Semler Scientific, Inc. - Quarter Report: 2021 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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For the quarterly period ended March 31, 2021

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For the transition period from ___ to ___

Commission File Number 001-36305

SEMLER SCIENTIFIC, INC.

(Exact name of registrant as specified in its charter)

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Securities registered pursuant to Section 12(b) of the Act: None.

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐    No ☒

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As of May 3, 2021, there were 6,725,226 shares of the issuer’s common stock, $0.001 par value per share, outstanding.

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.

In some cases, you can identify forward-looking statements by terminology, such as “expects,” “anticipates,” “intends,” “estimates,” “plans,” “believes,” “seeks,” “may,” “should,” “continue,” “could” or the negative of such terms or other similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this report.

You should read this quarterly report and the documents that we reference herein and therein and have filed as exhibits to this report and our other filings with the Securities and Exchange Commission, or SEC, completely and with the understanding that our actual future results may be materially different from what we expect. You should assume that the information appearing in this quarterly report is accurate as of the date of this quarterly report only. Because the risks and uncertainties referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statements. These risks and uncertainties, along with others, are described under the heading “Risk Factors” in our annual report on Form 10-K filed with the SEC on March 9, 2021. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of the information presented in this quarterly report, and particularly our forward-looking statements, by these cautionary statements.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

Semler Scientific, Inc.

Condensed Statements of Income

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

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See accompanying notes to unaudited condensed financial statements.

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Semler Scientific, Inc.

Condensed Balance Sheets

(In thousands of U.S. Dollars, except share and per share data)

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See accompanying notes to unaudited condensed financial statements.

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Semler Scientific, Inc.

Statements of Stockholders’ Equity

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

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Semler Scientific, Inc.

Condensed Statements of Cash Flows

Unaudited

(In thousands of U.S. Dollars)

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See accompanying notes to unaudited condensed financial statements

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

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1.           Basis of Presentation

Semler Scientific, Inc., a Delaware corporation (“Semler” or “the Company”), prepared the unaudited interim financial statements included in this report in accordance with United States generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2020 filed with the SEC on March 9, 2021 (the “Annual Report”). In the opinion of management, these financial statements include all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. The results of operations for the interim periods shown in this report are not necessarily indicative of the results that may be expected for any future period, including the full year.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations.

COVID-19

On January 30, 2020, the World Health Organization (“WHO”) declared the recent novel coronavirus (COVID-19) outbreak a global health emergency, which prompted national, state and local governments to begin putting actions in place to slow the spread of COVID-19. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic. The outbreak of COVID-19 resulted in travel restrictions, quarantines, “stay-at-home” and “shelter-in-place” orders and extended shutdown of certain businesses around the world. While restrictions began to ease in the second quarter and activities began to resume, recent outbreaks could lead to restrictions being reimplemented. In the first half of 2020, the Company’s revenues, primarily from variable-fee licenses, were negatively impacted by the COVID-19 pandemic. In the second half of 2020 and the first quarter of 2021, the Company’s revenues, primarily from variable-fee licenses, rebounded to and even exceeded pre-COVID-19 levels. The extent and duration of the pandemic is unknown, and the future effects on the Company’s business are uncertain and difficult to predict. The Company is continuing to monitor the events and circumstances surrounding the COVID-19 pandemic, which may require adjustments to the Company’s estimates and assumptions in the future.

Recently Issued Accounting Pronouncements

Accounting Pronouncements Recently Adopted

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the general principles for income taxes. This update is effective for the Company’s annual periods beginning after December 15, 2020, including interim periods within those fiscal years. The Company adopted the new standard on January 1, 2021 and determined that the adoption of this new accounting guidance did not have a material impact on its financial statements.

In January 2020, the FASB issued ASU No. 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). The amendments in this ASU clarify the interaction between the accounting for investments in equity securities, investment in equity method and certain derivatives instruments. The ASU is expected to reduce diversity in practice and increase comparability of the accounting for these interactions. This ASU is effective for fiscal years beginning after December 15, 2020. The Company adopted the new standard on January 1, 2021 and determined that the adoption of this new accounting guidance did not have an impact on its financial statements.

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

In October 2020, the FASB issued ASU No. 2020-10, Codification Improvements. This ASU is the final update of the 2019 proposed ASU, Codification Improvements, of which various topics in the Codification are amended, clarified, simplified, or otherwise modified to improve the Codification. The amendments in Section B of this ASU improve the Codification by ensuring that all guidance that requires or provides an option for an entity to provide information in the notes to financial statements is codified in the disclosure section of the Codification. The amendments in Section C of this ASU are varied in nature and may affect the application of the guidance in cases which the original guidance may have been unclear. The amendments in Sections B and C of this ASU are effective for the Company’s annual periods beginning after December 15, 2020, and the amendments should be applied retrospectively, and should be applied at the beginning of the period that includes the adoption date. The Company adopted the new standard on January 1, 2021 and determined that the adoption of this new accounting guidance did not have a material impact on its financial statements.

Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”). This ASU requires timelier recording of credit losses on loans and other financial instruments held. Instead of reserves based on a current probability analysis, Topic 326 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. All organizations will now use forward-looking information to better inform their credit loss estimates. Topic 326 requires enhanced disclosures regarding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide information about the amounts recorded in the financial statements. In addition, Topic 326 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326 Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, to introduce amendments which will affect the recognition and measurement of financial instruments, including derivatives and hedging. In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments – Credit Losses (Topic 326); Targeted Transition Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments upon adoption of Topic 326. This standard and related amendments are effective for the Company’s fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year 2023. The Company does not anticipate this new standard will have a material impact on its financial statements.

In March 2020, the FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments. This ASU improves and clarifies various financial instruments topics, including the current expected credit losses standard issued in 2016 (ASU No. 2016-13). The ASU includes seven different issues that describe the areas of improvement and the related amendments to GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments have different effective dates. The Company is evaluating the effect of adopting this new accounting guidance, but does not expect adoption will have a material impact on the Company's financial statements.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedient and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. In response to the concerns about structural risks of interbank offered rates and, particularly, the risk of cessation of the London Interbank Offered Rate, regulators in several jurisdictions around the world have undertaken reference rate reform initiatives to identify alternative reference rates that are more observable or transaction-based and less susceptible to manipulation. The ASU provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. The ASU can be adopted no later than December 1, 2022, with early adoption permitted. The Company has not yet adopted this ASU and is evaluating the effect of adopting this new accounting guidance.

In August 2020, the FASB issued ASU No. 2020-06, Debt--Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity's Own Equity (Subtopic 815-40). The amendments in this ASU affect entities that issue convertible instruments and/or contracts in an entity's own equity. For contracts in an entity's own equity, the contracts primarily affected

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

are freestanding instruments and embedded features that are accounted for as derivatives under the current guidance because of failure to meet the settlement conditions of the derivatives scope exception related to certain requirements of the settlement assessment. The FASB simplified the settlement assessment by removing the requirements (1) to consider whether the contract would be settled in registered shares, (2) to consider whether collateral is required to be posted, and (3) to assess shareholder rights. Those amendments also affect the assessment of whether an embedded conversion feature in a convertible instrument qualifies for the derivatives scope exception. Additionally, the amendments in this ASU affect the diluted EPS calculation for instruments that may be settled in cash or shares and for convertible instruments. The ASU reduces the number of accounting models for convertible debt instruments and convertible preferred stock by eliminating the beneficial conversion feature model and cash conversion model. As compared with current GAAP, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument. The interest rate of more convertible debt instruments will be closer to the coupon interest rate. This ASU is effective for the Company’s fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company has not yet adopted this ASU and is evaluating the effect of adopting this new accounting guidance.

In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). This ASU clarifies the scope of Topic 848 so that derivatives affected by the discounting transition due to reference rate reform initiatives are explicitly eligible for certain optional expedients and exceptions in Topic 84. In addition, to efficiently address another emerging issue related reference rate reform and respond to stakeholder feedback on the proposed feedback on the proposed update on this project, the Board decided to clarify that a receive-variable-rate, pay-variable-rate cross-currency interest rate swap may be considered an eligible hedging instrument in a net investment hedge if both legs of the swap do not have the same repricing intervals and dates as of the result of reference rate reform. The amendments in this update are elective and apply to all entities that have derivative instruments that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform. The amendments also optionally apply to all entities that designate receive-variable-rate, pay-variable-rate cross-currency interest rate swaps as hedging instruments in net investment hedges that are modified as a result of reference rate reform. An entity may elect to apply the amendments in this update on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The amendments in this update do not apply to contract modifications made after December 31, 2022, new hedging relationships entered into after December 31, 2022, and existing hedging relationships evaluated for effectiveness in periods after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that apply certain optional expedients in which the accounting effects are recorded through the end of the hedging relationship (including periods after December 31, 2022). The Company has not yet adopted this ASU and is evaluating the effect of adopting this new accounting guidance.

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2.Variably-Priced Revenue

The Company recognizes variable-fee licenses (i.e., fee per test) and sales of hardware equipment and accessories in accordance with Topic 606. Total fees from variable-fee licenses represent approximately $5,658 and $2,703 for the three months ended March 31, 2021 and 2020, respectively. Total sales of hardware and equipment accessories represent approximately $331 and $270 of revenues for the three months ended March 31, 2021 and 2020, respectively. Essentially all of the variable-fee licenses are with large healthcare organizations. The remainder of the revenue is earned from leasing the Company's testing product for a fixed fee, which is not subject to Topic 606.

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3. Inventory

Inventory, which is made up of finished goods, is recorded at the lower of cost or net realizable value. Cost is determined on the first-in, first-out method. The Company periodically analyzes its inventory levels to identify inventory that has a cost basis in excess of its estimated realizable value, and writes down such inventory as appropriate.

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

In September 2020, the Company entered into an agreement with Private company #1 to exclusively market and distribute a new product line. Product inventory under this agreement was as follows for the periods presented:

Under this agreement, the Company committed to purchase $1,200 of product inventory. The Company prepaid for $900 of product inventory and has received $289 of product inventory as of March 31, 2021. The balance of prepaid inventory was $611 as of March 31, 2021.  

The Company also agreed to make royalty payments ranging from 0% to 10% of net sales depending on the average net sales price of the distributed products. Unless early terminated in accordance with its terms, this exclusive distribution agreement will remain in full force and effect until December 31, 2024, and thereafter there is an option for this agreement to be automatically renewed for additional 4-year terms.

The Company had other hardware inventory of $356 purchased from other vendors as of March 31, 2021. Total inventory, which includes inventory from Private company #1, was $639 and $340 as of March 31, 2021 and December 31, 2020, respectively.

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4.           Assets for Lease, net

The Company enters into contracts with customers for the Company’s QuantaFlo^® product. The Company has determined these contracts meet the definition of a lease under Topic 842. Operating leases are short-term in nature (monthly, quarterly or one year), and all of which have renewal options. The assets that may be associated with these leasing arrangements are identified below as assets for lease. Upon shipment under operating leases, assets for lease are depreciated. Upon shipment under variable-fee license contracts, these assets for lease are sold to the customers, and the asset is recognized as cost of revenue under Accounting Standards Codification or ASC 606, Revenue from Contracts with Customers. During the three months ended March 31, 2021 and 2020, the Company recognized approximately $7,194 and $6,457, respectively, in lease revenues related to these arrangements, which is included in Revenues on the Condensed Statements of Income.

Assets for lease consist of the following:

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Depreciation expense amounted to $113 and $128 for the three months ended March 31, 2021 and 2020, respectively. Reduction to accumulated depreciation for returned items was $141 and $65 for the three months ended March 31, 2021 and 2020, respectively. The Company recognized a loss on disposal of assets for lease in the amount of $83 and $66 for the three months ended March 31, 2021 and 2020, respectively.

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5.            Property and Equipment, net

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Capital assets consist of the following:

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Depreciation expense amounted to $43 and $31 for the three months ended March 31, 2021 and 2020, respectively.

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

6.Long-Term Investments

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Long term investments consist of the following for the periods presented:

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Private Company #2:

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In October 2020, the Company purchased 211,928 shares of common stock of Private company #2 from certain sellers in exchange for 40,922 shares of the Company’s common stock. The total fair value of the purchase consideration as of December 31, 2020 was approximately $2,230. The Company had the right to, in various circumstances, sell any or all of these shares of common stock back to the sellers in exchange for the shares of the Company’s common stock originally issued to the sellers. These rights were tied to (a) Private company #2 completing a bona fide equity financing, (b) the share price in such financing, (c) the timing of delivery of certain documents to the Company or (d) at the Company’s sole option, at any time between March 31, 2021 and October 8, 2021. Subsequent to March 31, 2021, the Company exercised the put option. See Note 14 to the Unaudited Condensed Financial Statements for the details.

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In September 2020, the Company acquired a promissory note from Private company #2 in the principal amount of $500, $100 of which was retained for expense reimbursement. Subsequently, in December 2020, the Company agreed to convert the promissory note, together with all accrued interest thereon, into shares of preferred stock of Private company #2 as repayment in full of the promissory note. The value of the note exchanged for the shares of preferred stock of Private company #2 held by the Company as of December 31, 2020 was approximately $512.

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Private Company #3:

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In October 2020, the Company acquired from a seller a convertible promissory note previously issued by Private company #3 to such seller for a purchase price of $59, which represented the $50 principal amount of the note and all accrued and unpaid interest thereon.

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Subsequently, in October 2020, the Company purchased $250 of shares of preferred stock of Private company #3, and in connection with such transaction, the convertible promissory note, together with all accrued interest thereon, also converted pursuant to its terms into shares of preferred stock of Private company #3 as repayment in full of such convertible promissory note. The value of consideration exchanged for the shares of preferred stock of Private company #3 held by the Company as of March 31, 2021 was approximately $309.

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Subsequent to March 31, 2021, the Company entered into a distribution agreement with Private company #3. See Note 14 to the Unaudited Condensed Financial Statements for the details.

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The investments in Private company #2 and #3 securities that were retained by the Company as of December 31, 2020 and March 31, 2021 were recorded in accordance with ASC 321, Investments – equity securities, which provides that investments in equity securities in privately-held companies without readily determinable fair values are generally recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, less impairments. The Company elected the practical expedient permitted by ASC 321 and recorded the above investments on a cost basis. As a part of the assessment for impairment indicators, the Company considers significant deterioration in the earnings performance and overall business prospects of the investee as well as significant adverse changes in the external environment these investments operate. If qualitative assessment indicates the

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

investments are impaired, the fair value of these equity securities would be estimated, which would involve a significant degree of judgement and subjectivity. No impairment was recorded during the three months ended March 31, 2021.

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7.           Accrued Expenses

Accrued expenses consist of the following:

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8.           Concentration of Credit Risk

Credit risk is the risk of loss from amounts owed by the financial counterparties. Credit risk can occur at multiple levels; as a result of broad economic conditions, challenges within specific sectors of the economy, or from issues affecting individual companies. Financial instruments that potentially subject the Company to credit risk consist of cash and accounts receivable.

The Company maintains cash with major financial institutions. The Company’s cash consists of bank deposits held with banks that, at times, exceed federally insured limits. The Company limits its credit risk by dealing with counterparties that are considered to be of high credit quality and by performing periodic evaluations of the relative credit standing of these financial institutions.

Management periodically monitors the creditworthiness of its customers and believes that it has adequately provided for any exposure to potential credit loss. For the three months ended March 31, 2021, two customers accounted for 38.3% and 30.4% of the Company’s revenues, respectively. For the three months ended March 31, 2020, two customers accounted for 46.1% and 21.4%, of the Company’s revenues, respectively. As of December 31, 2020, four customers accounted for 31.2%, 19.4%, 15.7% and 10.4% of the Company’s accounts receivable, respectively. As of March 31, 2021, four customers accounted for 39.5%, 21.4%, 12.8% and 12.0% of the Company’s accounts receivable, respectively.  The Company’s largest customer in terms of both revenues and accounts receivable in the three months ended March 31, 2021 is a U.S. diversified healthcare company and its affiliated plans.

As of December 31, 2020, two vendors accounted for 15.9% and 24.3% of the Company’s accounts payable, respectively.  As of March 31, 2021, three vendors accounted for 34.8%, 10.8% and 10.0% of the Company’s accounts payable, respectively.

9.          Leases

On July 31, 2020, the Company entered into a 61-month lease agreement for office space to use, as necessary, for office administration, lab space and assembly and storage purposes, located in Santa Clara, California. The Company took possession of the leased office space in September 2020, and the lease is effective through September 30, 2025.

As of March 31, 2021, the remaining lease term is four years and six months with no options to renew. The Company recognized facilities lease expenses of $44 and $17 for the three months ended March 31, 2021 and March 31, 2020, respectively. The

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

following table summarizes the future minimum rental payments required under operating leases that had initial or remaining non-cancelable lease terms greater than one year as of March 31, 2021:

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As of March 31, 2021, the Company’s right-of-use (“ROU”) asset was $373, which was recorded on the Company’s balance sheet as other current assets, and the Company’s current and noncurrent lease liabilities were $77 and $305, respectively, which were recorded on the Company’s balance sheet as other short-term liabilities and other long-term liabilities, respectively. As of December 31, 2020, the Company’s ROU asset was $399, which was recorded on the Company’s balance sheet as other current assets, and the Company’s current and noncurrent lease liabilities were $75 and $332, respectively, which were recorded on the Company’s balance sheet as other short-term liabilities and other long-term liabilities, respectively.

Lease Arrangements

The Company enters into contracts with customers for the Company’s QuantaFlo^® product. The Company has determined these contracts meet the definition of a lease under Topic 842. The lease portfolio primarily consists of operating leases that are short-term in nature (monthly, quarterly or one year, all of which have renewal options). The Company allocates the consideration in a bundled contract with its customers based on relative standalone selling prices of the lease and non-lease components. The Company made an accounting policy election to apply the practical expedient to not separate lease and eligible non-lease components. The lease component is the predominant component and consists of fees charged for use of the equipment over the period of the arrangement. The nature of the eligible non-lease component is primarily software support. The assets associated with these leasing arrangements are separately identified in the Balance Sheet as Assets for Lease and separately disclosed in Note 4 to the Unaudited Condensed Financial Statements.

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10.          Commitments and Contingencies

Facilities Leases

On July 31, 2020, the Company entered into a 61-month lease agreement for office space to use, as necessary, for office administration, lab space and assembly and storage purposes, located in Santa Clara, California. The Company took possession of the

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

leased office space in September 2020, and the lease is effective through September 30, 2025. See Note 9 to the Unaudited Condensed Financial Statements for the details.

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Indemnification Obligations

The Company enters into agreements with customers, partners, lenders, consultants, lessors, contractors, sales representatives and parties to certain transactions in the ordinary course of the Company’s business. These agreements may require the Company to indemnify the other party against third party claims alleging that its product infringes a patent or copyright. Certain of these agreements require the Company to indemnify the other party against losses arising from: a breach of representations or covenants, claims relating to property damage, personal injury or acts or omissions of the Company, its employees, agents or representatives. The Company has also agreed to indemnify the directors and certain of the officers and employees in accordance with the by-laws of the Company. These indemnification provisions will vary based upon the nature and terms of the agreements. In many cases, these indemnification provisions do not contain limits on the Company’s liability, and the occurrence of contingent events that will trigger payment under these indemnities is difficult to predict. As a result, the Company cannot estimate its potential liability under these indemnities. The Company believes that the likelihood of conditions arising that would trigger these indemnities is remote and, historically, the Company has not made any significant payment under such indemnification provisions. Accordingly, the Company has not recorded any liabilities relating to these agreements. In certain cases, the Company has recourse against third parties with respect to the aforesaid indemnities, and the Company believes it maintains adequate levels of insurance coverage to protect the Company with respect to potential claims arising from such agreements.

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11.           Stock Incentive Plan

The Company’s stock-based compensation program is designed to attract and retain employees while also aligning employees’ interests with the interests of its stockholders. Stock options have been granted to employees under the stockholder-approved 2007 Key Person Stock Option Plan (“2007 Plan”) and stock options and restricted stock have been granted to employees under the stockholder-approved 2014 Stock Incentive Plan (“2014 Plan”). Stockholder approval of the 2014 Plan became effective in September 2014. The 2014 Plan originally provided that the aggregate number of shares of common stock that may be issued pursuant to awards granted under the 2014 Plan may not exceed 450,000 shares (the “Share Reserve”), however in October 2015, the stockholders approved a 1,500,000 increase to the Share Reserve. In addition, the Share Reserve automatically increases on January 1st of each year, for a period of not more than 10 years, beginning on January 1st of the year following the year in which the 2014 Plan became effective and ending on (and including) January 1, 2024, in an amount equal to 4% of the total number of shares of common stock outstanding on December 31st of the preceding calendar year. The Company’s Board of Directors may act prior to January 1st of a given year to provide that there will be no January 1st increase in the Share Reserve for such year or that the increase in the Share Reserve for such year will be a lesser number of shares of common stock than would otherwise occur. On January 1, 2021, the Share Reserve increased by 268,017 shares due to the automatic 4% increase. The Share Reserve is currently 3,312,882 shares as of March 31, 2021.

In light of stockholder approval of the 2014 Plan, the Company no longer grants equity awards under the 2007 Plan. As of March 31, 2021, there were no shares available for future stock-based compensation grants under the 2007 Plan and 1,523,508 shares of an aggregate total of 3,312,882 shares were available for future stock-based compensation grants under the 2014 Plan.

Stock Awards

The Company granted fully vested stock awards for an aggregate 5,400 shares of common stock to the non-employee members of the board of directors, employees and one non-employee as compensation during the three months ended March 31, 2021. Fair value of these stock awards on grant date was $537.

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

Stock Options

Aggregate intrinsic value represents the difference between the closing market value as of March 31, 2021 of the underlying common stock and the exercise price of outstanding, in-the-money options. A summary of the Company’s stock option activity and related information for the three months ended March 31, 2021 is as follows:

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The total compensation cost related to unvested stock option awards not yet recognized was $132 as of March 31, 2021.  The weighted average period over which the total unrecognized compensation cost related to these unvested stock awards will be recognized is 0.71 years. There were no options granted during the three months ended March 31, 2021 or 2020.

The Company has recorded an expense of $589 and $67 as it relates to stock-based compensation for the three months ended March 31, 2021 and 2020, respectively:

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12.           Income Taxes

The Company’s income tax provision for the three months ended March 31, 2021 and March 31, 2020 reflect its estimate of the effective tax rates expected to be applicable for the full year, adjusted for any discrete events that are recorded in the period in which they occurred. The estimates are re-evaluated each quarter based on the estimated tax expense for the full year.

For uncertain tax positions that meet a “more likely than not” threshold, the Company recognizes the benefit of uncertain tax positions in the financial statements. The Company’s practice is to recognize interest and penalties, if any, related to uncertain tax positions in income tax expense in the statements of operations.

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The effective tax rate for the three months ended March 31, 2021 was 18.99% compared to 22.52%, in the same period of the prior year. The decrease in the effective tax rate for the three months ended March 31, 2021 is primarily related to tax benefits associated with share-based compensation plans.

The effective tax rate for the three months ended March 31, 2021 differed from the U.S. federal statutory rate of 21% primarily due to state income taxes (net of federal benefit) partially offset by tax benefits associated with share-based compensation plans and federal and state research and development credit benefit. The difference between the U.S. Federal statutory rate of 21% and the Company’s effective tax rate of 22.52% for the three months ended March 31, 2020 was primarily due to current state taxes that have no net operating loss to offset such taxes.

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Semler Scientific, Inc.

Notes to Condensed Financial Statements

Unaudited

(In thousands of U.S. Dollars, except share and per share data)

As of March 31, 2021 and December 31, 2020, the Company had $342 and $341, respectively, of unrecognized tax benefits, excluding interest and penalties. The Company’s practice is to recognize interest and penalty expenses related to uncertain tax positions in income tax expense, which was zero for the years ended December 31, 2020 and March 31, 2021.

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13.           Net Income Per Share, Basic and Diluted

Basic earnings per share (“EPS”) represent net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period. Diluted EPS represents net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period while also giving effect to all potentially dilutive common shares that were outstanding during the period using the treasury stock method.

Basic and diluted EPS is calculated as follows:

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The were no weighted average shares outstanding of common stock equivalents excluded from the computation of diluted net income per share for the three months ended March 31, 2021 and 2020.

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14. Subsequent Events

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In October 2020, the Company purchased 211,928 shares of common stock of private company #2 from certain sellers in exchange for 40,922 shares of its common stock. On April 1, 2021, the Company exercised its option to “put” these shares of common stock back to the sellers in exchange for the shares of the Company’s common stock originally issued to the sellers. Following this transfer, the Company continues to hold the shares of preferred stock acquired in December 2020.

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In April 2021, the Company entered into an agreement with private company #3 to exclusively market and distribute its product line in the United States, including Puerto Rico, except for selected accounts. Under this distribution agreement, the Company agreed to purchase $2.0 million of product inventory. Unless early terminated in accordance with its terms, the exclusive distribution agreement will remain in full force and effect until April 1, 2026, and thereafter there is an option for this agreement to be automatically renewed for additional one-year terms. The Company continues to hold the shares of preferred stock acquired from this company in October 2020.  

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read together with our condensed unaudited financial statements and the related notes appearing elsewhere in this quarterly report on Form 10-Q and with the audited financial statements and notes for the fiscal year ended December 31, 2020, and the information under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on March 9, 2021, or the Annual Report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” in our Annual Report.

Overview

We are a company providing technology solutions to improve the clinical effectiveness and efficiency of healthcare providers. Our mission is to develop, manufacture and market innovative proprietary products and services that assist our customers in evaluating and treating chronic diseases. In 2011, we began commercializing our first patented and U.S. Food and Drug Administration, or FDA, cleared product, which measured arterial blood flow in the extremities to aid in the diagnosis of peripheral arterial disease, or PAD. In March 2015, we received FDA 510(k) clearance for the next generation version of our product, QuantaFlo®, which we began commercializing in August 2015. In September 2020, we entered into an agreement with a private company to exclusively market and distribute a new product line in the United States, including Puerto Rico, and, in September and October 2020, in an effort to provide access to potentially complementary product offerings, we made investments in two private companies working in other product areas.  We believe our current products and services, and any future products or services that we may offer, position us to provide valuable information to our customer base, which in turn permits them to better guide patient care. In the three months ended March 31, 2021, we had total revenues of $13.2 million and net income of $4.9 million, compared to total revenues of $9.4 million and net income of $2.7 million in the same period in 2020.

Recent Developments

Late in the first quarter and into the second quarter of 2020, we experienced decreased test volumes due to COVID-19 related “social distancing” and other executive orders mandating “shelter-in-place” or similar restrictions, which limited patient visits by our customers. As such restrictions have been lifted around the country and non-emergency medical services resumed in late 2020, our business has returned to and even exceeded pre-COVID-19 levels. In the third and fourth quarters of 2020, we experienced even higher test volumes as our customers accelerated usage due to a backlog of untested patients.  However, as we look forward into 2021, there is uncertainty that the recent roll-back in restrictions will be maintained. New, additional or different restrictions could be imposed, which could impact the usage of our product by our customers. Other customers who have fixed-fee licenses could decide to cancel their licenses if they are not able to use our device as frequently as they had anticipated in light of such restrictions.

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In September 2020, we entered into an agreement with a private company to exclusively market and distribute a new product line in the United States, including Puerto Rico, for which we are currently developing a marketing plan. Under this distribution agreement, we agreed to purchase $1.2 million of product inventory. We also agreed to make royalty payments ranging from 0% to 10% of net sales depending on the average net sales price of the distributed products. Unless early terminated in accordance with its terms, the exclusive distribution agreement will remain in full force and effect until December 31, 2024, and thereafter there is an option for this agreement to be automatically renewed for additional 4-year terms. During September 2020, we prepaid for $0.9 million of product inventory, of which we have received $0.3 million as of March 31, 2021.

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In September 2020, we acquired a $0.5 million promissory note from a second private company in a new product area. We funded $0.4 million of the note, and the remaining $0.1 million was retained for expense reimbursement. In December 2020, we agreed to the conversion of the $0.5 million promissory note, together with all accrued interest thereon, into shares of the private company’s preferred stock as repayment in full of such promissory note. In October 2020, we purchased 211,928 shares of common stock of such private company from certain sellers in exchange for 40,922 shares of our common stock, and had the right to “put” share shares of common stock back to the sellers in exchange for the return of shares of our common stock issued to them in certain circumstances, including beginning March 31, 2021 for a limited time period.  Accordingly, in April 2021, we exercised this right and returned these shares of common stock back to the sellers in exchange for the shares of our common stock originally issued to the sellers. Following this transfer, we continue to hold the shares of preferred stock we acquired from this company in December 2020.

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In October 2020, we acquired a convertible note in a third private company in a new product area for a purchase price of $58,000, which note converted into shares of preferred stock of such private company concurrent with our purchase of additional shares of preferred stock of such private company for $0.3 million. Subsequently, we acquired a $1.5 million convertible promissory note and warrants to purchase shares of common stock of this third privately-held company. We funded $1.4 million of the note, and the remaining $0.1 million was retained for expense reimbursement. In November 2020, the $1.5 million convertible promissory note, together with all accrued interest thereon, converted pursuant to its terms into shares of the private company’s preferred stock as repayment in full of such convertible promissory note. In December 2020, we transferred and sold these shares of preferred stock, along with the warrants to purchase common stock we had acquired from such company in October 2020, to one of our significant stockholders, for a cash purchase price of $1.9 million. Following this transfer, we continue to hold the shares of preferred stock we acquired from this company in October 2020. In April 2021, we entered into an agreement with this private company to exclusively market and distribute their product line in the United States, including Puerto Rico, except for selected accounts. We are currently developing a marketing plan. Under this distribution agreement, we agreed to purchase $2.0 million of product inventory. Unless early terminated in accordance with its terms, the exclusive distribution agreement will remain in full force and effect until April 1, 2026, and thereafter there is an option for this agreement to be automatically renewed for additional one-year terms.

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We invested in these three private companies as they are developing products that may allow us to expand our current product offering beyond QuantaFlo® for PAD, in addition to our internal research and development efforts. Their products deal with better chronic disease management and may be used by primary care practitioners, are FDA-cleared or equivalent, produced positive clinical data and two of the three new products seek to improve aspects or sequelae of the metabolic syndrome. 

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Results of Operations

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

Revenues

We had revenues of $13.2 million for the three months ended March 31, 2021, an increase of $3.8 million, or 40%, compared to $9.4 million in the same period in 2020. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from sale of accessories used with these products. We recognized revenues of $12.9 million from fees for our vascular testing products for the three months ended March 31, 2021, consisting of $7.2 million from fixed-fee licenses and $5.7 million from variable-fee licenses compared to $9.2 million in the same period of the prior year, consisting of $6.5 million from fixed-fee licenses and $2.7 million from variable-fee licenses. The remainder was from sales of other products, which were $0.3 million for each of the three months ended March 31, 2021 and 2020.

Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, usually billed as a fixed monthly fee, or as a variable monthly fee dependent on usage. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.

Operating expenses

We had total operating expenses of $7.2 million for the three months ended March 31, 2021, an increase of $1.2 million or 20%, compared to $6.0 million in the same period in the prior year. The primary reasons for this change were increases due to personnel expense including stock-based compensation and increased headcount, partially offset by payroll tax reductions that were granted by the federal government in the current quarter compared to the same period in the prior year. As a percentage of revenues, operating expenses decreased to 54% in the first quarter of 2021 as compared to 63% in the prior year period. The changes in the various components of our operating expenses are described below.

Cost of revenues

We had cost of revenues of $1.6 million for the three months ended March 31, 2021, an increase of $0.7 million, or 86%, compared to $0.9 million in the same period of the prior year. The primary reasons for this change were non-recurring inventory adjustment for supplies and increased headcount. As a percentage of revenues, cost of revenues increased to 12% in the first quarter of 2021, as compared to 9% in the prior year period.

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Engineering and product development expense

We had engineering and product development expense of $0.7 million for the three months ended March 31, 2021, a decrease of $0.1 million, or 18%, compared to $0.8 million in the same period of the prior year. The decrease was primarily due to payroll tax credit as well as decreased consulting costs associated completed projects, partially offset by higher clinical studies costs and increased headcount. As a percentage of revenues, engineering and product development expense was 5% in the first quarter of 2021, as compared to 9% in the prior year period.

Sales and marketing expense

We had sales and marketing expense of $2.8 million for the three months ended March 31, 2021, an increase of $0.1 million, or 4%, compared to $2.7 million in the same period of the prior year. The increase was primarily due to increased headcount and associated expense to serve a continued expansion of customer activities, partially offset by lower travel expenses and payroll taxes. As a percentage of revenues, sales and marketing expense decreased to 21% in the first quarter of 2021, as compared to 29% in the prior year period. 

General and administrative expense

We had general and administrative expense of $2.1 million for the three months ended March 31, 2021, an increase of $0.5 million, or 30%, compared to $1.6 million in the same period of the prior year. The increase was primarily due to the growth in our business, which led to increased expenses including the expansion of board of directors, insurance and other professional fees. As a percentage of revenues, general and administrative expense decreased to 16% in the first quarter of 2021, as compared to 17% in the prior year period. 

Other income/expense

We had other income of $1,000 for the three months ended March 31, 2021, compared to other expense of $2,000 in the same period of the prior year. The increase was primarily due to miscellaneous income and interest income, partially offset by credit card merchant fees.

Pre-tax net income

For the foregoing reasons, we had pre-tax net income of $6.0 million, for the three months ended March 31, 2021, an increase of $2.5 million, or 74%, compared to a pre-tax net income of $3.5 million for the same period of the prior year.

Income tax expense (benefit)

We had income tax expense of $1.1 million for the three months ended March 31, 2021, an increase of $0.3 million or 47%, compared to income tax expense of $0.8 million in the same period of the prior year. The tax expense in the current quarter was due to increased income from operations.

Net income

For the foregoing reasons, we had net income of $4.9 million, or $0.73 per basic share and $0.60 per diluted share, for the three months ended March 31, 2021, an increase of $2.2 million, or 82%, compared to a net income of $2.7 million, or $0.41 per basic share and $0.33 per diluted share, for the same period of the prior year.

Liquidity and Capital Resources

We had cash of $26.5 million at March 31, 2021 compared to $22.1 million at December 31, 2020, and total current liabilities of $5.0 million at March 31, 2021 compared to $4.5 million at December 31, 2020. As of March 31, 2021, we had working capital of approximately $28.2 million.

Our cash is held in a variety of non-interest bearing bank accounts. We may also hold interest-bearing instruments subject to investment guidelines allowing for holdings in U.S. government and agency securities, corporate securities, taxable municipal bonds,

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commercial paper and money market accounts. In addition, we may also choose to invest some of our cash resources in other entities that may have complementary technologies or product offerings, such as our recent decision to acquire inventory for distribution in the United States, including Puerto Rico, of two new product line offerings, as well as make two minority investments in other privately-held companies in new product areas.

Operating activities

We generated $4.6 million of net cash from operating activities for the three months ended March 31, 2021 compared to $3.7 million of net cash from operating activities for the same period of the prior year. The change was primarily due to increase of net income, which occurred due to growth in our business. Non-cash adjustments to reconcile net income to net cash from operating activities provided to net cash of $1.5 million and were primarily due to stock-based compensation expense of $0.6 million, deferred tax expense of $0.6 million, depreciation of $0.2 million, and loss on disposal of assets for lease of $0.1 million. Changes in operating assets and liabilities used $1.7 million of net cash. These changes in operating assets and liabilities included cash used by trade accounts receivable of $1.6 million, prepaid and other expenses of $0.4 million, inventory of $0.3 million and trade payables of $0.2 million, partially offset by cash provided by accrued expenses of $0.7 million and deferred revenue of $0.1 million.

Investing activities

We used $0.2 million of net cash in investing activities for the three months ended March 31, 2021, which reflects funding of purchases of assets for lease of $0.1 million and fixed asset purchases of $0.1 million to support our growing business.

We used $0.2 million of net cash in investing activities for the three months ended March 31, 2020, which reflects purchases of assets for lease of $0.1 million and fixed asset purchases of $0.1 million to support our growing business.

Financing activities

We generated $9,000 in net cash from financing activities during the three months ended March 31, 2021, due to proceeds from exercise of stock options.

We generated $3,000 in net cash from financing activities during the three months ended March 31, 2020, due to proceeds from exercise of stock options.

Off-Balance Sheet Arrangements

As of each of March 31, 2021 and December 31, 2020, we had no off-balance sheet arrangements.

Commitments and Contingencies

As of each of March 31, 2021 and December 31, 2020, other than employment/consulting agreements with key executive officers and our facilities lease obligation, we had no material commitments other than the liabilities reflected in our financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure material information required to be disclosed in our reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, as appropriate, to allow timely decisions regarding required financial disclosure. In designing and evaluating the disclosure controls and procedures, we recognized that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that

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the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Under the supervision of and with the participation of our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2021. Based upon that evaluation, our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance concluded that our internal control over financial reporting, our disclosure controls and procedures were effective. Our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, has concluded that the consolidated financial statements included in this Quarterly Report on Form 10-Q are fairly stated, in all material respects, in accordance with generally accepting accounting principles in the United States for each of the periods presented herein.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our first fiscal quarter ended March 31, 2021.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

None.

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Item 1A. Risk Factors.

Not applicable.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

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Item 3. Defaults upon Senior Securities.

None.

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Item 4. Mine Safety Disclosures.

Not applicable.

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Item 5. Other Information.

Not applicable.

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Item 6. Exhibits.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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