What Happened To Semler? (NASDAQ:SMLR)

Potential CMS Changes

On Wednesday, February 1st, the CMS announced their 2024 Advanced Notice for Medicare advantage Capitation rates and Part C & Part D payment policies. This is the adjustment model for the value of certain procedures/diagnostic tools and which get covered. This is just a first stab at 2024 capitation rates. We are currently in the 30 day comment period following the announcement. On April 3rd, the final rate announcement will be made after the comments are reviewed and adjustments are made.

The February 1st CMS announcement was of concern to Semler Scientific (NASDAQ:SMLR) because HCC code 108, which is for peripheral artery disease (PAD), wasn’t put in the 2024 proposed model. Semler’s main product, QuantaFlo, is an easy to use early test for PAD. This means health insurance companies won’t get an additional monthly bonus for patients who test positive for PAD. Under the capitation model, insurance companies get more money from Medicare advantage to treat patients when they are diagnosed with a disease.

UnitedHealth’s Role In This

This news came out on February 1st, but the stock crashed 36% on February 6th. There’s always the question of whether investors’ opinions are impacted by news or stock prices. You can never separate the two when stocks immediately react to the news. This was a rare instance when you can because I read about this code change on the 2nd which was a few days before the stock declined. My opinion was that UnitedHealth (UNH), Semler’s largest customer, would challenge this ruling. Semler doesn’t have a large lobbying arm, but UnitedHealth and the other insurance companies do. UnitedHealth represented 41% of Semler’s Q3 2022 sales which is a separate concentration issue that doesn’t factor in as a negative here.

UnitedHealth and other insurance firms will challenge the proposal because it only calls for a 1% increase in Medicare advantage spending which is below the current inflation rate, let alone the increase in medical care costs. UnitedHealth is well aware of the benefits of QuantaFlo since it sponsored the Nevada paper which was published early in 2022. Therefore, it should look to get the PAD code reinstated.

Overview Of The Nevada Paper

As a reminder, the Nevada paper refers to the study of 13,971 Medicare advantage beneficiaries 65 years and older who had a PAD screening in 2016. The study showed 31.6% had previously undetected PAD. While PAD can be asymptomatic, knowledge of this disease is crucial for patients because those with a positive test had a 5% mortality event rate after 1 year and a 15.6% mortality rate after 3 years. Patients who tested negative had mortality rates of 2.4% and 8% after 1 and 3 years respectively.

The current healthcare paradigm only focuses symptomatic patients. Patients need to see a specialist to do the ankle brachial test (ABI) which is the current standard of care for testing symptomatic patients. Because a specialist is required, the population, which consists of mostly asymptomatic patients, can’t be tested. QuantaFlo can be easily done during home care or an annual physical exam by any healthcare practitioner. This allows for testing at the population level. This can save the system money because proper treatment can be given and lifestyle changes can be made to prevent the major cardiac events prevalent in those with PAD.

QuantaFlo Relies On The Capitation Model

Getting back to this latest news event, under the capitation system, disease diagnoses like a PAD detection, give the health insurance companies more money for patient care. The low cost QuantaFlo test can save the system a lot of money and make health insurance companies profits. This incentive structure for insurance companies made it easy for QuantaFlo to grow. Semler’s customers have been growing usage for the firm since they have been getting paid by Medicare advantage to do so. It’s great when your customers are your biggest marketers. Semler says in its SEC filings, it doesn’t know what percentage of the cost of the test is reimbursed since the Medicare advantage monthly payment is likely what insurance companies care the most about.

The Market Is Focused On The Worst Case Scenario

I spoke with Renae Cormier who it the Head of Corporate Communications & Business Strategy for Semler. As an aside, it’s worth noting how helpful she has been on the past couple conference calls. Before she arrived, management barely answered any analyst questions. She didn’t give me much additional color compared to the her statement which I received in an email, so I’ll paste it here.

“We are aware of the CMS 2024 Advance Notice. It is premature to speculate at this time about the potential impact on our customers. Final call letter will come out on April 3, 2023.”

The company can’t give any more details because it’s too early to tell what will happen. That doesn’t stop investors from speculating of course.

There are a few possible scenarios for QuantaFlo. It’s pretty obvious which one the market is focused on given the stock’s 4 day decline of 49.9% (the worst case). The market fears the code will be gone, it won’t be replaced with a new code that covers PAD, and health insurance companies won’t get the Medicare advantage monthly bonus through capitation for QuantaFlo. This market speculates this will lead to less usage. A seamless diagnosis of PAD impacts Semler the most because it wants testing at the population level for at-risk patients (much more testing than what currently exists via ABI). This is different from tests being done on a case by case basis when patients are symptomatic. Remember, the standard of care has been the ABI test.

This isn’t the only possibility, but when uncertainty reigns supreme, that’s what gets priced in. We will find out very soon if this is correct because the final call letter comes out on April 3rd. In the meantime, Semler will report quarterly earnings about 3 weeks from now. That’s perfect timing because it gives the company time to get a handle of the possible outcomes and analyze the situation.

I think it makes sense to wait until the call before selling your shares since the major flush down in the stock has occurred. You can still sell the stock before the call letter comes out in April if you don’t like the commentary on the quarterly call. By selling after the conference call, at least you are making an informed decision instead of panicking. I don’t think the stock will have a big reaction to Q4 earnings and sales results because everyone is focused on this new risk.

The Other Possibilities

Let’s look at what else can happen besides the worst case scenario. That’s useful since the market has the negatives covered. The lobbying done by UnitedHealth and other insurance companies could bring the PAD code back or combine it with a new code which results in no changes for QuantaFlo. Secondly, Semler can find a way to get QuantaFlo used with a different code. The board of directors has a few experts on healthcare reimbursements. Semler has successfully utilized the health insurance system throughout its history.

If the monthly Medicare advantage payment goes away, it doesn’t mean QuantaFlo will stop being used, but it could be more difficult to do so because every usage will need to be reimbursed. There could be less incentive for UnitedHealth and other insurers to promote the usage of QuantaFlo. If Semler needs to be the main promoter of QuantaFlo, that will hurt margins because they would need to hire more salespeople. However, this messy scenario doesn’t mean QuantaFlo is dead as a product. Growth just gets harder.

I’m Not Selling My Shares

I understand why someone would sell their Semler shares. This is a new risk the company might need to deal with. It could amount to nothing which would make the stock very cheap, but we don’t know the exact odds of Semler getting the code back, using a new code, or gaining adoption without it. We should get some color on this during the comment period and on Semler’s earnings call.

The firm could accelerate its buyback program if management is really confident nothing bad will happen. The firm’s $20 million buyback program, which has about $18 million left, is now a large portion of its current $143 million market cap. Semler had $45.5 million in cash on the balance sheet as of Q3 and very little long-term debt.

I take issue with investors calling this new risk ‘thesis changing’ because my theses on investments always start at the ground level. My original thesis on Semler was QuantaFlo is the easiest way to diagnose PAD which is a severely underdiagnosed disease because 75% of patients are asymptomatic. Even some patients that do have symptoms like leg pain, don’t get the proper diagnosis. Early detection is great for patients because a treatment plan can be made. If PAD is tested for at the population level, I believe better treatments will result over time since more diagnoses will exist. There is greater motivation for treatment development when millions of diagnoses are given and the enormous population risk is known.

Secondly, this is great for the government and health insurance companies because early detection of diseases like PAD lowers overall healthcare costs.

The thesis on the benefits of QuantaFlo is summarized by this conclusion in an AJPM research article.

“A national peripheral artery disease screening effort is feasible. Detecting previously undiagnosed peripheral artery disease is a way to risk stratify a population that would benefit from further cardiovascular risk management.”

If you originally were bullish on QuantaFlo because this product is great for patients and saves the healthcare system money, then nothing has changed in the long term. The short term might be rockier depending on how the 2024 capitation codes are adjusted. I won’t sell the stock just because there might be issues with Medicare advantage bonuses to health insurance firms since I already knew that was a risk before this news.

I would sell Semler if I discovered a new product that was better than QuantaFlo or if one of their two biggest customers decided this product has no merit. Obviously, Semler losing a top customer would cause the stock to drop, meaning I would be selling at a major loss. However, we just experienced that large drop without any thesis changing news. Therefore, this is a notable way to juxtapose what I consider thesis changing events versus what just happened.

Semler is a mid-single digit position in my portfolio after the drop in February. I won’t be selling my shares on this news and I’m unlikely to add to my position in the near term.