Thursday, December 1, 2011

Simulations Plus ( Nasdaq - SLP ) -- Sheds Non-Core Business

Simulations Plus (SLP $3.00) reported unexceptional Q4 (August) results.  Performance was impacted by the non core Words Plus text to speech line.  The company sold off that operation on November 30th, the final day of Q1 2012.  Combined non-GAAP earnings (excluding stock option expense) slipped 50% in the August period to $.01 a share.  Sales were down, as well, by 4% to $2.12 million.  The high potential pharmaceutical simulation software line posted a 7% revenue gain in the August quarter.  The year earlier period included a non-recurring project fee ($350,000) which skewed the comparison.  Excluding that software revenues advanced 40%. 

Margins promise to expand in the upcoming year.  Simulations Plus is the leading provider of simulation tools used by drug developers to identify promising molecules.  The technology speeds up time to market by narrowing down the search so laboratory testing and clinical trials can focus on the highest potential candidates.  The discontinued Words Plus operation produced about 25% of total sales but was lucky to break even.  Without that drag non-GAAP profitability is poised to soar into the 45%-50% area (pretax).

Organic growth of 15% or more is likely to be maintained.  Simulations Plus sells its software on an annual subscription basis.  The renewal rate was 93% in fiscal 2011 (August) and historically has been above 90%.  New customers accounted for 22% of software sales.  That trend is likely to continue as additional divisions of large drug companies adopt the technology, existing users purchase additional modules, and smaller biotech and academic users come on board. 

Only a small portion of the potential market has been penetrated to date.  Organic growth could accelerate as the technology's productivity benefits become more widely known.  Faster computers, greater reliance on parallel processing, and easier to use interfaces could reinforce growth.  Near term hurdles are the poor economy, which is having an effect on drug company profits; and the growth in regulatory uncertainty.

We estimate non-GAAP income will advance 22% in fiscal 2012 (August) to $.22 a share.  Sales could advance 15% to $10 million, excluding the discontinued Words Plus operation.  Cash flow continues to build.  In the year just ended Simulations spent $2.0 million to repurchase stock.  The company also is investigating potential acquisitions.  Several targets are believed to be in the company's sights.  Past negotiations have stalled due to valuation concerns.  The current environment might bring prices more into line.  Simulations Plus has a great platform that it could leverage with additional niche products.  Growth could accelerate with an effective transaction or two.

In 2-3 years non-GAAP earnings could reach $.30 a share.  Applying a P/E multiple of 20x suggests a target price of $6.00 a share, potential appreciation of 100% from the current quote.  Faster gains are possible if the technology gains wider adoption.  Acquisitions could yield further leverage. 

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