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SMLR Revenue On A Tear With No Signs Of Letting Up

By Brian Marckx, CFA


Q1 2017 Results:  Revenue Jumps 37% YoY. Investments, Order Book Implies Strong Growth Will Continue…...

Semler (NASDAQ:SMLR) reported financial results for their first quarter ending March 31st.  Revenue remains relatively very strong.  Despite Q1 typically being the company’s lightest in terms of revenue, vascular testing related sales in the most recent quarter were the second highest in company history – and only bested by Q4 2016.  And since the final quarter of the year has typically been the best in terms of revenue, the Q4 to Q1 sequential comparison is innately difficult.  

Also encouraging were management’s comments on the call noting that additional orders were received late in Q1 for delivery in Q2 and that order flow may be accelerating.  In order to meet this expected increase in demand Semler has made certain preparations aimed at increasing manufacturing capacity.  They also purchased an additional $399k worth of equipment (i.e. vascular testing assets) in Q1 for lease – another sign that demand is on the rise   And while we think the HRA channel likely contributed little in Q1 given the influence from insurance policy-related nuances which typical benefit later periods, this should be more meaningful in the second half of the year.  So while vascular testing revenue was up 37% yoy, 11% better than our estimate and at the second highest level ever, fundamentals suggest that Q1 could prove to be relatively weak as compared to the remaining three quarters of 2017.

But while revenue was certainly a highlight, the financial snapshot in Q1 also included a sizeable increase in operating expenses and lower than estimated gross margin.  Much of the incremental OpEx and at least some of the gross margin “miss” (to be clear GM, at 73.7%, was still very healthy) appears to be associated with product-related (cyber) security upgrades.  Those costs, while expensed, are effectively product improvements (i.e. competitive enhancements) and are also not expected to persist over the long term.  And the decision to update the cybersecurity features seems almost prescient given the recent “WannaCry” ransomware attack which caused major problems including the shutdown of some hospitals.  Management also noted that additional expense related to the increase in (third-party) manufacturing capacity showed up in Q1.  So while the increase in OpEx offset much of the revenue growth in Q1, presumably all of this incremental expense/investment will be recouped by growth in (near-term) future sales.  

But while the increase in OpEx pushed operating loss higher than Q3 and Q4 2016, at $750k it is still improved compared to both of the first two quarters of last year.  Reaching profitability remains one of management’s near-term goals and, at least on a yoy basis, Q1 took another positive step in that direction.  

Q1 numbers…
Revenue was $2.06M, up 37% yoy, down 11% sequentially and about 11% higher than our estimate.  As a reminder, as Well-Chec was decommissioned at the end of 2015 that year, all current revenue relates to vascular testing.  We continue to model sequential revenue growth throughout the remainder of the year and view SMLR’s recent capacity and equipment-related investments as well as management’s comments related to growth in order-flow as positive indications in that regard.  

SMLR recently began targeting home risk assessment organizations (HRA) with its vascular testing offering.  The HRA channel is essentially an extension of the company’s base business (i.e. vascular testing largely targeting Medicare Advantage plans) 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.  While SMLR does not break out the source of vascular testing revenue (i.e. HRA vs insurance customers), management did indicate on the call that the HRA channel was not a significant contributor in Q1.  We do expect this to grow in the latter part of the year, however.  

Gross margin of 73.7% was up from 72.2% in Q1 2016, although down from 77.3% in Q4 2016 and below our 76.0% estimate.  As noted, some of the incremental development-related expense ran through cost of services which contributed to the sequential tightening.  While we think GM may continue to move around a little bit, we think it still has room trend incrementally higher.  Management has indicated that margins from the HRA customer segment will be at least as high as that from insurers.  In addition, the potential for some IT-related customization work as well as incremental contribution from sensor sales could offer additional margin enhancement.

OpEx was $2.27M, up from $2.02M in Q1 2016 and $1.89M in Q4 2016.  As explained earlier, most of the increase relates to R&D expense which should not persist over the long term.  

In terms of cash, SMLR used $505k ($516k ex-changes in working capital) in cash for operations in Q1.  They used another $399k for the (capital) purchase of additional vascular testing equipment – which is expected to be immediately put to use to generate additional revenue.  For comparison, SMLR purchased $591k in equipment in all of 2016.  Cash balance at Q1 quarter-end was $159k.  While SMLR raised $475k in Q1 via the sale of 190k shares (to major existing shareholders) through stock purchase agreements, the company has largely financed operations through debt.  We expect the company will continue to also seek to secure non-dilutive funding from sources such as loans as they have done in the past.    

We are maintaining or $7.50/share price target.  See below for free access to our updated report on SMLR.


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