Thursday, March 20, 2014

Simulations Plus ( Nasdaq - SLP ) -- Automating Drug Discovery

Simulations Plus (SLP $6.25) is a leading provider of  software used by pharmaceutical companies to improve their drug development efforts.  Approximately 150 companies employ the technology, mainly in the United States and Europe.  Many of those are large organizations that purchase  licenses for multiple sites.  Simulations Plus enjoys a 95% or better renewal rate.  Most contracts are for one year.  Some customers make 2-year commitments.  There are no perpetual sales.  All of the company's revenue is recurring.  Most customers that don't renew either merge or reorganize in some other fashion.  The actual scientists who used the technology normally submit new purchase orders once they resurface at a new location.  Simulations Plus holds a significant lead over its direct competition, due to greater functionality and broader scope.  The potential market is believed to be less than 10% penetrated, mainly due to in-house alternatives.  As the technology keeps improving internal efforts are becoming less compelling.  Simulations Plus helps reduce costs and speed development time by identifying the most promising molecules with software rather than trial and error experimentation.  Like every medical research application the company's technology still has a long way to go before it's perfected.  But an intermediate term inflection point appears to have been reached.  Financial performance has started to accelerate.  That trend could gain momentum over the next several years.

Sales to China and other Far East nations are advancing.  In the past Simulations Plus had a difficult time with those markets because scientist salaries were low, allowing Asian drug companies to attack problems with brute force.  The combination of rising labor costs and better software solutions has helped the company make inroads, especially in China.  Further gains are likely as the pharmaceutical market expands and competitive pressure drives faster development schedules.  Greater use of generics in the U.S. and Europe is boosting demand, as well.  Besides making direct copies many new companies are developing combinations of existing drugs.  Software analysis is helping them avoid molecules that have unexpected problems.  Simulations Plus still emphasizes chemical entities.  But the company is picking up traction among biotechnology developers, too.

A 5-year contract with the F.D.A. could facilitate wider adoption.  Simulations Plus is working with the agency to test toxicity in a wide range of consumer and other applications.  That's beginning to open up new commercial opportunities.  Perhaps more important, though, as the F.D.A. becomes more familiar with the technology it may start to accept software generated data in the place of laboratory work in new drug applications.  Drug developers might start working with the technology before any such rules are implemented, moreover, to be in position  to move when the time comes.

Demonstration projects performed by the company have become strong selling points.  Last year Simulations Plus used its own technology, people, and money to identify a promising malaria vaccine.  Seven molecules were produced by a bunch of programmers, not scientists.  They all were synthesized by outside laboratories, and were active against the malaria target.  The company recently completed a second project, this time aiming at Cox-2 inhibitors.  Those drugs were removed from the market (except Celebrex) by the F.D.A. due to heart related side effects.  The company's project was aimed at keeping the positive effects (pain reduction) while eliminating the heart threat.  The results suggested a very promising profile.  The company doesn't plan to develop the drugs any further.  It only wanted to show how productive its software can be at zeroing in on a molecular format.  If a commercial lab had generated the results and was aiming to develop a superior Cox-2 product, its scientists now would fine-tune the molecules to come up with an ideal candidate.

We estimate sales will rise 14% in fiscal 2014 (August) to $11.5 million.  Earnings are on track to improve 17% to $.21 a share.  Faster gains are possible in subsequent years.  Consulting work is likely to expand in response to the demonstration projects.  Customers probably will hire the company to perform preliminary screens more efficiently than they are able to in-house.  Software license sales promise to advance rapidly, as well.  Emerging market business should keep expanding.  New products could yield further impetus.  Acquisitions of related technologies could be leveraged by the company's software platform and distribution network.  In 2-3 years sales could reach $14-$18 million to provide earnings of $.25-$.35 a share.

( Click on Table to Enlarge )

Saturday, March 15, 2014

Profire Energy ( Nasdaq - PFIE ) -- Burns Rubber

Profire Energy (PFIE $3.50) is the leading provider of automated burner management systems used by oil and gas producers to remove contaminants after the energy is pulled up from the ground.  The products are used, to a lesser extent, in downstream operations to clean up oil and gas while in transit.  Most U.S. wells employ manual systems that require workers to relight a unit if the flame is extinguished.  Profire's machines monitor the burners with computers.  That allows operators to adjust the flame density automatically as the amount of oil and gas increases or diminishes.  The systems also relight the units if they go out.  Canadian regulations require automated units like Profire's to improve worker safety.  Similar rules have not been implemented in the U.S. to date.  Dozens of American workers continue to be blown up every year using the old technology.  A growing contingent of U.S. producers are adopting Profire's automated approach not only to enhance safety, but to improve efficiency and generate environmental benefits, too.

Profire originally was a service company that focused on burners and other oilfield equipment.  The company saw the opportunity to automate the process and developed its own technology in the late 2000s.  Sales initially addressed the Canadian market due to the regulatory tailwind there.  Initial success led to expansion in the United States.  The transition to becoming a manufacturing company wasn't seamless.  Financial performance was inconsistent prior to the current fiscal year (March).  But Profire emphasized product development and customer service despite the ups and downs, enabling it to become the industry leader by a wide margin.  Less than 5% of the potential market has been penetrated to date.  That market is continuing to expand at above average rates as North America becomes the #1 energy producing region in the world.  And Profire is ensconced as the industry leader.  The company holds 65%-70% of the market today, and that figure is continuing to rise.

Growth has accelerated in response to expanding U.S. adoption.  Sales are on track to more than double to $35 million in the fiscal year ended March.  Margins have recovered from last year's decline, supporting a likely 400% expansion in profits to $.15 a share.  Regulatory uncertainty caused a hiatus in Canadian sales for a large part of last year.  Profire also misplayed its sales force expansion in the United States.  The U.S. situation was resolved by the time the current fiscal year began.  That paved the way for the explosion in sales.  The Canadian business has bounced back but remains less vibrant than it might be.  Regulations exist but have been enforced inconsistently, encouraging some drillers to employ alternative (non-automated) solutions.  The lack of pipeline capacity has impacted production in Western Canada, as well.

Geographic expansion promises to sustain growth at superior levels.  Profire covers a small portion of the U.S. market presently.  New offices are being opened at a fast clip in North Dakota, Texas, Oklahoma, and Pennsylvania to provide deeper hands on coverage.  The sales force has doubled over the past six months.  That group promises to make significant contributions in the June period and become fully operational in Q2-Q3.  Relationships with OEMs are being expanded.  About of 25% of sales are made to makers of complete systems that are installed at the well site.  Most of the rest go to installation companies that buy parts from multiple manufacturers and assemble them.  About 25% of sales are retrofits to existing systems.  International sales remain low but distribution channels have been established in Brazil and Australia.  Efforts recently were initiated to enter the Middle East and other high potential international markets.

New products will be introduced on a regular basis.  Profire is upgrading its systems with the latest semiconductor technology to facilitate remote software updates and other performance enhancements.  The line is being extended to more upstream applications, as well.  Several large non-energy industries employ old fashioned burners, moreover.  Profire believes its next generation systems could penetrate those markets, probably in conjunction with resellers that already have the necessary marketing relationships.  Ancillary products are being developed, too.  Approximately 30% of sales are comprised of third party items like valves and regulators.  Margins are good on those sales.  But they will be even better once Profire starts manufacturing them in-house.

Prices may increase in the upcoming fiscal year.  Current units sell for $2,000-$3,000 apiece, depending on the number of features included.  The average well produces $50,000-$100,000 a day in revenue.  Manual re-light systems can go dark for days at a time until a worker swings by and starts up the unit again.  That normally entails putting a lighted rag on the end of a stick, and inserting it into the burner.  Profire's computer based machines are more economical even when the flames don't go out.  Older units keep the flame steady at a high level no matter how much oil or gas is flowing.  The company's automatically adjust, saving energy.  The units also sharply reduce the amount of natural gas that is flared into the atmosphere, cutting greenhouse gas emissions.  Many of the 35,000 new wells drilled each year in the U.S. now use an automated system.  But about 850,000 older wells are still out there with manual systems.

Acquisitions could enhance performance.  Our estimates reflect Profire's organic potential.  But the company is investigating several deals, both in the burner management space and among other types of products that could be sold to the same customer base.  Any transactions within the industry would be made to acquire distribution capabilities.  Profire probably would sunset any acquired systems and transition the new sales force to its existing line-up.

The U.S. retrofit market could surge if safety regulations are implemented.  The industry is moving in that direction due to the high benefits and low costs associated with Profire's units.  But that transition is mainly focused on new wells currently.  If tighter rules are created the company probably would be the largest beneficiary.  That level of adoption also might facilitate international growth.

We estimate sales will improve 40%-55% next fiscal year to $50-$55 million.  Acquisitions could yield upside from there.  Earnings have the potential to reach $.20-$.25 a share.  In 2-3 years sales could achieve $100-$125 million, delivering income of $.45-$.55 a share.  Growth could remain at a high level in subsequent years as North American energy production continues to grow, the retrofit market develops, and international demand becomes a more important element.  Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $10 a share, potential appreciation of 185% from the current quote.

( Click on Table to Enlarge )