Monday, October 4, 2010

Simulations Plus ( SLP - Nasdaq )

Simulations Plus (SLP $2.80) is the leading supplier of computer based simulation tools used by the pharmaceutical industry to screen promising drug candidates.  The software estimates pretty accurately how a hypothetical molecule will interact with the human body, reducing the need for animal testing in the pre-clinical stage.  Scientists can zero in on a general concept by testing hundreds of analogs in software to identify promising compounds.  Costs are reduced.  Development time is accelerated.  And the odds for success improve.  Simulations Plus is the market leader in several key areas, particularly how drugs are affected by the gastro-intestinal tract.  Other products compete with niche market specialists.  Volume is expanding as the large drug companies employ more simulation in their research programs.  Those companies are starting to consolidate purchasing with a single vendor, moreover, which is placing the niche suppliers at a disadvantage.  As scientists move from one job to another they usually insist on taking the software they are accustomed to with them.  The number of laboratories using the technology is climbing as a result.  Aggressive marketing is pushing results forward, as well.

A non core product line still represents 30% of sales.  Words Plus type-to-speech handheld computers allow people who can't talk to communicate with a synthetic voice.  The products come in a variety of form factors.  Most are reimbursed by government health insurance payers.  Competition is active, and receivables are difficult to collect from the government.  So it's not an attractive business.  But the operation more or less breaks even, depending how corporate overhead costs are allocated.  Simulations Plus has no plans to discontinue the line at this point.  In fact, sales recently began growing again following some product upgrades.  A spinoff could occur down the line, though.

The pharmaceutical software line promises to grow at a superior rate.  We estimate that segment grew 21% in fiscal 2010 (August), supporting an overall revenue gain of 17% to $10.7 million.  Earnings likely expanded 75% to $.14 a share.  (Please refer to "Accounting Notes.")  For all intents and purposes the entire income figure was produced by the simulation business.  The company stepped up its marketing efforts toward the end of last year.  A lot of that revolved around attending more trade shows, to meet prospective customers face to face.  That effort initially impacted margins, causing fiscal 2009 profitability to dip.  The poor economy didn't help, either.  Margins recovered as sales rebounded.  Simulations Plus also raised prices for the first time in five years,  providing additional impetus. 

That momentum is poised to continue.  We estimate overall sales, led by the pharmaceutical unit, will advance 21%-26% in fiscal 2011 (August) to $13.0-$13.5 million to produce earnings of approximately $.20 a share.  Simulations Plus has been pursuing acquisitions of complementary software products, to no avail so far.  But the company is piling up cash at a steady pace.  It has the ability to strike if the opportunity arises.  Any transaction could boost earnings right away, excluding restructuring or acquired intangible amortization costs. 

In 2-3 years sales could reach $20 million to produce earnings of $.30 a share.  Applying a P/E multiple of 20x suggests a target price of $6.00 a share, potential appreciation of 115% from the current quote.  Acquisitions could yield significant additional leverage.

(Click on table to enlarge)

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