SomnoMed (SOM) | BUY: RSS network shaping up nicely 28.08.2017

Date

28 August 2017

Theme

Financial Results

Company

SomnoMed (SOM)

Recommendation	BUY
12-mth target price (AUD)	$4.27
Share price @ 25-Aug-17 (AUD)	$3.55
Forecast 12-mth capital return	20.4%
Forecast 12-mth dividend yield	0.0%
12-mth total shareholder return	20.4%
Market cap	$205m
Enterprise value	$194m
Shares on issue	58m
Sold short	0.0%
ASX 300 weight	n/a
Median turnover/day	$0.0m

BUY: RSS network shaping up nicely

We maintain our BUY rating with a revised price target of $4.27 per share. SomnoMed remains on the Wilsons Conviction list following its FY17 results. The release provided some early evidence that RSS clinics are breaking even within six months, with good volume and revenue signals. We are excited about the prospects for this clinic network to increase US market penetration for oral appliance therapy and drive earnings. The core medical device business had another solid year, notwithstanding some challenges in the US. Europe was strong and will remain so, with positive French reimbursement policy a key driver over the next three years. As good as SomnoMed's Core business is, we forecast that the RSS network can overtake it by FY20 as the dominant source of EBITDA. Key points FY17 result snapshot. SomnoMed grew group sales by 12% to $49.3m. Underlying EBITDA in its Core business was in line at $6.5m; while the new RSS network lost $4.1m, reflecting start-up investments (result in line with guidance). Reported EBITDA loss of $1.7m was higher than our $1.5m forecast. Guidance and model changes. SomnoMed is guiding $75-80m revenue and approximately $5m EBITDA in FY18 ($6.5m for Core and a $1.5m loss for RSS). Our revised estimate sits in line for Core but lags the RSS guidance at this stage, given the business is very early stage and its track record is just developing. Our FY18e EBITDA forecast is $3.9m. Our NPAT reductions are modest in absolute dollars: a $1.5m net impact for FY18e and $0.7m in FY19e. RSS shaping up nicely and accelerating. The first RSS centres are demonstrating clinic-level breakeven at five months post-opening, with volume and revenue attributes similar to the S3 centres in Texas, on which the business model was based. Management observes a small lag in revenue recognition (resolving reimbursement issues and diagnostic requirements) which should recede as the network develops both scale and experience. As a reminder, RSS centres are expected to develop $1m in EBITDA per centre over their first 2-3 years and SomnoMed plans to have 19 open by the end of FY18. We are forecasting that RSS will surpass Core in EBITDA generation by FY20. Valuation. We value SomnoMed using separate DCF models for Core and RSS. Standalone valuation for Core is $3.50 per share; while our risked valuation for SomnoMed's 84% share of RSS is $1.27 per share. As RSS proves itself, we assess upside here to $3.00 or more developing over the next 3-5 years as the market begins to extrapolate from early RSS performance. Risks and catalysts Important risks and catalysts are listed on p.5 of this report.

Shane Storey, PhD MBA [e-mail] Tel. [phone]

12-mth price performance ($)

4. 50

4. 10

3. 70

3. 30

2. 90

2. 50

Aug-16 Dec-16 Apr-17 Aug-17

SOM	XSI Rebased
1-mth	6-mth	12-mth
Abs return (%)	9.2	9.7	2.0
Rel return (%)	9.0	6.1	5.8

Earnings forecasts
Year-end June (AUD)	FY16A	FY17A	FY18F	FY19F	FY20F
NPAT rep ($m)	0.2	-3.3	2.1	10.7	14.8
NPAT norm ($m)	0.2	-2.4	2.1	10.7	14.8
Consensus NPAT ($m)	4.5	11.9	15.4
EPS norm (cps)	0.3	-4.4	3.6	18.5	25.6
EPS growth (%)	-73.3	-1476.9	181.9	412.8	38.6
P/E norm (x)	1108.6	-80.5	98.4	19.2	13.8
EV/EBITDA (x)	131.4	-114.2	49.9	10.7	7.7
FCF yield (%)	0.1	-2.5	-1.2	2.5	4.9
DPS (cps)	0.0	0.0	0.0	0.0	0.0
Dividend yield (%)	0.0	0.0	0.0	0.0	0.0
Franking (%)	0	0	0	0	0
Source: Company data, Wilsons estimates, S&P Capital IQ

Key changes
10-May	After	Var %
NPAT:	FY18F	3.6	2.1	-43.1%
norm	FY19F	11.4	10.7	-6.4%
($m)	FY20F	14.8
EPS:	FY18F	6.3	3.6	-42.6%
norm	FY19F	19.9	18.5	-7.1%
(cps)	FY20F	25.6
DPS:	FY18F	0.0	0.0	0.0%
(cps)	FY19F	0.0	0.0	0.0%
FY20F	0.0
Price target:	4.50	4.27	-5.0%
Rating:	BUY	BUY

Wilsons Equity Research

Issued by Wilsons Advisory and Stockbroking Limited ABN 68 010 529 665 - Australian Financial Services Licence No 238375, a participant of ASX Group and should be read in conjunction with the disclosures and disclaimer in this report. Important disclosures regarding companies that are subject of this report and an explanation of recommendations can be found at the end of this document.

Price target
Valuation	Price target
DCF methodology
WACC (%)	11.4
Terminal growth assumption (%)	3.3
PV of forecast FCFs ($m)	53.1
PV of terminal value ($m)	183.5
Enterprise value ($m)	236.5
Net debt (cash) ($m)	-14.2
Equity value ($m)	250.7
DCF valuation (A$/sh)	4.27
Price target (A$/sh)	4.27

Key assumptions
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17A	FY18F	FY19F	FY20F
Revenue growth (%)	21.3	40.1	33.0	28.0	11.9	53.3	48.2	32.6
EBIT growth (%)	-39.1	35.0	-45.7	90.2	-747.2	-172.8	633.5	41.1
NPAT growth (%)	-9.0	-9.2	-4.8	-72.4	-1,534.2	-186.9	421.0	38.6
EPS growth (%)	-2.5	75.4	-55.3	-73.3	-1,476.9	-181.9	412.8	38.6
EBIT/sales (%)	1.8	1.7	0.7	1.0	-5.9	2.8	14.0	14.9
Tax rate (%)	-93.3	3.4	44.8	85.0	-14.3	27.0	27.0	27.0
ROA (%)	2.0	2.3	0.9	1.1	-7.0	4.3	24.1	28.5
ROE (%)	6.3	5.1	2.8	0.5	-7.3	5.4	21.1	24.2
SomnoMed EBITDA ($m)	0.8	1.1	0.9	1.5	2.7	6.5	9.6	11.2
RSS EBITDA ($m)	-4.1	-2.6	8.5	14.0

Interims ($m)
Half-year (AUD)	Dec 16	Jun 17	Dec 17	Jun 18
1HA	2HA	1HE	2HE
Sales revenue	23.8	25.5	33.2	42.4
EBITDA	0.4	-2.1	0.1	3.8
EBIT	-0.2	-2.8	-0.7	2.8
Net profit	-0.3	-2.0	0.0	2.1
Norm EPS	-0.7	-3.7	0.0	3.6
EBIT/sales (%)	-0.7	-10.8	-2.1	6.7
Dividend (c)	0.0	0.0	0.0	0.0
Franking (%)	0.0	0.0	0.0	0.0

Profit and loss ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17A	FY18F	FY19F	FY20F
Sales revenue	18.5	25.9	34.4	44.1	49.3	75.6	112.0	148.5
EBITDA	0.8	1.1	0.9	1.5	-1.7	3.9	18.1	25.2
Depn & amort	0.5	0.6	0.6	1.0	1.2	1.8	2.5	3.2
EBIT	0.3	0.4	0.2	0.5	-2.9	2.1	15.6	22.1
Net interest expense	-0.1	0.0	-0.1	0.0	-0.1	0.0	0.0	0.0
Tax	-0.4	0.0	0.2	0.4	0.4	0.6	4.2	6.0
Minorities/pref divs	0.1	-0.2	0.1	0.1	-0.8	-0.5	0.7	1.3
Equity accounted NPAT	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Net profit (pre-sig items)	0.7	0.6	0.1	0.0	-2.4	2.1	10.7	14.8
Abns/exts/signif	-0.1	-0.2	0.5	0.2	-1.0	0.0	0.0	0.0
Reported net profit	0.6	0.4	0.6	0.2	-3.3	2.1	10.7	14.8

Financial stability
Year-end June (AUD)	FY17A	FY18F	FY19F
Net debt	-14.2	-11.7	-16.8
Net debt/equity (%)
Net debt/EV (%)
Current ratio (x)	4.1	3.9	4.1
Interest cover (x)	20.3
Adj cash int cover (x)	33.3
Debt/cash flow (x)	0.0	0.0	0.0
Net debt (cash)/share ($)
NTA/share ($)	0.5	0.5	0.6
Book value/share ($)	0.6	0.6	0.8
Payout ratio (%)	0	0	0
Adj payout ratio (%)	0	0	0

Cash flow ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17A	FY18F	FY19F	FY20F
EBITDA	0.8	1.1	0.9	1.5	-1.7	3.9	18.1	25.2
Interest & tax	0.0	-0.5	0.1	-0.2	-1.2	-0.6	-4.2	-6.0
Working cap/other	-0.3	-1.3	-1.2	0.9	0.2	-2.3	-5.2	-5.5
Operating cash flow	0.6	-0.8	-0.2	2.1	-2.7	1.0	8.7	13.8
Maintenance capex	-0.2	0.3	-1.2	-1.9	-2.4	-3.5	-3.6	-3.8
Free cash flow	0.4	-0.5	-1.4	0.2	-5.1	-2.5	5.1	10.1
Dividends paid	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Growth capex	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Invest/disposals	-0.5	-0.3	-0.2	-1.3	-0.3	0.0	0.0	0.0
Other inv flows	-0.1	-0.4	-0.3	-0.4	-0.1	0.0	0.0	0.0
Cash flow pre-financing	-0.2	-1.2	-1.9	-1.5	-5.5	-2.5	5.1	10.1
Funded by equity	0.5	0.0	7.3	10.7	2.4	0.0	0.0	0.0
Funded by debt	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Funded by cash	-0.3	1.2	-5.3	-9.2	3.1	2.5	-5.1	-10.1

Returns
FY17A	FY18F	FY19F	FY20F
ROE (%)	-7	6	28	29
ROIC (%)	-12	8	46	51
Incremental ROE	-54		133	30
Incremental ROIC	-134	165	182	73

EPS reconciliation ($m)

FY17A Rep Norm		FY18F Rep Norm
Sales revenue	49	49	76	76
EBIT	-3.9	-2.9	2.1	2.1
Net profit	-3.3	-2.4	2.1	2.1
Notional earn	0.0	0.0	0.0	0.0
Pref/conv div	0.0	0.0	0.0	0.0
Profit for EPS	-3.3	-2.4	2.1	2.1
Diluted shrs (m) 54 54 57 57
Diluted EPS (c)	-6.2	-4.4	3.6	3.6

Balance sheet summary ($m)
Year-end June (AUD)	FY13A	FY14A	FY15A	FY16A	FY17A	FY18F	FY19F	FY20F
Cash	4.2	2.9	8.3	16.7	14.2	11.7	16.8	26.9
Current receivables	4.4	5.5	7.2	9.4	10.2	12.8	19.2	25.9
Current inventories	0.9	1.0	1.3	1.8	1.9	3.0	4.5	6.1
Net PPE	1.2	1.3	2.1	3.8	4.5	5.7	6.3	6.4
Investments	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Intangibles/capitalised	5.3	8.5	8.9	10.2	10.4	11.0	11.6	12.2
Other	0.2	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Total assets	16.1	19.1	27.8	42.0	41.2	44.2	58.4	77.4
Current payables	3.5	3.3	3.9	6.9	8.0	9.2	11.7	14.3
Total debt	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other liabilities	1.0	3.2	2.4	1.8	2.3	2.5	2.8	3.1
Total liabilities	4.5	6.6	6.2	8.8	10.3	11.7	14.4	17.4
Minorities/convertibles	0.6	0.2	0.2	-0.6	-1.3	-1.3	-1.3	-1.3
Shareholder equity	11.6	12.6	21.5	33.2	31.0	32.5	43.9	60.1
Total funds employed	11.6	12.6	21.5	33.2	31.0	32.5	43.9	60.1

SomnoMed Limited: FY17 result review

Table 1: SomnoMed 2H17 and FY17 results versus pcp and Wilsons' estimates

($ in mn)	FY16	1H17 2H17	FY17	%chg Forecast %chg Var (abs$) %var
USA Europe APAC RSS	19.6 20.6 3.9 -	10.4 9.4 11.4 12.7 2.1 1.9 - 1.6	19.7 24.0 4.0 1.6	1% 20.3 4% (0.6) -3% 16% 24.2 17% (0.1) -1% 3% 3.8 -3% 0.3 7% 2.1 (0.5) -25%
Net revenue	44.1	23.8 25.5	49.3	12% 50.2 14% (0.9) -2%
COGS Gross profit	18.7 25.3	10.1 10.4 13.7 15.1	20.5 28.8	9% 22.4 19% (1.8) -8% 14% 27.8 10% 1.0 4%
EBITDA	1.5	0.4 (2.1)	(1.7)	-215% (1.5) -201% (0.2) 0%
SomnoMed RSS	1.5 -	1.4 1.0 (1.0) (4.2)	2.4 (4.1)	60% 2.7 84% (0.3) -13% (4.2) n/a 0.2 0%
Interest, other Tax Minorities Adjustments	(0.0) 0.4 0.0 (0.2)	(0.1) (0.1) 0.4 (0.0) (0.2) (0.6) - -	(0.1) 0.4 (0.8) -	nm (0.1) nm (0.1) 0% nm 0.6 nm (0.2) 0% nm (0.7) nm (0.1) 9% nm - nm - 0%
NPAT EPS (cps)	0.2 0.3	(0.6) (2.7) (1.1) (5.1)	(3.3) (6.2)	nm (2.9) nm (0.4) 14% nm (5.5) nm (0.8) 14%
Operating cash flow	2.1	(0.9) (1.6)	(2.7)	nm (3.1) nm 0.4 14%
% of net revenue	FY16	1H17 2H17	FY17	Wilsons
Gross profit MAS gross profit	57.5% 68.0%	57.6% 59.2% 67.3% 71.8%	58.4% 70.0%	55.5% 68.0%

FY17 Guidance

Units 67,000

Revenue $50m

EBITDA -$1.5m

Source: SOM, Wilsons estimates

Income statement

No great revelations in the formal FY17 earnings numbers given SomnoMed's practice of regular, quarterly updates on volume, revenue and cash flows. In FY17 SomnoMed grew unit sales by 15% to 68,100 and revenue by 8% noting adverse FX translation versus pcp.

• USA. Sales growth in the core business was only 1% at $19.7m, disrupted in the middle quarters by channel conflict relating to RSS. The RSS network reached seven centres and debuted in the 2H with $1.6m in sales. Including RSS, US sales were $21.3m or up 9%. The US segment loss of $2.2m (versus $1.2m profit in FY16) reflected RSS investments but were broadly in line with our forecast.

• Europe. Sales in this segment grew 16% to $24.0m with earnings of $3.3m (missed our forecast by $0.3m).

• APAC. Sales grew 3% to $4.0m - earnings flat and in line with our model.

  Group EBITDA loss was ~$200K more than we forecast at $1.7m. SomnoMed Core's EBITDA of $2.4m was below our forecast for $2.7m (Europe miss). RSS lost $4.1m versus our estimate of $4.2m. The reported NPAT loss of $3.3m was correspondingly higher than our estimate of $2.9m (small differences in tax and RSS minority interests).

  Cash flow and balance sheet

  The operating cash outflow of $2.7m was less than our forecast and again, reflected the start-up investments associated with the seven RSS clinics opened over FY17. SomnoMed closed FY17 with $14.2m cash and no material debt.

  Outlook and earnings forecasts

  Guidance

  SomnoMed Core

• Revenue growth: >15% to >$55m and EBITDA ~$6.5m.

  RSS

• Revenue $20m-$25m and aggregate EBITDA loss of ~$1.5m.

Model changes

The principal change to our model is the recognition of additional costs associated with an accelerated rollout of RSS. We also recognise more measured margin leverage in SomnoMed Core. Originally we were modelling nine RSS openings in FY18, which has been taken up to twelve, to align with the guidance. Although our RSS revenue forecasts are up marginally, note that we are still sitting below management's guidance range for that business. The aggregate earnings change in FY19e is only 5%.

Table 2: Summary of Core and RSS revenue and EBITDA changes

FY18e	FY19e
SomnoMed revenue - Before	$m	58.0	69.5
SomnoMed revenue - After	$m	56.7	68.1
- Change	%	-2.2%	-2.0%

SomnoMed EBITDA - Before	$m	7.7	11.0
SomnoMed EBITDA - After	$m	6.5	9.6
- Change	%	-15.6%	-12.7%

RSS revenue - Before	$m	17.9	42.1
RSS revenue - After	$m	18.9	43.9
- Change	%	5.6%	4.3%

RSS EBITDA - Before	cps	-1.4	8.0
RSS EBITDA - After	cps	-2.6	8.5
- Change	%	85.7%	6.3%

Source: Wilsons' estimates

Table 3: Divisional earnings forecasts FY15-20

FY15	FY16	1HFY17e	2HFY17e	FY17e	1HFY18e	2HFY18e	FY18e	FY19e	FY20e
SomnoDent unit sales	51,355	58,983	33,309	34,791	68,100	39,524	43,790	83,314	104,098	124,879
Group revenue ($m)	34.4	44.1	23.8	25.5	49.3	33.2	42.4	75.6	112.0	148.5
SomnoMed	34.4	44.1	23.8	23.9	47.7	26.9	29.8	56.7	68.1	79.8
RSS	-	-	-	1.6	1.6	6.3	12.7	18.9	43.9	68.8
Gross profit ($m)	19.5	25.3	13.7	15.1	28.8	21.2	28.3	49.4	78.1	106.7
EBITDA ($m)	0.9	1.5	0.4	(2.1)	(1.7)	0.1	3.8	3.9	18.1	25.2
SomnoMed	0.9	1.5	1.4	1.0	2.4	3.1	3.4	6.5	9.6	11.2
RSS	-	-	(1.0)	(3.1)	(4.1)	(3.0)	0.4	(2.6)	8.5	14.0
Depreciation and amortisation	0.6	1.0	0.6	0.7	1.2	0.8	1.0	1.8	2.5	3.2
EBIT ($m)	0.2	0.5	(0.2)	(2.8)	(2.9)	(0.7)	2.8	2.1	15.6	22.1
Net interest	0.1	0.0	(0.1)	(0.1)	(0.1)	-	-	-	-	-
Tax	0.2	0.4	0.4	(0.0)	0.4	(0.2)	0.8	0.6	4.2	6.0
Minorities	0.1	0.1	(0.2)	(0.6)	(0.8)	(0.5)	0.0	(0.5)	0.7	1.3
NPAT ($m)	0.6	0.2	(0.6)	(2.7)	(3.3)	0.0	2.1	2.1	10.7	14.8
EPS (cps)	1.2	0.3	(1.1)	(5.1)	(6.2)	0.0	3.6	3.6	18.5	25.6
Source: SomnoMed, Wilsons' estimates