SomnoMed Limited yesterday reported a fully 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 net profit after tax, due in large part to slightly decreased gross profit margins and increased general administration expenditure.

To be more specific, 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 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 systems 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."

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 even more vociferous 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. While the company enthusiastically reports and even forecasts EBITDA, I have to say reading the report I was reminded of Charlie Munger's advice that, "Every time you see the word EBITDA in a presentation, you should replace it with 'bullshit earnings'."

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 more irrelevant "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.

Strategically, the company focussed their sales efforts on medical doctors, who actually prescribe treatments for sleep apnoea (as opposed to the dentists, who fit the company's mouth-guards). The recent capital raising for $7 million will allow the company increase production capacity in line with increasing sales.

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.

The author owns shares in SomnoMed. The purpose of this blog is to document my thoughts on different companies in an easily accessible way and to make connections with likeminded investors. Subscribers to the Free Newsletter get sent research first, and have access to the Hidden Research.


Claude Walker  4 years, 2 months ago Reply
4 years, 2 months ago Reply

I have decided to share my 2 step trading strategy for Somnomed:

Step 1: Buy shares
Step 2: Hold on to shares

I'm still working on step 3

mike  4 years, 1 month ago Reply

Hey Claude,
Do you think management that undertakes 'dodgy EBITDA reporting' is trustworthy?
That would be my main concern.

Mark  4 years, 1 month ago Reply

I actually find SOM disclosure fine. Agree the "underlying EBITDA" isn't real, but I appreciate they they are actually pointing out the effective dollar value they are reinvesting in growth. A disclosure that adds value to understanding IMO.

Re EBITDA like it or not it is a metric that has been used as a reference point longer than I've been alive and will likely be around when I die. Like all financial metrics use it as a starting point. Munger understands that and I'm sure all his financial modelling has the line in there somewhere.

Claude Walker  4 years, 1 month ago Reply
4 years, 1 month ago Reply

I generally mistrust EBITDA as a matter of course, but I would not say it is dodgy. Mark makes a decent point about it being useful as a reference point although I'm not sure Munger uses EBITDA.

If you want an example of highly questionable use of EBITDA accounting look no further than RFL. If SomnoMed starts changing the way the calculate EBIDTA then it is a black mark. Other than that I just think it is less helpful than many people think it is.

Thanks both of you for your comments! :)


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