Nanosonics (NAN) Preparing for new international markets. Maintain Hold, price target amended to $3.20 SOURCE: BELL POTTER SECURITIES ESTIMATES

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1 21 February 2017 Analyst John Hester Authorisation TS Lim Nanosonics (NAN) Growth Slowly Emerging In Europe Recommendation Hold (unchanged) Price $2.80 Target (12 months) $3.20 (previously $3.28) Expected Return Capital growth 14.3% Dividend yield 0% Total expected return 14.3% Company Data & Ratios Enterprise value $777m Market cap $834m Issued capital 297.7m Free float 85% Avg. daily val. (52wk) $2.6m 12 month price range $ $3.60 GICS sector Healthcare Equipment and Services Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Preparing for new international markets Nanosonics had previously reported 1H17 revenues and cash flows, hence there was minimal news in the result announcement. Revenues of $36.1m were driven by the ongoing uptake of the now dominant Trophon across Australia and North America. The US represented 93% of revenues in the half. Despite the issuance of guidelines for use in Wales and Scotland, uptake in those countries is moving slowly. Combined revenues from Europe were $0.77m for the half, albeit most of the revenues from the UK are from the managed equipment services model (MES) and this does defer revenue recognition. Gross profit margin for the group was 73% which was modestly lower than our forecast 75% and the 81% achieved in the pcp. The change in margin was primarily driven by sales mix and the increasing proportion of sales generated by GE Healthcare which are at lower margin relative to other distribution modes. Operating profit of $10.3m was in line with forecast. The company provided guidance for full year operating expenses of $39.0m which implies a 26% increase in the run rate over 1H17 at $17.2m. We expect most of this increase will be support for the Trophon market penetration in France, Germany and the UK. Nanosonics is now focussed on product launches for the Trophon in Japan where first revenues are expected to be earned in calendar The company will almost certainly engage with more than one ultrasound OEM for distribution in the Japanese market. Product registrations have also now occurred in numerous countries throughout the Middle East. Maintain Hold, price target amended to $3.20 NAN has now recognised a deferred tax asset relating to prior year tax losses in Australia. Other than this non cash flow, book adjustment, there no significant changes to earnings and we maintain our Hold recommendation. Price target is amended from $3.28 to $3.20. Absolute Price Earnings Forecast $4.00 $3.00 $2.00 $1.00 $0.00 Feb SOURCE: IRESS Jun NAN Oct Feb Jun Oct S&P 300 Rebased June Year End FY FY17e FY18e FY19e Revenues EBITDA $m NPAT (underlying) $m NPAT (reported) $m EPS underlying (cps) EPS growth % Large Large 54% 43% PER (x) 5, FCF yield (%) -0.5% 1.5% 2.8% 5.1% EV/EBITDA (x) Dividend (cps) Dividend yield 0% 0% 0% 0.6% Franking 0% 0% 0% 0% ROE % 0% 32% 19% 22% SOURCE: BELL POTTER SECURITIES ESTIMATES BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 5 THAT FORM PART OF IT. Page 1

2 Results in line with forecast Figure 1 - Summary of 1H17 Result 1H 1H17 1H17 Item ($m) Actual Actual % Chg Forecast % Diff Revenues % % Gross profit % % GP margin 81% 73% 75% -3% Operting profit (3.2) 10.3 large % Reported NPAT (3.2) 22.0 large % EPS - reported (1.2) 7.4 na % SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES The result was in line with forecast. Figure 2 - Summary of earnings adjustments $m New Old % chg New Old % chg New Old % chg Revenues % % % EBITDA % % % NPAT % % % EPS % % % SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES The adjustments at the NPAT line relates to the recognition of a deferred tax asset for the accumulated losses in Australia. As a result NAN reported an $11.7m tax credit in the income statement. Going forward NAN will report a tax expense equal to approximately 30% of the reported pre-tax earnings for Australia, however, it will not pay tax until the deferred tax asset has been extinguished. This is unlikely to occur before FY19. Price target is lowered to $3.20 following minor changes to the gross margin assumption in FY18 and FY19. We maintain our hold recommendation. Page 2

3 Nanosonics Nanosonics is a standout Australian company which has developed and commercialised the Trophon a device invented for the purpose of point of care infection control in the hospital or clinical setting. The Trophon provides high level disinfection (HLD) of sensitive medical instruments (that are not suitable for high temperature sterilisation) with the first application in sonography probes targeting obstetrics and gynaecology patients. The Trophon is the most significant innovation in patient and operator safety (in relation to sonography) since the invention of the ultrasound. The efficacy of the device in killing pathogens on the surface of intracavity and surface ultrasound probes is unquestionable and has been proven in clinical studies and backed up by broad adoption by the most prestigious hospitals across Australia and the United States. The benefits of the device were so convincing that GE Healthcare a large market participant in the medical imaging industry became the exclusive distributor of the Trophon in the US between 2012 to 20. During this period, GE delivered immense value through its high profile promotion of the device. Nanosonics has now matured into a powerhouse promoter of the Trophon in its own right. While GE remains a non exclusive distributor, Nanosonics has a dedicated sales force in the US the deepest market in the world. In the year since it commenced in the US with a dedicated sales force, revenue growth has accelerated significantly as the Nanosonics team creates new sales opportunities at non GE Healthcare sites. The rest of the world market is largely untapped. The company has established beach heads in the United Kingdom and Germany and we expect rapid sales growth in these and other markets over the next two to three years. We conservatively estimate the global market for the Trophon amongst key markets as greater than 60,000 units. The company s estimates are larger but include markets not yet under consideration for business development. Key to opening these markets is finding the right distribution partner. Ideally Nanosonics will partner first before establishing or buying its own franchise in key markets, however, there are probably only 10 national markets of sufficient size to warrant a dedicated sales force. Nanosonics has a small R&D program. We understand the team may be focussed on development of the second generation Trophon which is expected before June This will coincide with the period when first generation Trophon devices come to the end of their useful lives. There are potentially numerous other applications for nano-nebulant technology in the medical setting, though first revenues from additional applications are not yet on the horizon. The company is yet to elaborate on the first target market outside of ultrasound. The company is led by Chief Executive Michael Kavanagh (formerly VP Global Marketing at Cochlear) and supported by an executive group, each of whom have many years experience in their relevant area of expertise. We expect NAN will generate its maiden profit in FY17. Page 3

4 Install Base Revenues A$m Nanosonics as at 21 February 2017 Recommendation Hold Price $2.80 Target (12 months) $3.20 Nanosonics (NAN) 21 February 2017 Table 1 - Financial summary Profit & Loss FY FY FY17e FY18e FY19e Valuation Ratios (A$m) FY FY FY17e FY18e FY19e Year Ending 30 June $m Reported EPS (cps) Total revenues Normalised EPS (cps) Revenues growth 3% 93% 71% 20% 24% EPS growth (%) 94% Large Large 54% 43% EBITDA PE(x) na 5, Margin -21% 2% 23% 29% 33% EV/EBITDA (x) na Depreciation EV/EBIT (x) na na EBIT NTA (cps) Net interest P/NTA (x) Pre tax profit Book Value (cps) Tax expense Price/Book (x) NPAT- normalised DPS (cps) Net abnormal items Payout ratio % % 20% Reported NPAT Dividend Yield % 0.0% 0.0% 0.0% 0.4% 0.6% Franking % Cashflow (A$m) FY FY FY17e FY18e FY19e FCF yield % -0.5% -0.5% 1.5% 2.8% 5.1% Gross cashflow from operations Net interest Performance Ratios FY FY FY17e FY18e FY19e Tax paid ROA -10% -1% % 22% 26% Other ROE -12% 0% 32% 19% 22% Operating cash flow ROIC -54% -3% 66% 80% 1% Maintenance capex Net debt/equity -83% -83% -71% -80% -81% Net debt/assets Free cash flow Gearing na na na na na Proceeds from issuance Total debt/ebitda (x) Movement in borrowings Interest cover (x) Dividend paid Interim results 2H 1H 2H 1H17e 2H17e Other Revenues Change in cash held EBITDA Cash at beginning of period EBIT Cash at year end NPAT Balance Sheet (A$m) FY FY FY17e FY18e FY19e Install Base Cash USA 6,700 8,700 10,740 12,722 Receivables ROW 1,200 1,300 1,735 1,829 Inventory ,900 10,000 12,475 14,551 Other current assets Property, Plant and Equipment Intangible assets Deferred tax asset Other non current assets Total assets , Trade payables Provisions Other Borrowings Total Liabilities Net Assets ,000 50,000 40,000 30,000 20, Share capital Reserves Other Retained earnings Shareholders Equity ,000 - Global Install Base Revenues 50 0 SOURCE: BELL POTTER SECURITIES ESTIMATES Page 4

5 Recommendation structure Buy: Expect >% total return on a 12 month view. For stocks regarded as Speculative a return of >30% is expected. Research Team Staff Member TS Lim Sam Haddad Jonathon Higgins Title/Sector Head of Research Phone tslim shaddad jhiggins Hold: Expect total return between -5% John O Shea joshea and % on a 12 month view Chris Savage csavage Sell: Expect <-5% total return on a 12 month view Jonathan Snape Tim Piper John Hester Healthcare jsnape tpiper jhester Speculative Investments are either start-up enterprises with nil or only prospective operations or recently commenced operations with only forecast cash flows, or companies that have commenced operations or have been in operation for some time but have only forecast cash flows and/or a stressed balance sheet. Such investments may carry an Tanushree Jain Financials TS Lim Lafitani Sotiriou Peter Arden David Coates Associates James Filius Healthcare/Biotech Banks/Regionals Diversified Associate Analyst tnjain tslim lsotiriou parden dcoates jfilius exceptionally high level of capital risk and volatility of returns. Bell Potter Securities Limited ACN Level 38, Aurora Place 88 Phillip Street, Sydney 2000 Telephone The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. In the USA and the UK this research is only for institutional investors. It is not for release, publication or distribution in whole or in part to any persons in the two specified countries. In Hong Kong this research is being distributed by Bell Potter Securities (HK) Limited which is licensed and regulated by the Securities and Futures Commission, Hong Kong. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arraignment with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. ANALYST CERTIFICATION Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Page 5