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SMLR: Revenue, Earnings & Cash Flow Continue to Climb. Cash Flow Forecast Implies $45/Share Fair Value

By Brian Marckx, CFA



Q4 2018 Results: Revenue, Earnings & Cash Flow Continue to Climb. Cash Flow Forecast Implies $45/Share Fair Value…

Semler (SMLR) reported financial results for the fourth quarter ending December 31, 2018. While revenue slightly missed our estimate, it nonetheless came in strong – up 42% yoy, 7% better than Q3 and a new record high. Gross margin, at 88.2%, also remains strong and continues to show an incremental upward trajectory. Meanwhile, operating expenses were higher than what had anticipated and at an all-time high. The net result was EPS of $0.17, a penny miss to our $0.18 estimate, up from $0.04 in the prior year period and down from $0.19 in Q3’18.

But, despite the small earnings miss, we remain highly encouraged by the financial results, particularly as cash flow generation continues to be significant. Semler generated positive earnings and operating cash flow in every quarter during 2018, a trend that is expected to continue for the foreseeable future. We estimate that cash flow from operations was approximately $2M and $7M in the three and twelve months ending 12/31/18 (we’ll know the exact numbers when the 10-K is filed, likely next week). This compares to ~$900k and $440k in the respective prior-year periods. Net income and EPS for the full year were $5.0M and $0.66, compared to ($1.50M) and ($0.27) in 2017.

Management also made a priority of cleaning up their balance sheet and did so with their cash-generating proceeds. As of the close of fiscal 2017, SMLR was carrying more than $3.1M of debt and accrued interest. The was completely repaid by October 2018.

Cash flow estimate implies SMLR is worth $45/share…
As we noted in our Q3 update (Oct 29th Q3:Revenue Up 55%, Cash Flow Continues To Churn, Balance Sheet Cleaned, Moving PT to $35/share), given our comfort level with the likelihood of SMLR continuing to generate positive cash flow, we moved our valuation methodology from DCF to a cash flow multiple. Q4’s results, coupled with management’s ‘guidance’ of expected sequential revenue growth and sales outpacing that of operating expenses, further bolsters our confidence that our revised methodology is appropriate. Based on our 2019 cash flow estimate, fair value of SMLR is ~$45/share.

Management continues to guide for revenue to grow faster than expenses and for profitability and positive cash flow to persist. While the guidance includes the potential for some variability in the topline as associated with some ‘bulky’ order flow, the expectation remains that revenue will grow sequentially and continue to trend higher for the long-term. Gross margins ended 2018 at an average of better than 87% and could still have more room to widen. And while we may see some additional spend related to sales and support infrastructure as well as on areas aimed at enhancing the customer experience, management has demonstrated an ability to turn those ‘investments’ into revenue and profitability growth in short order. Our updated model shows SMLR generating revenue and EPS of $28.4M and $0.91 in 2019, which implies respective growth of 32% and 39%. If our model proves reasonably accurate, we think operating cash flow could be in the range of $10.5M - $11.5M, and possibly even higher. As it is now, we model cash flow of approximately $11.0M in 2019.

NASDAQ uplisting is in view…
The strong income growth, balance sheet cleansing and rapid increase in shareholders equity has gotten SMLR ever-closer to meeting NASDAQ eligibility requirements. Stockholders’ equity increased by $6.8M through the course of 2018, including by $1.9M in Q4, and ended the year at $4.2M. We think SMLR is likely to meet the $5M minimum stockholder equity requirement for uplisting to NASDAQ by the end of Q1 (they will also need to bring on at least another three independent directors in order to meet that related mandate).

Growth story remains intact…
The story and our outlook remain largely intact. So, we reiterate our comments from our recent earnings updates… the consistency and regularity of revenue growth and flatness of expenses lend credence to the validity of the company’s business model and strategy. Much of that hinges on the supposition that insurers have an economic interest in paying for their capitation-based insured to be tested for PAD. And with these insured tested annually, these are very sticky revenue units (somewhat analogous to an installed base but with much higher margins). Growth comes from adding new customers and additional testing from existing customers – which was the case in Q4 and throughout 2018 as a whole. And with SMLR’s customers (i.e. insurers) consisting of some of the largest Medicare Advantage plans and SMLR’s market penetration still in the low single-digits, this further validation of the company’s business model and insurers’ economic interests as it relates to PAD testing should signal ever-increasing confidence that revenue and profitability will continue to grow. The last three or four quarters have further bolstered our confidence in that regard.

Q4 numbers…
Revenue was $6.0M, up 42% (+$1.8M) yoy, up 7% ($385k) sequentially and about 2% (-$124k) lower than our $6.1M estimate. It was also a new record high. Citing a trend of both fixed and variable-type licenses which has resulted in less meaningful distinction between their previously-reported revenue categories of licensing (i.e. implied ‘fixed’) and usage (i.e. ‘variable’) fees, management noted that they will now report monthly revenue as either ‘fixed’ or ‘variable’. That breakdown was not shared on the Q4 call although may be something that we can provide some discussion around in future periods.

Q4 operating expenses (including cost of revenue) were $4.5M, or 76% of revenue, which is up from 72% (record low) in Q3’18 but well below the 91% in the prior year period. For the full year, operating expenses were $16.2M, equal to 75% of revenue, which compares to $13.3M and 107% of revenue in 2017. As we noted in the past, OpEx as a percentage of revenue was a key metric to keep an eye on and the consistent improvement is a testament to management’s efforts to keep costs in-check. It is also, in our opinion, further validation of the long-term viability of SMLR’s business model. The combination of ramping revenue and relatively flat growth in operating expenses has resulted in rapid improvement in operating income/loss.

View Exhibit I

Q4 net income was $1.4M – about 5% lower than Q3’18, the third highest (behind Q2 and Q3’18) in company history and more than 5x the $254k of net income in Q4’17. As the chart above illustrates, the improvement is reflective of both revenue growth and relatively flattish OpEx. The dramatic improvement in all three metrics (i.e. increasing revenue, flattish opex and growing income) is captured in the ‘OpEx as a % of revenue” line (lower is better).

When operating expenses were rapidly climbing during the early part of 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. It is also bolstered by management continuing to guide for the cost base to remain flattish despite continued anticipated revenue growth.

We cover SMLR with a $45/share price target. See above for free access to our most recent report which includes our financial model and valuation methodology.

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