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SMLR: Impressive 2016 Turnaround, Modeling Operating Profitability in 2017

By Brian Marckx, CFA


Q4 2016 Results:  Q4 Caps Year of Progressive Financial Improvement. Modeling Operating Profitability This Year…...

Semler (NASDAQ:SMLR) reported financial results for the fourth quarter ending December 31
st.  Revenue remains robust, setting a new record high in Q4 from the vascular testing business.  And revenue was just of one several highlights – others included relatively elevated gross margin and continued cost-control in OpEx.  The result was operating loss in Q4 coming in at the lowest level in history.

Importantly, and what contributes to our thesis that SMLR could reach operating profitability in the near term, is that the Q4 numbers fit a trend of progressive improvement throughout 2016.  This included sequential revenue growth and improvement in operating loss in every quarter throughout the year.  And while that step-by-step improvement may not continue in such a regular fashion going forward, we do not expect a reintroduction of the level of volatility that was associated with the WellChec business (which was essentially discontinued in late 2015).

Semler quickly shelved WellChec when it became obvious that the business was too resource-intensive and did not fit with their near-term goal of reaching cash flow break-even.  While management had viewed the multi wellness testing service as a complement to their core instruments (i.e. QuantaFlo / FloChec), the viability, or proof-of-concept, of that business had yet to be fully established.  WellChec had contributed significantly to revenue in late 2015 but that was compromised by the even more significant resources and related expense consumed in support of getting the business up and running and maintaining its operations.  And with gross margins which we estimated in the low double digits (i.e. 10% - 20%) and which paled in comparison to the instruments business (i.e.70% -  80%), it seemed WellChec’s days were numbered unless it could demonstrate the potential to significantly steepen its revenue curve and begin to establish scalability.

It was out with WellChec and in with providing home risk assessment organizations (HRA) with vascular testing capabilities.  HRA appears to be a much simpler complement to the company’s vascular testing business – in fact, it is essentially an extension of that business with just a slightly different revenue model.  SMLR charges HRA customers on a per-test basis – which differs from the annual/monthly licensing revenue model that they employ with the likes of Medicare Advantage plans.

Given that QuantaFlo and vascular testing is where SMLR’s expertise lies, there should be no ‘reinventing-the-wheel’ risk with HRA.  And in addition to being much less resource-intensive than WellChec, HRA should be lower risk from a capital standpoint.  The icing on the cake is that management believes margins from the HRA customer segment will be at least as high as that from insurers – the potential for some IT-related customization work as well as incremental contribution from sensor sales offer additional margin enhancement.

SMLR notes that revenue growth continues to be the product of increasing market penetration, growth of their installed base and their recurring revenue business model.  With management continuing to guide for revenue growth, expense control and stable-to-improving gross margins (which are already at a beefy 75%+ level), we continue to think the company could be at a level of positive operating income and break-even cash flow by later this year.

While migration of customers from their legacy FloChec technology over to (the higher priced) QuantaFlo had also been a source of revenue, that will likely dissipate given that the majority of switching is likely now complete.

Q4 numbers…

Revenue was $2.32M, up 17% sequentially from Q3 ’16 ($1.92M).  As a reminder, WellChec, which contributed $1.44M in revenue in Q4 ’15, was decommissioned at the end of that year.  So on a comparable yoy basis, and excluding WellChec, revenue increased 55% from Q4 ’15 to Q4 ’16.  Vascular testing revenue set an all-time record in Q4 ’16.  While SMLR does not break out the source of vascular testing revenue (i.e. HRA vs insurance customers), management did indicate on the Q4 call that there was at least some contribution in the quarter from HRA customers.

For the full year 2016, revenue was $7.44M – which, excluding WellChec revenue (which contributed $1.86M in 2015), was up 45% ($2.29M) from 2015.

Gross margin of 77.3% in Q4 ’16 and 74.8% for the full year 2016 compared favorably to the 33.2% and 59.9% in the respective year-earlier periods.  As noted, the HRA-related customer base is expected to generate this level or better margins going forward.

In terms of operating expenses, management continues to deliver on their goal of trimming fat.  Operating expenses ballooned in late 2015 – Q4 ’15 OpEx was $5.2M, much of which related to stock compensation as well as some ongoing costs related to WellChec.  Since then SMLR has tightened the belt, resulting in average quarterly OpEx falling to $1.9M throughout 2016 – that compares to a quarterly average of $3.2M in 2015.  In Q4 ‘16, OpEx was $1.9M, equal to 82% of revenue - a record low and substantially improved from the previous best of 93% of revenue (Q3 ’16).  This will be a key metric to watch going forward.

Similar to revenue growth, operating loss has shown consistent improvement over the course of 2016.  Q4 ’16 operating loss was just $103k – also an all-time best.   With management guiding for revenue to continue to grow faster than operating expenses, coupled with gross margins that should remain at least stable (and potentially widen), we think operating leverage should continue to benefit and break-even operating income is reasonably attainable in the near-term.

In terms of cash, SMLR exited 2016 with $622k in cash and equivalents.  Management indicated that they expect the positive trends in revenue and progress towards profitability to continue and have a goal of reaching a point of positive cash flow generation during 2017.  The company has largely financed operations through debt and has previously mentioned that in the event they need additional operating capital, that they will seek to secure non-dilutive funding from sources such as loans as they have done in the past.

We cover SMLR with a $7.50/share price target.  See below for free access to our updated report on the company which includes our financial model and valuation methodology.


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