Ann: December 2012 Appendix 4D , page-14

Hi Kanna,

In summary, it was a padded result, meaning that there are signs that management took the liberty of aggressively increasing investment in product development during a period of healthy financial conditions.

Put another way, they tried their hardest to make sure they kept within the upper limits of their profit guidance provided six months ago.

Specifically, Reported full- year NPAT was $4.69m, compared to guidance of $4m to $5m.

At the time of the guidance, I thought it was conservative and thought $5m-plus was easily do-able.

One of the most salient features of the second-half result was the big jump in R&D expense, to $0.73m in the second-half from $0.2m in DH2012, for a full-year R&D spend of $0.93m, a big jump from FY12's $0.55m.

Had this investment level have been held consistent with prior periods, the full-year result would have come in at around $5.2m. On the other hand, to be objective, the tax rate in the second half was about $200k or $300k lower than I had expected (note that SDI will never pay full 30% tax because it receives several tax-free R&D concessions and derives significant profits from tax jurisdictions that have lower rates than Australia)

So, all in all, I think the "clean" NPAT number is around $5.0m flat, and it looks distinctly to me like management has reverse engineered the result to fall within guidance by deploying the excess into product development.

Mature and smart.

As a shareholder, I appreciate that sort of investment in the future of the business, rather than merely shoot the lights out of guidance in order to derive some short-term glory.

Also, Operating Cash Flow was very strong, a half-year record in fact, at $5.4m in the June half.

As a result, NIBD finished the year at $6.4m, down from $9.8m at the end of Dec 2012, and half of its level 18 months ago.

Consequently, NIBD/EBITDA for the half was effectively 0.7x, and will fall to less than 0.5x in the current financial year, even after the 67% increase in dividends to be paid in FY14.

Credit metrics for SDI are moving into a range that represents an all-time low for the company.

The other standout feature of the result was the continuation of discipline in terms of controlling non-COGS costs: Cost of Doing Business (i.e., corporate and administration overheads) as a percentage of Revenue fell to 43.1% (for context, over the preceding three half-years this metric was 50.6% (DH11), 45.3% (JH12) and 46.9% (DH12)).

The one brickbat I had with the result was the Gross Profit Margin that disappointed, falling to a still-impressive 55.6% in the June 2013 half, down from 64.6% in DH12 and an average of 57.2& across 2012.

My suspicions, taken from management's commentary that they are gearing up to launch new Composite and Glass Ionomer restorative products are due for release in the current half, is that they discounted stock in order to move it ahead of the new products release. This appears to be borne out by the $2m reduction in inventories over the half.

So the GP margin move doesn't really worry me. I think it's simply what you get with medical device companies who produce products with relatively short life cycles.

And despite its modest size, SDI has proven that it has the ability to flourish and innovate, given its GPM has been above 50% its entire existence spanning over a decade.

So, in summary, I think it was a clean result, with many hallmarks of a management team on top of the business and proactive in managing it in a continuously competitive global environment.

The Brazilian business, while still loss-making, is clearly turning around ($0.4m loss in JH13, $0.7m loss in DH12, $1.6m loss in JH12, $1.0m loss in DH11), and the Australian business, which has been sluggish for the past few half-years looks set for a lift with the company's management looking at re-initiating exports ex Australia given the lower Australian dollar.

Importantly, in terms of the current financial year, it is clear that the benefits from the lower silver price and the lower A$ have still had limited positive impact on the company's financials.

I haven't re-calibrated my model comprehensively, but at first pass it looks like a further 25% to 30% EPS growth is achievable without too much going right for the company.

Cam