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LMD.V: Apteryx Contributes To Revenue, Gross Margin

06/06/2017
By Brian Marckx, CFA

TSX:LMD.V
OTC:LEDIF

Q1 2017 Financials: Apteryx Contributes to Revenue. Gross Margin…

LED Medical (TSX:LMD.V) (OTC:LEDIF) reported Q1 financial results on May 30th.  This was the first quarter which included contribution from Apteryx, the acquisition of which closed around mid-February.  While LED does not disclose revenue by segment, footnotes in the Q1 filing credit sales of Apteryx's imaging software products as partially responsible for the 12%+  growth in total revenue from Q4 2016.  But despite the sequential growth, we would not characterize revenue as a particular highlight (discussed more below).  On a much brighter side, however, was gross margin which apparently also benefitted from relatively high margin Apteryx-related sales and came in at the highest level since Q2 2014.  Operating expenses also surprised on the upside (i.e. good side) and remained relatively tame despite headcount jumping ~75% from the close of 2016 to the end of Q1 (also related to the acquisition).

Q1 revenue was $2.1M, down 2.5% yoy, up 12.5% sequentially and about 6% higher than our $2.0M estimate.  In addition to contribution from Apteryx, growth in sales from the VELscope segment was mentioned as benefitting total revenue.  This may suggest contraction in imaging hardware sales (at least on a yoy basis) which was implicated as a significant contributor to the relatively very weak Q4 2016 topline number.  As a reminder, revenue fell 67% yoy and 25% sequentially in Q4 due in large part to what management noted was an inability to purchase sufficient inventory due to lack of capital.  While inventory balance didn't budge from Q4, the recent cash infusion is expected to help prepare for the typically strong dental equipment season late in each calendar year. 

And while Q1 revenue beat our $2.0M estimate by about 6%, we had yet to model contribution from Apteryx - as such, the 6% beat is less than impressive.  As a reminder, we were hopeful that pro formas for the combined companies would be forthcoming and, as such, decided to wait to model any effects of the Apteryx acquisition until that time.  But with Apteryx now incorporated into LED's results and Q1 in the books, we are now incorporating (best-guess) effects of the acquisition in our model.  These assumptions, which are subject to future updating, include (per management's expectations at the time the acquisition was announced) that Apteryx will be significantly accretive to revenue, EBITDA and net income in 2017.  

As Apteryx likely only contributed ~6 weeks (potentially slightly less) worth of revenue in Q1, we should see much more substantive incremental sales from the software segment throughout the remainder of 2017.  Another potentially potent advantage of the software business model (in addition to relatively beefy margins) is that, unlike dental imaging capital equipment, software licensing offers more opportunity for recurring (i.e. predictable and non-lumpy) revenue.   

Gross margin, at 49.0% in Q1 was well ahead of both Q4 2016 (13.7%) and Q1 2016 (24.9%).  This was the highest level in the last 11 quarters.  The relative strength also appears to be related to Apteryx sales.  As we had noted, while we didn't know exactly what to expect in terms of margins going forward, given that Apteryx is primarily involved in software development (i.e. typically a high-margin business), we thought it reasonable to believe LED's overall gross margins would benefit from the acquisition.  That appears like it may be the case. 

And while imaging product sales have always carried relatively low (reseller-type) margins, LED’s proprietary VELscope and related disposables margins are believed to be much healthier.  In fact VELscope consumable sales were also credited with benefitting gross margin Q1.  So with expectations that VELscope sales continue to grow, coupled with contribution from Apteryx, 2017 gross margin's could dwarf those of 2016 (24.4% for the full year).         
     
Operating expenses in Q1 were $1.8M, which is up slightly from $1.5M in Q4 2016 but down from $2.5M in Q1 2016 and only a hair higher than our $1.6M estimate (which did not model Apteryx).  It is also marginally lower than the $1.9M quarterly average in 2016.  This is despite staffing levels increasing from 39 and 28 in Q1 and Q4 2016, respectively to 49 at the end of the most recent quarter.  Most of the increase in headcount versus Q4 2016 is evenly split between R&D and support functions with some additional personnel also added to sales/marketing - again, the staffing increase relates to Apteryx.  We do expect operating expenses to increase from this level, however, given likely continued software development activities as well as the fact that Q1 included only ~6 weeks worth of Apteryx-related expenses.  That said, however, there should be opportunities for operational synergies given the complementary nature of the hardware and software products which share similar call points.  As such, and combined with upside in gross margin and revenue growth, we model fairly regular improvement in operating loss.  

Cash used in operating activities was $1.4M ($860k ex-changes in working capital), compared to $690k ($1.8M ex-changes in w/c) and $648k ($1.3M ex-changes in w/c) in Q1 and Q4 2016, respectively.  While we think it is too early to specifically credit Apteryx, which as noted generates positive cash flow, for the recent improvement in EBITDA, our thesis remains that the acquisition will have that effect.  Cash balance at Q1 quarter end was $2.9M.   
  
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