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SMLR: Q4 2017 Results: Management Delivers on Guidance, Expects Growth in Revenue, EPS, Cash to Continue

By Brian Marckx, CFA


Semler (OTC:SMLR) reported financial results for their fourth quarter and full year ending December 31st.  Results were, again, extraordinarily strong, including revenue which set another new record high, beating the prior best by a healthy 17%.  The impressive top-line strength was far from the only highlight, however.  The final three months of 2017 marked the first quarter in company history with net income and EPS in the black – and that’s despite taking a sizeable (non-cash, one-time) charge related to write-down of WellChec assets.  Most importantly, operating cash flow was positive in Q4 – which marked the second consecutive quarter of generating cash from operations.  

Management has delivered on their prior guidance, which we think provides credence in their ability to meet their current forecasts.  As a reminder, early in 2017 management said that they expected to set new revenue records during the year.  Not only was full year revenue at a new high, but three of the four quarters (Q2, Q3, Q4) set new consecutive records in vascular testing (i.e. comparables exclude discontinued operations) revenue.  Management also said that they expected growth in revenue to outpace that of operating expenses – that also happened and resulted in consecutive quarterly improvement in profitability.  And finally, they predicted reaching cash flow positive - which happened by Q3 (and also in Q4).     

Per their comments on the Q4 call (Feb 1st), management believes growth in QuantFlo installations, higher pricing, growth in the HRA-related segment (i.e. usage fees) and leverage from their recurring revenue model will continue to push the top line higher.  And, coupled with the ability to maintain a relatively flat operating cost structure, SMLR expects profitability will also increase.  Improved profitability means cash flow generation should also increase which, coupled with cash on-hand, should be sufficient to meet operational needs and debt obligations.  2018 is expected to mark the first full year of positive net income and positive operating cash flow.  Importantly, management does not expect to need to raise additional capital.    

While the rapid (and expected continued) improvement in revenue, profitability and cash flow are the major highlights as it relates to strength of the business, this is complemented by recent increased diversification and balance of the revenue sources via growth in the HRA segment.  While most of the recent revenue growth has come from the (traditional) licensing channel, it appears that the home risk assessment (HRA) segment has now started to become a more substantial contributor.  

While Semler has not always disclosed the break-out of revenue by source, comments on recent earnings calls suggest that the HRA business has continued to gain additional traction.  Usage fees (i.e. HRA-related revenue) grew from approximately $215k in Q2 2017 (~8% of total revenue), to ~$550k in Q3 (~15% of total revenue) and to ~$800k in Q4 (~19% of total revenue).  And while usage fee revenue may be somewhat more variable in nature (based on HRA contracts with insurers) as compared to SMLR’s licensing-related revenue, the expectation is that this segment will continue to grow over the long-term.  

Importantly, management indicated that there is no expectation of the licensing business slowing down.  In fact, comments on the Q4 call included expectation for sequential growth in licensing revenue through at least the first two quarters of 2018.  We also continue to think market fundamentals favor long-term growth for Semler.  PAD afflicts an estimated 20M Americans, yet has been diagnosed in only 25%.  Insurers have a financial interest in diagnosing PAD as the potential consequences, including heart attack and stroke, are relatively extremely costly to treat.  Physicians are also incentivized to use QuantaFlo as it offers an easier-to-use and (per clinical data) more accurate diagnosis than competing technologies (such as Doppler).  The relative operating simplicity of QuantaFlo means a relatively low-level (and low cost) medical aide can administer the test – which frees up physicians and improves profitability.  

Déjà Vu: Revenue Growing Faster Than Expenses, Driving Profitability, Cash Flow  
Aside from the updated financial results, SMLR’s story has remained largely the same since our last recent updates.  Given that the story is regular and continued improvement in financial results, no change to the plot is obviously positive.  While expenses have increased, the rate of growth has been outpaced by that of revenue – resulting in regular improvement in operating loss/income throughout 2017.  This trend is expected to continue and result in not only sustainable and growing operating income, but also reaching a point of positive cash flow in the near-term.    

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.  An additional near-term upgrade is to provide system compatibility with iOS (in addition to current capability with Android and Windows).  

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.  The initial related increase in R&D expense happened from Q4 2016 ($232k) to Q1 2017 ($439k) and ticked up to $486k in Q4 2017.   

But the good news is how these investments have already benefitted revenue growth – specifically that growth in revenue has significantly outpaced that of expenses from Q1 to Q2 (25% vs 12%) and Q2 to Q3 (40% vs 13%) and Q3 to Q4 (17% vs 3%, ex-one time charge) as well as yoy for the full year 2017 (68% vs 36%).  The net result has been regular and significant improvement in profitability and cash flow.  The even better news is that these trends are 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 which should result in continued improvement in net income and cash burn.     

Q4 numbers…
Revenue was $4.2M, up 82% (+$1.9M) yoy, up 17% (+$606k) sequentially and about 5% higher than our $4.0M estimate.  This was also a new record high.  As noted, while the company does not publicly itemize revenue by customer channel, indications are that the HRA segment has recently become a more meaningful contributor (accounting for ~19% of total revenue in Q4).

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 continue to account for the majority revenue, at least over the near-term.

The recent increase in QuantaFlo placements at HRA customer sites means this segment’s proportional contribution to total revenue could continue to grow.  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.  

Q4 operating expenses (including cost of revenue) were $3.8M, or 91% of revenue, compared to our $3.9M, or 95% of revenue, estimate.  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.
When operating expenses were rapidly climbing earlier in 2017 we cautioned that a bloated and growing expense base could be of potentially significant concern, particularly if the sole goal was to chase revenue growth or market share at the expense of mounting operating losses.  But, we also noted that we believed management’s explanation for the recent jump in expenses was sound (i.e. related to revenue-generating investments) and, as such, saw no indications for significant concern.  Importantly, our confidence is further bolstered by the last few quarters’ results and the rapid pace of absorption of incremental expenses.   

Q4 operating income of $376k – but, excluding a non-cash charge for write-down of WellChec-related assets, operating income would have been $627k.  This is just the second quarter in SMLR’s history posting positive operating income (the other, in Q3 2017 was $76k) and the first time generating positive net income.  Net income and EPS were $254k (or $505k ex-charge) and $0.04 (or $0.08 ex-charge).  

We have made meaningful upward revisions to our forecasted revenue and EPS in every period in our model.  We are modeling 2018 revenue and EPS of $18.4M (+48%) and $0.25 (vs. minus $0.27 in 2017).    

Updates to our model have resulted in our price target moving from $9/share to $11/share. Our full report, available for free via link below, includes our financial model and valuation methodology. 


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