Simulations Plus ( Nasdaq - SLP ) -- Higher Costs Hit Earnings

Simulations Plus (SLP $4.00) reported reasonably good Q3 (May) results.  Year to year comparisons were impacted by the sale of a non core subsidiary earlier in the year.  Revenues declined on an as reported basis due to the spin off.  The remaining pharmaceutical simulation software line exhibited a 6% increase to $2.77 million.  License sales rose 15% and represented virtually the entire amount.  In the year earlier period the company also generated some consulting and grant income, which wasn't replicated this year.  Almost all of Simulations Plus's software licenses are sold on an annual basis, creating a predictable recurring revenue stream.  Renewal rates typically are in the 95%-100% range.  The occasions when licenses aren't renewed relate to customer mergers, facility relocations, and employee job changes.  Even then, the deals tend to reemerge elsewhere as new business.  Margins narrowed somewhat in the quarter as a result of higher R&D spending.  Marketing and sales costs advanced, too.  And overhead was spread over a smaller revenue base, due to the subsidiary divestiture.  All the same, pretax margins were 47.8% in the period (excluding non cash stock option expense), far above the industry norm.

Earnings fell 29% to $.05 a share.  Besides the margin contraction, income was affected by a higher tax rate, as well.  The fourth quarter (August) usually is the company's weakest from a seasonal standpoint.  Activity tends to moderate over the summer.  A solid year to year comparison is likely, though.  For the entire year we estimate income will advance 11% to $.20 a share on sales of $10 million.

Next year faster growth appears achievable.  Software gains of 15%-20% are possible as drug companies endeavour to lower research costs.  Collaboration revenue could provide an additional 3%-5%.  And while consulting revenues have gone virtually to zero, meaningful improvement is likely in the aftermath of the company's self funded malaria project.  Simulations Plus took on that project to demonstrate its software's ability to identify promising drug candidates without any physical testing to accompany it.  The technology identified nine prospective molecules, all of which showed activity against malaria.  Pharmaceutical companies could hire out the company's experts to provide similar jump starts on their own projects.

Income could hit $.25 a share (+25%) next year on sales of $12 million (+20%).  A new product will be launched early in the fiscal year, which could yield further leverage.  Acquisitions also could be employed to leverage the company's broad distribution network.  The cash dividend is likely to be maintained at $.05 a share per quarter, delivering a 5% yield.

( Click on Table to Enlarge )