Simulations Plus: An Acquisition Candidate With Unique Products

| About: Simulations Plus, (SLP)

The main product line of Simulations Plus (SLP) is a growth industry and cutting edge. SLP creates software that simulates drug experimentation. Its software simulates the work that scientists would do in a lab like mixing chemicals and experimenting on humans and animals. This software is used by biotech companies, governmental agencies like the FDA, and by med and even grade school students.

This pharmaceutical simulation software is in high demand and growing. From fiscal years 2009 to 2010, and 2010 to 2011, the company's revenue has grown 17.2% and 9.4%, respectively. In those same periods, net income has grown 52.7% and 25.9%, respectively. For FY 2012, revenues and profits are on track to rise 8% and 10%, respectively, over last year.

Although the company is a micro cap, it has amassed so much cash that it issued its first dividend earlier this year. It had $13.17 million in cash on February 29, 2012 before it paid its quarterly dividend of $0.05 per share amounting to about $800K. The company is also using its cash to do share buybacks, buy-out royalty agreements, and look for acquisitions.

A Buyout Candidate

Simulations Plus had a huge gross margin of 85.9% in the latest quarter, and a high SG&A percentage of revenues of 34.3%. When I looked at these numbers, I realized that Simulations Plus is a ripe takeover candidate. Compare the company's numbers with a large-cap stock and a potential acquirer in the medical research industry: Laboratory Corp (LH). LH has a gross margin of 41% and SG&A expense percentage of 20.9%. Bigger companies in any industry generally have smaller gross margin and SG&A percentages.

Those kinds of companies in the medical industry with a unique product, high gross margin and high SG&A expense make good takeover candidates. The reason why is the takeover company can market the product more widely through its contacts, and take advantage of the high gross margin. The SG&A expense as a percentage of revenue can be absorbed by the bigger company's SG&A departments. The product can also complement some of the acquiring company's products.

Look at Zoll (ZOLL), a company I've admired and written about. It had all of the above characteristics and got acquired at a multi-year high for a price that gives it a P/E ratio of about 60. SLP is currently trading at $4.44. If it were bought out at a 60 P/E, that would make the buyout price a little over $12 per share.

Like SLP, ZOLL also has unique products that are in high demand. The ZOLL LifeVest is the only wearable defibrillator. ZOLL also has high financial percentages. For fiscal year 2011, ZOLL had a gross margin of 57% and an SG&A expense percentage of 39.5%. Those numbers can be compared to a bigger company in the same industry like Philips Electronics (PHG), with a gross margin of 38% and a SG&A expense percentage of 26%. Like SLP, ZOLL has amassed a large cash balance with zero debt.

Note that insiders own 46% of the company so they might not want to sell the company, even though they probably could for a high premium to the current share price.

Simulation Plus' Products

For FY 2011, Simulation Plus' revenue consisted of $8.72 million in pharmaceutical software and services, and $2.95 million from Word+ sales. That totals 74.7% and 25.3% of total net sales, respectively.

The company's five software products for pharmaceutical research are: ADMET Predictor™, MedChem Studio™, MedChem Designer™, DDDPlus™, and GastroPlus™.

The ADMET Predictor simulates drug clinical trials. It enables researchers to rapidly eliminate poor compounds before spending millions of dollars on research.

The MedChem Studio allows chemists to rapidly generate large numbers of novel chemical structures.

The MedChem Designer allows chemists to draw and design molecules.

DDDPlus allows scientists to simulate and measure the strength and speed of dissolution of a tablet.

GastroPlus is the flagship product, producing about 65% of the pharmaceutical software and service revenues. It simulates the absorption, pharmacokinetics, and pharmacodynamics of drugs administered to humans and animals, and is currently in use at numerous pharmaceutical companies, the FDA, and other government agencies in the U.S. and other countries.

As explained in the 10-K, some of their pharmaceutical softwares have direct competition, some have no significant competitive threat. Its GastroPlus or DDDPlus softwares have no significant threat, but a threat could be developed in time. Its MedChem Studio and ADMET Predictor operate in a more competitive environment.

Pharmaceutical software and services sales increased 14.7% in FY 2011 from FY 2010 to $8.72 million. The company was able to increase sales to new and existing customers.

Words+ Products

The company's subsidiary, Words+, creates software to help people with disabilities to communicate. The biggest products of Words+ is Eyegaze technology that allows people to operate a computer or device simply by looking at the screen.

Before the iPad and iPod, price wasn't an issue with the Words+ products. As long as the product fit the customer, the customer would pay a high price. However, because similar, cheaper products have come out for the iPad and iPod, there has been pricing pressure. In FY 2011, Words+ sales decreased 3.6% from FY 2010, to $2.95 million.

As shown in this 8-K filing on November 15, 2011, the company is selling its Words+ subsidiary for $2.1 million to the Prentke Romich Company. Once it's sold, the company will just focus on its pharmaceutical simulation software, which has plenty of growth potential ahead.

Trade recommendation: Buy

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.