Sunday, February 20, 2011

Computer Modelling ( Toronto - CMG ) -- Follow-up Report

Computer Modelling (CMG $25.00) reported Q3 (December) results that were somewhat below our expectation.  The main reason for the shortfall was a higher concentration of annual software license sales compared to perpetual licenses.  The company gives customers a choice of payment plans.  More took the year to year approach in the December period, requiring a lower upfront outlay.  Non-GAAP income slipped 9% to $.21 a share.  (All figures are shown in Canadian Dollars.)  Revenues increased 3% to $12.1 million.  Deferred revenue increased 17%, presenting a more accurate picture of the company's underlying growth rate.  Product development and marketing costs expanded in the period, pressuring margins to a degree.  Pretax income remained at 47% of sales.  The R&D line went up as Computer Modelling began putting on the final touches to its next generation software line.  Sales from that product will pyramid on top of the company's existing packages.  Computer Modelling improved its current products, as well, separating itself even further from the competition.  Selling efforts in the Middle East haven't borne fruit to date.  Political uncertainty may slow down those initiatives.  But new petroleum finds are becoming increasingly complex to analyze, even in the Middle East.  Demand is likely to emerge because Computer Modelling's software has been proven superior to Schlumberger's by a wide margin in those kind of applications.

We are maintaining our full year (March) earnings estimate at $1.10 a share.  The trend towards annual licenses may continue, in which case a lower number probably will be reported.  Those deals would lay the groundwork for greater recurring income in the future, though.  Rising energy prices promise to bolster demand over the intermediate term.  Tar sands, shale oil, shale gas, deep offshore, heavy oil, and other complex formations are where the action is when it comes to new discoveries.  As those fields get the go ahead demand for Computer Modelling's software is sure to follow.  The pipeline fiasco now afflicting the U.S. oil market may exert a slight restraint on activity.  But the U.S. has become one of the company's smaller markets, so the net impact shouldn't amount to too much.  Reported results also will be effected negatively if the U.S. Dollar declines materially, since two thirds of revenue is denominated in that currency while most costs are paid in Canadian Dollars. 

Financial results could accelerate sharply after the new software line is introduced.  The technology was field tested last year.  The software currently is being enhanced to run faster with better user interfaces.  Commercial launch is expected later this calendar year.  With a major new product in the wings, demand still growing rapidly for the company's core product, and no direct competition in sight, these shares continue to hold exceptional appreciation potential.  Meantime, the shares are yielding a 3%-4% cash dividend.

( Click on Table to Enlarge )