Typically tentative first report from dental dotcom

Friday 31st August 2001

A company's first annual report always makes interesting reading because it shows actual performance relative to the rosy-hued statements in its prospectus. Often, reality has a way of making a mockery of forecasts and sometimes raises questions about the competence of the forecasters.

That is not the case with dental software company Software of Excellence International, whose reports show it to have been particularly conservative in its expectations.

In the year to March, it produced 9% more revenue than its November prospectus forecast at $9.4 million while its net loss was 11% lower at $673,000.

Both figures are an improvement over the previous year, when the company recorded revenue of $8.8 million and a net loss of $1.6 million.

Its public offering last year raised several million and $2.2 million of this remains on deposit at the bank. The additional capital is important as the company's balance sheet was in need of beefing up.

Last year the company had shareholders' funds of just over $1 million against assets of $3.9 million. This is an equity ratio of around 25%. That may be acceptable for a private company but is considered imprudent for a public one, even a software company. This year, thanks to the capital injection, the company has shareholders' funds of $6.6 million and assets of $9.5 million, a conservative ratio of 69%.

Small companies with big expansion plans often find meeting cash flow requirements a strain and Software of Excellence appears no exception. Its net operating cash flow was negative $1.8 million after costs of $9.6 million in 2001 compared with a $200,000 surplus year on costs of $7.7 million in the previous year.

This is one area where the company has not met prospectus forecasts, which indicated a surplus of $787,000. Commendably, the company explains the difference, saying the "collection rate" on sales was lower than expected.

A review of the year by executive directors (five out of the nine- person board) indicates future profits may also be affected by expansion costs, especially in the huge US market in which it is hoping to gain a foothold.

"Entering the US market will require more resources and needs to be carefully planned and executed. It is likely that any significant entry into the US market will have a short-term negative impact on profitability," they say.

The report repeats the prospectus forecast of net profit of $2.4 million in 2002 and $4.6 million in 2003, so investors may assume US expansion is some way off.

Segmented figures in notes to the accounts show the company has not grown in its key market in the past 12 months.

The UK is by far the largest market for the company, representing $7.3 million of its $9.4 million turnover in its 2001 financial year. This is $50,000 down on 2000. The company showed much better growth in New Zealand and Australia but on smaller revenues.

No explanation is given for the static UK performance and comments in the directors' report are moderately bullish.

One clue may be given in the statement that, "Having expanded our infrastructure in the UK, and our ability to sell and install in higher volume, we are now looking for, and expecting increasingly profitable returns from this market."

In notes to the accounts there is a comment that revenue was higher than the prospectus forecast, "due mainly to higher than projected sales in the UK, where the last quarter was particularly strong." This suggests the company was expecting lower sales in the UK when it made its forecasts.

The last quarter was also the first following the acquisition of UK group Henry Schien, which may have made up the difference.

Whatever the reason, more detail about the company's divisions and business sectors would be welcome.

This report is a typically tentative first effort, as a once private company comes to grips with the complexities and disclosure regimes that come with being listed. Investors should be able to look forward to more information presented more confidently in future reports.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Internet: www.mcewen.co.nz Email: davidm@mcewen.co.nz

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