Simulations Plus ( Nasdaq - SLP ) -- Computer Monkey

Simulations Plus (SLP $6.45) is a leading software provider for pharmaceutical development.  Drug companies use the technology to simulate the performance of large numbers of prospective molecules.  That computer testing enables them to identify promising candidates efficiently, eliminating the need to conduct expensive and lengthy laboratory experiments.  Simulations Plus's products are built on mechanistic equations that explain the actual biologic reactions taking place.  That limits the software's scope because much of what occurs in the human body remains a mystery.  The company recently expanded its potential market with an acquisition.  The new operation ("Cognigen") develops statistical models that fit the data obtained during clinical trials, even if the correlation can't be explained scientifically.  The two segments currently operate independently.  But cross selling opportunities already are starting to emerge.  Penetration of existing accounts is likely to expand.  The broader product line promises to attract new customers more easily, as well.

Approximately 10% of sales is generated by non-pharmaceutical customers.  Most are chemical manufacturers.  Those customers employ simulation software to identify potential environmental risks and other toxicity problems.  The U.S. Environmental Protection Agency licenses the technology, as well.  The fact the regulators use the systems to assess risk endorses the products' quality.  It also encourages private sector users to buy their own copies so everyone is speaking the same language.

The U.S. Food and Drug Administration has become a significant user, too.  Government sales tend to be at discounted prices.  So the direct revenue contribution is insignificant.  The FDA's experience with the technology has expanded over the past several years, though.  Confidence in the results has grown to the point that new drug submissions are encouraged to include simulation data.  Simulation Plus's products are used by the drug companies in pre-clinical applications.  They also are applied in the entire clinical trial process, from Stage One to Stage Three.  Interaction with the F.D.A. occurs during the entire development process.  Simulation still represents only a small part of the entire new drug application.  The part the company can scientifically explain remains an important but incomplete element of the entire process.  The remainder of the approval process remains statistics based.  "What are the odds it will work?"  That's where the new Cognigen operation fits in.

Cognigen was acquired at the end of fiscal 2014 (August).  Results were consolidated for the entire first quarter (November).  Q1 performance was impacted by the transition.  Cognigen's main shareholder became president of Simulations Plus, which cut into the amount of time he had to sell the service.  New sales people were added to take up the slack.  But those deals won't contribute until later in the year.  The combination holds excellent potential, though.  Competition for new drug approvals is intensifying, fueled by a booming IPO market.  Funds are available to improve the likelihood of success.  Spending on simulation software and statistical modelling promises to keep rising at above average rates, accordingly.

International sales are advancing even more rapidly.  That's hard to explain intuitively.  American drug developers have more money to spend.  And the F.D.A. has endorsed the technology.  The biggest gains are being achieved in Asia.  Part of that reflects the superior growth that region is registering.  Asian drug companies also are protected by self-serving national regulations that tend to block foreign competition.  Asia also is the one area of the world where Simulations Plus employs third party distribution channels to sell its products.  Foreign sales are likely to keep rising at a superior rate as sales efforts move closer to end users.

First quarter (November) financial results were mixed.  The software business performed well.  The Cognigen operation generated lower than expected revenue, and low profitability.  We are confident the Cognigen segment will improve performance in upcoming periods.  Even without the industry tailwind there's little question the people involved would make the numbers improve.  Software sales promise to continue advancing at an above average clip.  A new biologics element could expand the addressable market by 25% or more.  A significant percentage of new drug development is biotechnology oriented.  The new product aims at that segment.  A separate niche product ("Membrane Plus") is being released, as well.  Renewal rates remain in the 95% range.  Pricing is on a recurring revenue basis.  Simulations Plus was a pioneer in the SAAS pricing model.  With volume up it now earns 40%-50% pretax on software sales (15%-20% on statistical modelling).

We estimate income will achieve $.25 a share in fiscal 2015 (August).  In 2-3 years that figure could reach $.35 a share.  Applying a P/E multiple of 30x suggests a target price of $10 a share, potential appreciation of 55% from the current quote.  Faster gains are possible.

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