed to do to be very undervalued, was to keep winning Visage contracts. The key question was whether it would. Given that it was well publicised the entire healthcare industry was moving towards deconstructed picture archiving and communication systems, there was a technological tailwind driving adoption. Thus, further wins seemed likely.

The Journey Since Then

As the company continued to win contracts and grow revenue, the market begun pricing in further wins. Whereas in late 2013 the price arguably reflected announced wins, rather than future wins, by 2019 the price arguably reflects many future wins, including both Visage and the Vendor Neutral Archive product. In this way, the market has become more optimistic and is now willing to pay a higher multiple of (much increased) earnings. You can see in the chart how I've traded the stock over the years. I still hold despite seeing it as too richly valued -- see here for my lament on why.

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Disclosure: The author owns shares in Pro Medicus.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

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Pro Medicus (ASX:PME) FY 2019 Results Analysis: Record Profit Yet Again

2019-08-22T22:05:06+00:00

Pro Medicus (ASX:PME) Posts Record Results In FY 2019

Yesterday radiology imaging company Pro Medicus (ASX:PME) reported revenue of $50.1 million for the full year, along with profit of $19.1 million, an increase of over 91% on last year. When I reported on the half year results, I noted that it would be hard for the company to grow half on half, since last half was such a strong half. I also expressed my hesitancy about the share price. It turns out I was too conservative, as the stock has gained well over 100% in the intervening period, to close above $30.50 on the day of the results.

The business seems to be doing very well indeed. As you can see below, the company grew profits strongly, half-on-half, in the end. Some of that growth coming from existing customers using the image viewer more. Many clients have signed transaction-based contracts, which mean Pro Medicus benefits if they view more images. However, the company also benefited from on-boarding new clients and receiving the first full year contribution from others.

The Australian business, which is primarily a radiology information system (RIS), showed good growth, largely because it now serves two of the biggest radiology companies, in iMed and Healius Ltd (ASX:HLS), along with other customers. The company had to invest for many years to win this dominant position, but it now enjoys natural growth as its clients themselves are growing.

It was the US business that stole the show, with the viewer product (Visage 7) accounting for the vast majority of the revenue. You can see below how revenue from the US is tracking.

Turning to free cash flow, the company did very well indeed, converting 90% of profit to free cash flow, which came in at about $17.1 million. That lead to net cash of just over $32 million. That puts the company on an enterprise value to free cash flow (EV/FCF) ratio of around 175; an eye-wateringly expensive price! The good news, at least, is that as the company continues to grow, free cash flow should remain strong (or even get stronger) relative to net profit, as accounting changes mean that some payments received up-front will be recognised over the period of the contract on a flat line basis. There will of course be some volatility in cash flows related to capital sales.

While there is no doubt that the stock is not cheap, any more, it also seems clear that the company is of very high quality. For example, it still has minimal salespeople but has only ever lost 4 tenders for its Visage 7 product. This year, it did increase staff numbers, but its investments were in R&D and implementation. This expenditure helps delight customers, if not win them. Over time radiologists who have used Visage become advocates for it when they move to an institution that does not have Visage. Therefore, in my view, the best kind of marketing is continual investment in the product. This focus is evidenced by the fact the company has around 40 software engineers out of a total staff of about 75 globally.

Following on from our sociological examination of the Pro Medicus share price, it seems clear the company is getting a lot more attention now, with several questions from analysts indicating that they were relatively new to the stock. In my view, this process of discovery is a large part of why the share price is so high at the moment.

Longer term, it was pleasing to learn more about the twofold potential for artificial intelligence algorithms on the Visage viewer platform. As the company develops AI applications, it can roll out those improvements with the next update. Some technology will be made available to all users.

However, the company is also encouraging other organisations and people to develop their own diagnostic algorithms for radiology, and make those technologies available for radiologists for a price through the Visage 7 platform. Pro Medicus would take a cut. If the company ever achieves this, it will have profoundly improved the business because it would have positioned itself to profit from the capital (monetary and intellectual) of third parties. This path would result in better outcomes for patients (based on past documented experience of the impact of Visage), and also potential savings for radiologist employers. In the US, radiologists are paid a lot, so anything that improves their workflow is very beneficial. For me, a key milestone in the next few years will be when the company first manages to sell a third party product (an algorithm, essentially) over the Visage 7 platform.

On the call, one analyst elicited some interesting insight into the radiology market over in the USA. According to the CEO, requests for tender amongst radiology groups is in “deep freeze” because there has been so much consolidation in that market. When a radiology group is looking to either buy another, or sell itself to another, it is not an attractive time to change move to a deconstructed PACS system with Visage. Once consolidation dies down in this sector, Pro Medicus should see a pick up in the pipeline selling to these kinds of clients. Longer term, consolidation is a tailwind for Pro Medicus, as the company specialises in large radiology and hospital groups. The reason for this is that their product is expensive, and the product is designed to optimise ROI for large groups; and these are the contracts Pro Medicus tenders for.

Valuation

Notably, one of the difficulties for modelling how Pro Medicus might justify its current $3 billion market cap is that at present the company is focussed on the larger, more attractive end of the radiology market. However, they already are making quite a splash in this end of the market, and it’s not clear how much further they can grow before it simply gets harder to continue to increase market share. From memory, they already have 5 of the top 20 hospital groups. I think they can go to 10, or even 15; but would that be enough to justify the current price?

That is not guaranteed.

One bright spot, however, is that the company’s vendor neutral archiving is continuing to appeal. The CEO said that one day he thinks it could be worth 30%-40% of the imaging business, which would be a significant contribution. At present, it seems there is some potential for them to cross sell the VNA product to customers who already use their viewer, and going forward, it seems more likely they will manage to sell some combined offerings. We’ll need to see growth in the VNA business if the company is to fulfil its potential.

I stand by my recent comment that the aggressive buying of Pro Medicus shares at around $33 by passive index funds is frothy-mouthed accumulation. However, I also think those people who have been short selling the company, many of them since much lower prices, are cruising for a continued bruising. Time is their enemy, because even though the valuation is frothy as it comes, the company continues to improve in quality over time.

I have upgraded my valuation on the back of these results. I think the company is now worth at least $1.5 billion (or a share price of around $15) which has me at a much more conservative valuation than most. Having said that, the main argument for it being worth buying at $3 billion is to understand the company through a gorilla game framework.

If Pro Medicus to become the gorilla in its niche it will need to achieve the following:

Maintain its technology advantage through continual improvements to its Visage and VNA technology (Within its control).
Sell other people’s algorithms over its platform to assist with diagnosis in both radiology and other medical sciences (Partly within its control).
Continue to be able to find clientele who are willing to spend money to make money. Pro Medicus provides strong ROI to its clients, but some (for example, public health organisations) cannot make that ROI because internal process mandate they go for the cheapest option, even when it will leave them worse off in the long term. (Not really within its control).

If Pro Medicus does end up dominating algorithmic radiological diagnosis, in the long term, then I suggest that in fact it will be considered to have been cheap at current prices. While I do not necessarily think the risk versus reward is brilliant at current prices, I maintain Pro Medicus as my largest single shareholding, due to this long term potential. Of course, I do not expect a smooth run, and I will take profits as and when I deem appropriate.

Finally, it’s worth noting that the founders have previously said they would sell 3 million shares each but have only sold 1 million each so far, so we may see a further sell-down after these results. It is very positive that the founders remain committed to the business and I believe that the retention of the team at Pro Medicus (at multiple levels, not just top management) is the most important thing for me to track. It’s truly rare to see a group of people doing such good work and the longer that is sustained, the better for everyone.

Disclosure: Claude Walker owns shares in Pro Medicus at the time of publication, and will not sell for at least two days.

Post Script: Claude's subsequent coverage of Promedicus can be found on A Rich Life

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Will Someone Buy Pro Medicus (ASX:PME) At Any Price?

2019-08-01T04:00:25+00:00

Will Someone Buy Pro Medicus (ASX:PME) At Any Price?

I'm on record as saying I think Pro Medicus is my favourite stock on the ASX. But the stellar share price run from around $1 five years ago to $33 today is truly stupendous. When we covered its results less than a year ago, we did not predict it would gain more than 200% in just one year.

We need multiple mental models to understand markets. At this point, I believe it's largely a waste of time to try to use a valuation model to understand the current pricing of Pro Medicus shares. The business is super high quality. It has far more room to grow than most people realise, given its stated aim to move beyond radiology, and into vendor neutral archiving (which it is already doing, profitably). But there can be no doubt that only through a series of long-sighted and optimistic estimates can one calculate significant upside at the current share price.

Obviously, I do not think Pro Medicus shares are a buy at any price. But someone thinks they are a buy at above $33 in July 2019. Let's take a look at why.

A sociological model combined with a supply/demand model.

Pro Medicus has a remarkably tight share register. Over half the shares are held by the founders who cannot currently sell due to their trading rules. Small-cap funds like LHC Capital and Lakehouse Capital have been in the stock for years, but are run by savvy operators who prioritise quality and know how to drip-feed shares and hold for the long term. Both those funds have disclosed selling (some of) their stock, but these aren't the kind to let go of high quality businesses on the cheap.

Furthermore, for a $3 billion company, Pro Medicus has a surprisingly large retail shareholder base. This is partly due to it being a darling of The Motley Fool, Ethical Equities, Three Wise Monkeys and more recently, momentum traders, and partly due to the fact that it had, for many years, a clear, understandable, exciting business plan with strong share price momentum. Retail investors often don't value shares themselves, so overvaluation will not cause them to sell.

While supply is scarce for the aforementioned reasons, the institutional complex has recently arrived on the scene, bringing huge demand for shares. First, we have seen a veritable explosion in broker coverage, from less than three analysts covering it a few years ago, to more than ten today. This has stimulated a lot of buying demand. Second, the company's rising share price has seen it added to first the S&P All Australian 200, and then the S&P ASX 200.

This means that many index funds are mandated to buy shares of Pro Medicus and many more index hugging funds are strongly inclined to buy them. I said to (paid) newsletter subscribers on Friday, "The main reason I am selling [Pro Medicus] slowly is because I think index funds and index huggers are forced buyers and I'm hoping for one last spike before reality hits."

As I write, the share price is up over 7%, largely off the back of the announcement yesterday evening that the company would enter the ASX 200 on August 7.

So, is this the final spike before reality hits?

I think that there are a huge amount of momentum traders in the stock, who are basically taxing the 'dumb money' index funds that are now forced buyers. While I don't know where the short term share price will top, what I do predict is when the hype comes out of this stock, it will come out very quickly. What we are seeing is a transfer of wealth from your best mate's superannuation fund to long term active investors (and momentum traders). The blind faith in "passive investing" will only create more of these kind of opportunities in the future.

Me? Pro Medicus is still my largest shareholding, but I've been selling a lot lately. I first bought the stock at 86 cents and accumulated more at below $1.20, around five years ago. Subsequently, I joined Motley Fool Hidden Gems where I recommended the stock -- and members got in at below $1.60. Finally, I publicly called it my favourite stock at around $3.50, and continued to regularly feature it as a Best Buy Now at Hidden Gems until I left the role last year (It had a share price of below $9.) I'm making hay while the sun shines. I've never sold so many shares as I have in the last few weeks. But when the dust settles, I'll still be holding on to some, because this company is such high quality that I want to hold at least some for the rest of my life (if I can).

While for many years Pro Medicus has been a classic example of growth at a reasonable price, over the last year the share price has veritably exploded in a frothy-mouthed frenzy of fomo accumulation and example of stock market euphoria.

But I'll be holding at least some Pro Medicus shares for what (I imagine) is the virtually inevitable retrace. I'm bracing for it.

Disclosure: Claude Walker hold shares in Pro Medicus. He sold shares earlier today, and intends to continue selling shares -- but not all his shares.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Three Wise Monkeys Podcast: Pro Medicus (ASX:PME), Wisetech Global (ASX:WTC) and How We Use Leverage

2019-03-27T22:04:06+00:00

In Episode 18 of the Three Wise Monkeys Podcast Claude outlines why he's holding on to Pro Medicus Limited (ASX:PME) even at high prices.

Meanwhile, Matt talks Wisetech Global (ASX:WTC) and gives a rundown on the capital raising.

And the primates discuss leverage, recessions and how they think about position sizing.

Listen to episode 18 on Soundcloud here.

Or, if you prefer, subscribe to the feed on iTunes by clicking here.

Please feel free to sign up to the forums and let us know what you think!

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Disclosure: The Author, Claude Walker, owns shares in PME, at the time of publication. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Three Wise Monkeys Podcast: MNF Group (ASX:MNF), Pro Medicus (ASX:PME), Appen (ASX:APX), Nanosonics (ASX:NAN), A2 Milk (ASX:A2M) and Webjet (ASX:WEB)

2019-03-01T02:37:40+00:00

The latest episode of the Three Wise Monkeys Podcast is out now. The pint-size chimps cover MNF Group (ASX:MNF), Pro Medicus (ASX:PME), Appen (ASX:APX), Nanosonics (ASX:NAN), A2 Milk (ASX:A2M) and Webjet (ASX:WEB) in an action packed earnings season episode.

Listen to episode 15 on Soundcloud here.

Or, if you prefer, subscribe to the feed on iTunes by clicking here.

Please feel free to sign up to the forums and let us know what you think!

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Disclosure: The Author, Claude Walker, owns shares in all the above-mentioned companies, at the time of publication. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Pro Medicus (ASX:PME) 1st Half Results: The Rarest Of ASX Gems [H1 2019]

2019-02-21T04:33:49+00:00

Pro Medicus (ASX:PME) H1 2019 Half Year Report: The Rarest Of ASX Gems

Radiology software company Pro Medicus (ASX:PME) today announced its results for the 1st half of FY 2019.

Over the years I have tracked net profit before tax excluding currency impacts. By that measure, Pro Medicus achieved a half year profit of $8.8 million. However, management have invited us to also look through the impact of the new accounting standard AASB 15. This results in an underlying profit of $9.2 million, an increase of 80% on the prior corresponding period.

Usually, I don’t get on board with adjustments that make underlying profit look bigger. However, Pro Medicus has a history of also making adjustments that make underlying profit look smaller - when currency movements have increased profit. When you consider that the adjustment is relatively small (the company has achieved a record result in any event), I am happy to adopt management’s measure of underlying profit. Statutory profit was $9 million.

You can see how underlying profit has progressed in the chart below (note, it is not adjusted for minor restatements).

Importantly, the 80% growth rate versus the prior period benefitted from a $3 million capital sale to a German hospital, while the prior period was notably bereft of a large capital sale. On top of that the CEO said that “The last half was a big half for implementations.” These capital sales make revenue and (to a greater extent) profit rather lumpy at times, and help explain why this half may be hard to match, next half.

However, growth in the US should be smoother as most contracts there are pay-per-view and so the revenue is spread evenly over time. As you can see in the chart below, US revenues were up about 10% half on half, and 38% versus the prior corresponding period. That’s a reasonable result, but not as fantastic as the 80% increase.

Closer to home, the Australian business had another good half, with revenue up on the prior corresponding period but down on the preceding half, presumably due to less implementation revenue.

Looking to cashflow, operating cashflow was flat due in part to a payment of $4.1 million that was received just after period end. The CEO said: "of the $8.6m increase in debtors [receivables], $4.1m relates to a payment we expected before the end of the half which arrived in the first week of January.."

If the company had received that payment during the half, then operating cashflow would have roughly matched profit. We can expect receivables to moderate slightly when measured against revenue, during the second half, according to management’s commentary.

Of course, receivables will continue to grow with the business. Free cash flow was very weak for the reasons mentioned above, coming in at $2.6 million. I expect a rebound in the next half.

Importantly, expenditure on software development increased faster than usual, by more than 10% half on half, to $3.6 million. I have generally been a fan of the slow growth in R&D as sometimes companies go overboard with R&D, which reduces the return on investment received.

However, it is very important that the company allows the software developers to enjoy the fruits of their labour by a) paying them well (which it appears they do) b) making them shareholders (which they already do, via the employee incentive scheme) and c) allowing them growth opportunities (which means expanding the team, carefully). The accounts are consistent with this, as are qualitative factors such as the existence of employee satisfaction as a management KPI for short term incentives.

The company has brought forward a fully franked dividend payment by increasing the interim payment to 6 cents per share. This is only interesting because it suggests management are mindful of shareholders. Let me explain:

This move does not cost the company anything, given it has $24.7 million in the bank. Meanwhile franking credits are worth more to some shareholders now than they will be if the next government reforms tax law to prevent non taxpayers from receiving a refund for franking credits (specifically, these people are mostly elderly people who do not pay tax and expect taxpayers to enrich them further through the rebate of franking credits).

The fact that the company has done something to mitigate this potential shareholder concern, however mundane it may be, reflects well on the board.

The verdict

This was a particularly good half, with underlying profit coming in above my expectations. It may be difficult for the company to beat this result in the second half, or even in the first half next year, particularly because implementation revenues will now be spread over the course of a contract due to the accounting change mentioned above. The effect of this is to make capital sales the main source of revenue lumpiness.

Looking forward

The company has said they have “a positive view of the next 18 to 24 months,” which is just about the extent of what any good company should give by way of guidance. More importantly, the CEO said that “we’ve had the largest number of new RFP’s [requests for proposals] hit our desk in the most recent half”, so the sales pipeline remains strong. Furthermore, the company thinks they can maintain or improve margins. That’s great.

I think that it is reasonably likely that better buying opportunities will emerge, given that this half benefitted from a fairly lumpy capital sale in Germany. You can see in the chart above that the impact of a capital sale actually caused half year profit to decline from the second half of FY 2017 to the first half of FY 2018. Today’s buyers should have their eyes open to the potential that this half’s high water market is not surpassed next half. I don't know if that possibility is priced in, given the share price is up some 60% since we covered the company favourably in August.

But gazing further into the future Pro Medicus remains the rarest of ASX companies. It is majority owned by its founders who still lead the business. It is has a best in class product that is fast becoming the gold standard, worldwide. And most importantly, its management appears to achieve high levels of honesty and competence. It would appear they treat shareholders as partners in the business. Pro Medicus remains my biggest holding by far, and I am pleased with this report.

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The Author of this piece, Claude Walker, owns shares in Pro Medicus and will not trade the stock for at least two days after publication of this article. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Three Wise Monkeys Podcast: Pro Medicus (ASX:PME), A2 Milk (ASX:A2M) and Experience Co. (ASX:EXP)

2018-11-21T21:48:27+00:00

Three Wise Monkeys Podcast, Episode 3: Pro Medicus (ASX:PME), A2 Milk (ASX:A2M) and Experience Co (ASX:EXP)

What we lack up for in technology we make up for in my first hand account of the key takeaways from the Pro Medicus (ASX:PME) AGM. We talk details on the big new contract win, and why it's important. Andrew gets excited about AI, and then we throw a bit of cold water on it.

Meanwhile, Matt gives us his usual well-spoken thoughtful insights on the recent A2 Milk (ASX:A2M) results. Matt has been a long term holder of the stock, picking it up at low prices, but what does he think of it today?

And we also discuss Experience Co (ASX:EXP), in particular touching on why we are a bit wary. Andrew talks EBITDAHIJK.

You can listen to this episode on Soundcloud by clicking here.

Or, if you prefer, subscribe to the feed on iTunes by clicking here.

Claude

Please feel free to sign up to the forums and let us know what you think!

For early access to our content, join the Ethical Equities Newsletter.

Disclosure: The Author, Claude Walker, owns shares in Pro Medicus at the time of publication. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

EDIT

A Matter Of Position Sizing (Disclosure Update)

2018-10-01T21:21:02+00:00

When I covered the full year results of Pro Medicus (ASX:PME), I ended by saying:

“I own shares in this company (my largest single position) and I intend to continue to hold all of them.”

Since then, the share price has moved from about $8.71 to yesterday’s close of $12.41 -- a gain of over 42% in less than two months.

As a result of this, the company now makes up over 34% of my ASX portfolio.

At current prices I would not be buying. As part of my portfolio management, I consider a 30% holding to be too large, but especially so if the stock in question is rather optimistically priced.

Therefore, I now intend to sell some of my Pro Medicus shares -- probably around 10% of my holding. After that, it will still be my largest single shareholding.

Please feel free to sign up to the forums and let me know what you think!

For early access to our content, join the Ethical Equities Newsletter.

The Author of this piece, Claude Walker, owns shares in Pro Medicus. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Pro Medicus (ASX:PME) Keeps Growing: FY 2018 Annual Results

2018-08-15T21:20:31+00:00

Radiology imaging company Pro Medicus (ASX:PME) released its results for the 2018 financial year this morning. These results provide further evidence that this truly is a hidden gem of a company.

The headline revenue growth of 16% to $36 million was in line with the high expectations the market has of this stock. Meanwhile, the statutory profit of just over $12.7 million was assisted by currency tailwinds in the second half. My preferred measure of company profitability is profit adjusted for currency impacts, which was just under $12.6 million in FY 2018. Management continue to demonstrate their integrity by reporting metrics consistently, rather than picking the most favourable metric in any given report.

While the annual underlying profit was strong, I was particularly pleased to see a very strong second half, as you can see below:

Click to enlarge

Of course, long term shareholders take special note of the North American side of the business, since that is where we hope to see fast and sustained sales growth. As you can see below, the second half produced record revenue from the US, and the half on half growth rate rebounded to over 26%.

Click to enlarge

Importantly, shareholders must note that -- across all its divisions -- Pro Medicus receives both implementation and transaction (or licensing) revenue. Implementation revenue is earned as the company installs its systems, whereas the recurring transaction revenue comes over time as the clients uses the product.

In the first half there was less implementation revenue than there was in the second half of 2017, so we saw a slight drop half on half. It's great to see revenue rebound in the second half. That growth has allowed the company to achieve an EBIT (earnings before interest and tax) margin of over 47%. The management team seem proud of this fact and justifiably so.

The loss of key management, board members, and many other long-serving employees remains a key risk to this business. I was therefore pleased to read that the new long term incentive scheme includes a broader base of management and staff. As a reminder, the co-founders of this company -- Sam Hupert (the CEO) and Anthony Hall are both on the board, and control more than 50% of the shares betwixt them. As an aside, Pro Medicus my data (as you can see below) suggests there is low institutional ownership for a company of its size. I believe it is notable that the company's success has made a big difference to many ordinary people who have placed their faith in the team.

Commentary around qualitative business developments was positive in this most recent report. They have not lost any opportunities from their pipeline in the last six months, which is definitely good news. One of the signs that the company retains technology leadership is that it does not lose many contracts. On that subject, the CEO commented that "we believe we still have a 12 to 18 months lead, if not more. It’s not just the technology but also our proven ability to implement in less than a quarter of the time of the industry standard that gives us the edge”.

Therefore, it is also significant that the company can boast that "we are still either on, or ahead of schedule with all our implementations”.

Operating cashflow was flat at $13.9 million, in large part due to an increase in receivables (and a smaller decrease in payables). The large increase in receivables (over $2 million) was because Pro Medicus "pre-agreed to a deferred payment scheme for two clients in order to fit into their budgetary cycles." That is appropriate.

Free cash flow came in at $7.7 million after $6.2 million expenditure on R&D. This cost has grown slowly and sensibly over the years and I am more than willing to back the team that has already created so much value. However, it's well worth noting that expenditure is about $1 million more than depreciation and amortisation, so we'd expect that line item to rise in future periods.

This performance allowed a 50% increase to the (small) dividend. The balance sheet is rock solid with over $25 million in cash.

The Future

There are many indications that the company will continue growing. Some degree of growth is already locked in. For example, the majority of the revenue from the Primary Health (ASX: PRY) contract is expected in FY 2019. Each implementation is different, but there is certainly a lag time between winning a big contract and booking revenues for it. You can see the big contracts that they've announced in the last couple of years, below:

Click to enlarge

The company aims to expand the use case of its core Visage Imaging technology and it has recently made its first sale of its Open Archive product. If the latter follows the pattern of the former, that may open up the possibility of further sales in the next couple of years. That would be a real positive, since the Open Archive product has real potential to make a meaningful contribution to the company.

Looking further into the future the company continues to work with academic institutions to maximise the long term potential of the Visage Imaging platform. This product should be able to incorporate machine learning tools as those technologies develop.

I own shares in this company (my largest single position) and I intend to continue to hold all of them.

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The Author of this piece, Claude Walker, owns shares in Pro Medicus. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.