Semler Scientific(SMLR) - 2020 Q4 - Annual Report

Part I Business Semler Scientific is a medical technology company focused on developing and marketing products for evaluating and treating chronic diseases - The company's main product is QuantaFlo®, an FDA 510(k) cleared device used to aid in the diagnosis of peripheral arterial disease (PAD)[22][25] - The business primarily uses a license model for QuantaFlo®, with approximately two-thirds of customers on a fixed-fee model and just under one-third on a variable, per-test fee model[27] - A significant portion of revenue comes from a single U.S. diversified healthcare company, which accounted for 47.2% of revenues in 2020[28] - In September and October 2020, the company entered into an exclusive distribution agreement for a new product line and made investments in two private companies to expand its product offerings beyond PAD[22][38][41] - As of December 31, 2020, the company had 86 full-time employees, a 28% increase from 67 employees in the prior year[99] Financial Performance | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Total Revenues | $38.6 million | $32.8 million | | Net Income | $14.0 million | $15.1 million | | Pre-tax Net Income | $16.5 million | $10.7 million | Products and Services The company's sole marketed product is QuantaFlo®, a non-invasive, four-minute test for PAD, primarily offered through a monthly license model - QuantaFlo® is a four-minute, in-office blood flow test that uses a sensor clamp on a toe or finger to generate a blood flow waveform and assess for flow obstruction[26] - The company primarily licenses QuantaFlo® to customers, including insurance plans, physician groups, and risk assessment groups, rather than selling the equipment outright[27][28] - In September 2020, the company entered an exclusive distribution agreement for a new product line, agreeing to purchase $1.2 million of inventory and pay royalties of 0% to 10% of net sales[38] Market Opportunity The market for QuantaFlo® is driven by financial incentives in Medicare Advantage for identifying PAD, a common and under-diagnosed condition - The Medicare Advantage program's risk adjustment model provides a financial incentive for health plans to identify and code for conditions like PAD, as it leads to higher per-patient payments[30][31] - Peripheral Arterial Disease (PAD) is estimated to be undiagnosed in 75% of cases, representing about 12 million Americans, with the total affected population in the U.S. estimated at 20 million[32] - The primary target market for QuantaFlo® includes insurance plans with Medicare Advantage patients and providers caring for over 80 million Americans older than 50[35] Strategy The company's strategy focuses on marketing QuantaFlo® via a recurring revenue model, expanding vascular testing, and exploring new product offerings - Target customers with patients at risk for PAD, including over 400,000 physicians and other potential customers in the U.S[43] - Expand tools available to internists and non-peripheral vascular experts, for whom traditional ABI testing was previously impractical[43] - Develop and explore additional product offerings through internal R&D and external arrangements, such as marketing, distribution, and potential acquisitions, to address chronic disease management[43] Competition QuantaFlo® primarily competes with traditional ankle-brachial index (ABI) devices, differentiating itself as a simpler, cuff-less tool for non-specialists - The main competitor is the standard blood pressure cuff ABI device, manufactured by several larger companies with more financial resources[50] - QuantaFlo® is positioned as a tool for internists and non-specialists, and for patients where traditional cuff-based ABI is difficult (e.g., obese patients, non-compressible arteries)[52] - The company anticipates that competitors will continue to enter the PAD market with competing digital devices[53] Government Regulation The company's products are subject to extensive FDA regulation, including 510(k) clearance, and are impacted by healthcare reimbursement policies and fraud and abuse laws - QuantaFlo® is a medical device subject to extensive FDA regulation, including design, manufacturing, labeling, and pre-market 510(k) clearance[64][67] - The success of QuantaFlo® is dependent on the availability of coverage and reimbursement from third-party payors, including Medicare and private insurance, although the product is not specifically approved under any single reimbursement code[75][76] - The company is subject to federal and state healthcare fraud and abuse laws, such as the Anti-Kickback Law and the False Claims Act, which carry severe penalties for violations[82][83][84] - The Health Care Reform Law (ACA) has influenced the business by shifting focus to capitated payments and rewarding the identification of chronic conditions, but the company faces uncertainty regarding the law's potential repeal or modification[94][95] Risk Factors The company faces significant risks including reliance on QuantaFlo®, customer concentration, extensive healthcare regulations, stock delisting, and intellectual property protection - Business Risks: The company actively markets only one product, QuantaFlo®, and its success is not guaranteed. A significant portion of revenue is concentrated with a few customers; in 2020, two customers accounted for 47.2% and 22.8% of revenues[110][125] - Regulatory & Reimbursement Risks: The business is subject to extensive FDA regulation and unannounced inspections. Widespread acceptance of QuantaFlo® depends on healthcare providers obtaining adequate reimbursement, which is not guaranteed as the product is not specifically approved under any single reimbursement code[116][117][145] - Market & Stock Risks: The company's common stock was delisted from the Nasdaq Capital Market and now trades on the OTCQB, which may negatively impact liquidity and stock price. A small number of executive officers, directors, and significant stockholders hold approximately 48.6% of the common stock, giving them substantial control[173][167] - Operational Risks: The company relies on a small number of key personnel and independent suppliers for manufacturing. Any disruption could negatively impact operations. The business has also been affected by the COVID-19 pandemic, which caused decreased test volumes in early 2020[121][126][108] - Intellectual Property Risks: Success depends on the ability to protect proprietary information. The company holds one U.S. patent for its apparatus, which expires in 2027, and faces risks of challenges or infringement claims[63][158][160] Properties The company's corporate headquarters and operations fulfillment space are located in a leased facility in Santa Clara, California - The company leases an operations fulfillment space in Santa Clara, CA, which also serves as its corporate headquarters[194] Legal Proceedings The company is not currently a party to any material legal proceedings expected to have a material adverse effect on its business or financial condition - As of the report date, the company is not involved in any litigation expected to have a material adverse effect on the business[195] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the OTCQB market under "SMLR" since its 2016 Nasdaq delisting, with no anticipated cash dividends - The company's common stock has traded on the OTCQB under the symbol "SMLR" since August 11, 2016[198] - As of February 26, 2021, there were 6,708,672 shares of common stock outstanding and approximately 37 stockholders of record[6][200] - The company has never declared or paid cash dividends and does not anticipate paying them in the foreseeable future[201] Fiscal Year 2020 Stock Price | Fiscal Year 2020 | High | Low | | :--- | :--- | :--- | | First Quarter | $57.84 | $30.00 | | Second Quarter | $51.50 | $32.52 | | Third Quarter | $60.00 | $43.20 | | Fourth Quarter | $95.00 | $50.11 | Management's Discussion and Analysis of Financial Condition and Results of Operations In FY2020, revenues grew to $38.6 million, pre-tax net income increased, and liquidity improved to $22.1 million cash, despite a net income decrease due to a 2019 tax benefit Results of Operations (2020 vs. 2019) In 2020, revenues increased by 17.8% to $38.6 million, and income from operations grew to $16.0 million, though net income decreased to $14.0 million due to a prior year tax benefit Financial Metric Comparison | Financial Metric | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Revenues | $38.6M | $32.8M | +17.8% | | - Fixed-fee licenses | $25.7M | $22.9M | +12.2% | | - Variable-fee licenses | $11.6M | $8.9M | +30.3% | | Total Operating Expenses | $22.6M | $22.1M | +2.3% | | Cost of Revenues | $3.4M | $3.7M | -8.1% | | Sales & Marketing Expense | $9.9M | $9.0M | +10.0% | | General & Admin Expense | $6.4M | $7.0M | -8.6% | | Income from Operations | $16.0M | $10.7M | +49.5% | | Net Income | $14.0M | $15.1M | -7.3% | - The decrease in net income was primarily due to a $4.4 million income tax benefit in 2019 from the release of a valuation allowance, compared to a $2.5 million income tax expense in 2020[240] Liquidity and Capital Resources The company's liquidity significantly improved in 2020, with cash increasing to $22.1 million at year-end, driven by $15.4 million in net cash from operating activities and no material indebtedness Cash and Working Capital | Metric (as of Dec 31) | 2020 | 2019 | | :--- | :--- | :--- | | Cash | $22.1 million | $7.7 million | | Working Capital | $21.7 million | N/A | | Total Current Liabilities | $4.5 million | $5.2 million | Cash Flow Activities | Cash Flow Activity (Year Ended Dec 31) | 2020 | 2019 | | :--- | :--- | :--- | | Net Cash from Operating Activities | $15.4 million | $12.7 million | | Net Cash used in Investing Activities | ($1.3 million) | ($1.7 million) | | Net Cash from (used in) Financing Activities | $0.23 million | ($6.6 million) | - The company has no material outstanding indebtedness as of December 31, 2020[248] Critical Accounting Policies and Estimates Management identifies critical accounting policies requiring significant judgment, including allowance for doubtful accounts, inventory, share-based compensation, income taxes, and valuation of private investments - Key critical accounting estimates include: allowance for doubtful accounts, inventory valuation, share-based compensation, income tax recognition and measurement, and valuation of investments[219] - Investments in privately held companies without readily determinable fair values are recorded at cost, adjusted for subsequent observable price changes or impairments[227] - The company uses the Black-Scholes model to value stock options, which requires subjective assumptions about volatility, expected life, and interest rates[224] Controls and Procedures As of December 31, 2020, management concluded disclosure controls were effective, having successfully remediated prior year material weaknesses in internal control over financial reporting - Management concluded that disclosure controls and procedures were effective as of December 31, 2020[255] - The company remediated material weaknesses identified in 2019, which related to insufficient segregation of duties, ineffective IT controls, inadequate data validation, and insufficient documentation for management review controls[257] - Remediation actions included hiring additional accounting staff, reassessing and formalizing policies, engaging an outside firm for assistance, and implementing enhanced controls and documentation procedures[258][266] Part III Directors, Executive Officers and Corporate Governance This section details the company's board of directors and executive officers, including their independence, audit committee composition, and the adopted Code of Business Conduct and Ethics - The board of directors consists of five members: Douglas Murphy-Chutorian, M.D. (CEO), Arthur Leibowitz, M.D., Daniel S. Messina, Cindy H. Moon, and Wayne T. Pan, M.D., Ph.D[268] - The board has affirmatively determined that four of its five directors are independent: Dr. Leibowitz, Mr. Messina, Ms. Moon, and Dr. Pan[281] - The audit committee is comprised of Dr. Pan (Chairman), Mr. Messina, and Ms. Moon. Mr. Messina is qualified as an "audit committee financial expert"[284] - The company has adopted a Code of Business Conduct and Ethics that applies to its principal executive and financial officers[288] Executive Compensation This section details the compensation for named executive officers, including CEO Dr. Douglas Murphy-Chutorian's $721,982 total compensation in 2020, and outlines non-employee director compensation Executive Compensation Summary | Name and Principal Position | Year | Salary ($) | Non-Equity Incentive Plan ($) | All Other Comp. ($) | Total ($) | | :--- | :--- | :--- | :--- | :--- | :--- | | Douglas Murphy-Chutorian, M.D., CEO | 2020 | 400,000 | 300,000 | 21,982 | 721,982 | | | 2019 | 400,000 | 744,708 | 25,545 | 1,170,253 | | Andrew B Weinstein, SVP, Finance | 2020 | 294,792 | 0 | 31,545 | 352,170 | | | 2019 | 265,625 | 0 | 1,686 | 322,311 | | Daniel E. Conger, VP, Finance | 2020 | 210,000 | 0 | 31,545 | 283,545 | | | 2019 | 200,000 | 0 | 23,058 | 263,058 | - As of December 31, 2020, CEO Dr. Murphy-Chutorian held outstanding options to purchase 765,000 shares, all of which were exercisable[299] - Non-employee directors receive an annual cash retainer of $45,000, plus additional retainers for committee service. In 2020, total cash fees paid to non-employee directors ranged from $6,000 to $70,500[302][303] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters This section details beneficial ownership of common stock as of February 26, 2021, with William H.C. Chang owning 16.7% and all directors/officers owning 13.5% as a group Beneficial Ownership | Name of Beneficial Owner | Percentage of Shares Beneficially Owned | | :--- | :--- | | William H.C. Chang | 16.7% | | Park West Asset Management, LLC | 9.7% | | Eric Semler | 8.5% | | Nantahala Capital Management, LLC | 5.4% | | Dr. Douglas Murphy-Chutorian (CEO) | 11.9% | | All directors and officers as a group | 13.5% | Equity Compensation Plan Information | Plan Category | Securities to be Issued Upon Exercise | Weighted Avg. Exercise Price | Securities Remaining for Future Issuance | | :--- | :--- | :--- | :--- | | Equity Compensation Plans Approved by Securityholders | 1,451,420 | $3.25 | 997,163 | Certain Relationships and Related Transactions, and Director Independence This section discloses related party transactions since January 1, 2019, including warrant repurchases from the CEO's family trust and a sale of private company securities to a significant stockholder - In May and November 2019, the company repurchased warrants to acquire a total of 159,339 shares from the family trust of CEO Dr. Murphy-Chutorian for an aggregate price of approximately $6.6 million[312][313] - In December 2020, the company sold shares of preferred stock and warrants of a private company to a significant stockholder for a cash purchase price of $1.9 million[314] - The company employs two immediate family members of Daniel E. Conger, its Vice President of Finance, and paid them an aggregate of $211,618 in salary and bonuses since January 1, 2019[315] Principal Accounting Fees and Services This section details fees paid to BDO USA, LLP for 2020 and 2019, totaling $356,850 and $429,000 respectively, primarily for audit services and all pre-approved by the audit committee Accounting Fees | Fee Type | 2020 | 2019 | | :--- | :--- | :--- | | Audit Fees | $328,700 | $402,000 | | Tax Fees | $28,150 | $27,000 | | Total | $356,850 | $429,000 | - All audit and non-audit services provided by BDO USA, LLP were pre-approved by the company's audit committee[320] Part IV Exhibits, Financial Statement Schedules This section lists financial statements, schedules, and exhibits filed as part of the Form 10-K, including corporate governance documents, material contracts, and officer certifications - This item provides an index of all financial statements and exhibits included with the annual report filing[323][324] Financial Statements Audited financial statements for 2020 and 2019 show significant asset growth to $34.6 million, with BDO USA, LLP providing an unqualified opinion and highlighting a private investment as a critical audit matter Balance Sheet (in thousands) | Balance Sheet (in thousands) | Dec 31, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Cash | $22,079 | $7,741 | | Total Current Assets | $26,263 | $11,443 | | Total Assets | $34,639 | $18,287 | | Total Current Liabilities | $4,514 | $5,207 | | Total Stockholders' Equity | $29,793 | $13,073 | Statements of Income (in thousands) | Statements of Income (in thousands) | Year Ended Dec 31, 2020 | Year Ended Dec 31, 2019 | | :--- | :--- | :--- | | Revenues | $38,603 | $32,767 | | Income from Operations | $15,961 | $10,708 | | Net Income | $14,007 | $15,084 | | Diluted EPS | $1.74 | $1.88 | - The independent auditor, BDO USA, LLP, identified the accounting for a non-routine investment in a private company via a stock purchase agreement as a Critical Audit Matter due to the significant judgment required[335][337] Notes to Financial Statements: Concentration of Credit Risk The company has significant customer concentration, with two customers accounting for 47.2% and 22.8% of 2020 revenue, and four customers representing a large portion of accounts receivable - In 2020, two customers accounted for 47.2% and 22.8% of the company's revenue[388] - As of December 31, 2020, four customers accounted for 31.2%, 19.4%, 15.7% and 10.4% of accounts receivable[388] Notes to Financial Statements: Income Taxes The company's effective tax rate was 15.04% in 2020, significantly different from 2019 due to a valuation allowance release, and holds federal and California NOL carryforwards Income Tax Metrics | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Total income tax provision (benefit) | $2,479,000 | $(4,383,000) | | Effective income tax rate | 15.04% | (40.96)% | - As of Dec 31, 2020, the company has federal NOL carryforwards of $310,000 and California NOL carryforwards of $5,746,000[411] - The company claimed $466,000 in employee retention payroll tax credits under the CARES Act during 2020[412]