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.

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