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SMLR: Revenue Jumps 25% QoQ, Profitability In Sight.

By Brian Marckx, CFA


Q2 2017 Results:  Revenue Jumps 25% Q-o-Q, Closing In On Profitability, Positive Cash Flow…

Semler (OTC:SMLR) reported financial results for their second quarter ending June 30th.  While the quarter was not a particular highlight from a (GAAP) profitability standpoint, it certainly was from both a revenue and growth perspective.  And, more importantly, based on management’s comments on the call, revenue, profitability and cash flow should continue to rapidly improve as recent investments aimed at accelerating customer acquisitions are already bearing fruit.  

Revenue is on a tear, posting yoy and sequential growth of 58% and 25%, respectively, through the most recent quarter.  Vascular testing-related revenue not only set a new record in Q2, it beat the prior high by more than 11%.  This is even more noteworthy given that the previous best was set in Q4 2016 and the final quarter of the year is typically the best in terms of the topline.  

And while revenue likely benefitted from orders that were received late in Q1 but not booked until Q2 (per comments on the Q1 call in May), management indicated on the Q2 call that a similar occurrence should benefit Q3 sales.  SMLR has been making preparations to satisfy the accelerating demand including increasing their manufacturing capacity and inventory levels.  

Almost all of the recent revenue growth has come from the (traditional) licensing channel with the HRA segment still in somewhat of an initial momentum-building phase.  That appears to have begun to evolve, however, with management mentioning that Q2 saw a significant number of QuantaFlo installations at both licensing and HRA customer sites.  These HRA installations represent future (potentially very near future) revenue given that this revenue model mostly hinges on per-test fees – as such, the recent ramp in installations should be a harbinger to initial meaningful contribution from this second customer channel.  

Management noted that they believe they are on their way to their best year ever.  Given that revenue in the 1H ’17 is ahead of any prior six-month period and this should only accelerate in the back half of this year, 2017 will almost undoubtedly be the best in terms of the top line.      

Revenue Growing Faster Than Expenses, Expected To Continue and Drive Profitability, Cash Flow
SMLR has recently made investments related to product upgrades, such as enhancing cybersecurity features, and certain software and integration customization work  - all aimed at facilitating the customer onboarding process as well as the overall customer experience and level of service.  This has resulted in an increase in expenses but, based on management’s comments, has been responsible for much of the recent revenue growth.  

To meet the increase in demand SMLR has also beefed up manufacturing capacity and incrementally expanded support-related capabilities.  These additional expenses have shown up in higher R&D expense and, to a lesser degree, in incremental cost of services.  While we had anticipated that R&D expense would taper from the near-record level in Q1 ($439k), that didn’t happen as these investment-type expenses actually ticked higher into Q2 and were solely responsible for the miss to operating loss relative to our number.  

But the good news is how these investments have benefitted revenue growth – specifically that growth in revenue outpaced that of expenses from Q1 to Q2 (25% vs 12%) as well as from 1H 2016 to 1H 2017 (48% vs 20%), resulting in improvement in operating loss in both the three and six month periods ending June 30, 2017.  The even better news is that this trend is expected to continue.  So while management is guiding for operating expenses to continue to climb, the positive ROI from these investments means that revenue will grow even faster.  The net result should be continued improvement in operating loss and cash burn.  Management’s goal is to reach operating profitability and a level of positive operating cash flow sometime this year.   

Q2 numbers…

Revenue was $2.58M, up 58% yoy, up 25% sequentially and about 16% better than our $2.23M estimate.  This was also an all-time high of vascular testing related revenue.  Management indicated that while there was some incremental contribution from equipment sales via the HRA channel, that the vast majority of the $523k sequential increase in revenue relates to new QuantaFlo installations at licensing-related accounts.  As a reminder, SMLR begins generating revenue immediately upon consummation of new licensing agreements.  Growth from this licensing channel is expected to remain robust and will likely account for the majority of growth, at least over the near-term.

The recent increase in QuantaFlo placements at home risk assessment customer sites means this segment, which we estimate has so far contributed little to revenue, could also soon make a more meaningful impact to Semler’s financials.  As a reminder of the HRA-related revenue model, Semler charges these customers on a per-test basis.  And as the HRA customer takes possession of the asset, the equipment is immediately expensed.  This differs from the annual/monthly licensing revenue model and asset depreciation (SMLR maintains ownership of the asset) that they employ with the likes of Medicare Advantage plans.  

While this was the second consecutive quarter of revenue beating our estimate (by a combined average of 13%), it was also the second consecutive quarter of operating expenses (including cost of services) coming in higher than what we expected (by a combined average of 16%).  Operating loss improved in the three and six months ending June 30, 2017 from the prior year comparable periods, although as a result of the aforementioned recent investments, the rate of the operating loss improvement has slightly lagged our expectations.  

A bloated and growing expense base could be of potentially significant concern, particularly if the sole goal is to chase revenue growth or market share at the expense of mounting operating losses.  But, given what we believe was sound explanation by management of the reason for the recent jump in expenses and what already appears to be a direct return in the form of even faster topline expansion (and improvement in operating loss), we see no indications which would warrant such concerns.   

Total operating expenses (including cost of revenue) were $3.13M in Q2.  While this is 12% higher than the $2.81M from Q1, as a result of revenue growing at the much faster rate of 25%, operating expenses fell to 121% of revenue in Q2 – down from 137% in Q1 of this year.  This metric (i.e. OpEx as percentage of revenue) will be the key one to watch and, given management’s prediction that revenue will grow at a rate faster than that of operating expenses, we should continue to see this fall.  Positive operating income will occur when this is under 100% which, again, SMLR has indicated could happen by current year-end (we more conservatively model initial positive operating income in 2018). 

We cover SMLR with a $7.50/share price target. See below for free access to our updated report including financial model.


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