Computer Modelling Group ( Toronto - CMG ) -- Q4 Results

Computer Modelling Group (Toronto - CMG $28.00) reported Q4 (March) results that were below our expectation.  The company prices its energy simulation software either as a perpetual license or on a year to basis.  More customers elected the annuity format which provided less upfront revenue.  Unit volume was on target.  The recurring fees will enhance future reporting periods.  Earnings were down 10% at $.28 a share (excluding non cash stock option expense).  Sales were flat at $14.4 million (Canadian).  For the entire fiscal year earnings rose 16% to $.99 a share.  Revenues improved 14% to $51.8 million.   Consulting was the fastest growing segment, although it only represented 16% of total sales.  Computer Modelling has upgraded its technology substantially over the past two years, adding functionality that many users need help with to implement.  Those engagements usually lead to license sales.  License sales also are benefiting as different divisions within large companies adopt the technology. 

Long term growth promises to remain vibrant.  Almost all new energy discoveries are difficult to develop, and candidates for Computer Modelling's technology.  Halliburton and Schlumberger continue to offer simulators for conventional fields but have been unable to catch up in the high end segment.  Worldwide energy demand continues to rise, fueled by emerging economies.  And even at current price levels oil and natural gas provide far superior price performance compared to alternative sources.  A second line will be introduced later this year, focused on above ground facilities.  Those simulators will enable customers to maximize productivity for their entire projects.  The company is partnering with Petrobas and Shell.  Computer Modelling will retain all rights to the technology even though it only paid a third of the development cost.  Petrobas and Shell will get first crack at putting it to use.  Substantial leverage is possible by selling the new line to existing customers and bundling it with existing products when making new sales.

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3S Bio ( Nasdaq - SSRX ) -- Follow-up Report

3S Bio (SSRX $18.00) reported excellent on target Q1 results.  Sales advanced 28% to $18.1 million.  The rising Chinese currency accounted for 5% of that increase.  If the RMB keeps advancing against the U.S. Dollar further translation benefits will accrue.  Earnings dipped to $.15 a share.  Higher depreciation charges on the company's new manufacturing facility impacted profit margins.  That plant quadrupled 3S Bio's capacity, of which 30%-35% currently is being used.  The company also increased wages, hired more sales people, and lifted R&D spending on new drugs.  3S Bio additionally laid the groundwork to increase export operations, targeting emerging markets like Malaysia, Turkey, South Africa, and Egypt.  The company will take on Western pharmaceutical makers with lower cost alternatives.  3S Bio is one of the few companies in China that already has the ability to compete head to head with Western corporations on the world stage.  The combination of top notch science and low costs promise to fuel growth even after the government protections that help run of the mill Chinese companies fade over time.

Our 2011 estimates are unchanged.  Earnings could reach $.75 a share on sales of $80 million.  Margins should improve in upcoming periods as volume increases and costs stabilize.

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3S Bio ( Nasdaq - SSRX ) -- Follow-up Report

3S Bio (SSRX $15.25) reported better than anticipated Q4 results.  Sales advanced 40% to $15.3 million.  The company's two main recombinant DNA drugs led the charge, growing 40% and 53% respectively.  Those products accounted for 91% of total revenue for both the quarter and the full year.  Higher marketing and R&D costs prevented income from advancing as quickly as sales.  In fact, earnings declined 50% to $.08 a share in the period.  Most of the shortfall stemmed from a one time payment to acquire the Chinese rights to sell a promising anti-rejection drug being developed in Canada.  3S Bio also made an equity investment in the developer, and will finance a Phase III clinical trial in China later in 2011.

Growth in the core business remains vibrant.  A new manufacturing facility came on line in 2010, expanding capacity by 300%.  The government's new national health insurance law is boosting patient coverage.  And while price controls limit 3S Bio's revenue potential, those regulations are accompanied by approved supplier lists that reduce competition, as well.  Several new products are in the pipeline, which could leverage performance in future years.  Cash reserves exceed $100 million.  So additional deals with non-Chinese drug companies are a possibility.

We estimate sales will improve 26% in 2011 to $80 million.  Earnings could rise 34% to $.75 a share as volume builds at the new facility and R&D costs level off as a percentage o sales.  3S Bio remains well positioned to thrive in China's still evolving health care industry.  The company is preparing to expand outside the country, as well, which should demonstrate it's ability to compete without government protection. 

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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.

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

Computer Modelling Group (CMG $25.00) appears on track to report excellent on target Q3 (December) results.  The company is the leading provider of simulation software used by energy producers to exploit heavy oil, tar sand, and other complicated reserves.  Computer Modelling is gaining market share from Schlumberger, which still leads in the conventional market, because most of the easy to produce oil already has been found.  New discoveries are increasingly complex and require the company's high performance software.  Demand is rising across the board in response to escalating petroleum prices, which recently climbed above $90 a barrel.  Anything higher than $75 per barrel generally causes the pace of exploration to gain momentum.  Business remains vibrant in Computer Modelling's established markets.  The company has started to penetrate new accounts, as well, which used to rely exclusively on Schlumberger or their own internal technologies.  Geographic expansion is materializing, too, in response to beefed up marketing efforts.  Schlumberger has not responded with competitive high end products yet, and it appears that a major development effort is not underway.  Start-up competition has not emerged, either, and the likelihood of anyone new catching up at this point has become a dim prospect.  Computer Modelling is applying the finishing touches on a more comprehensive next generation system, which promises to lengthen its competitive lead after it is commercially introduced, perhaps as early as 2012.  Meantime, orders are pouring in as the energy industry prepares for a sustained increase in petroleum demand as the Third World matures over the next few decades.  Income is poised to keep rising at a fast pace.  Much of that is likely to be paid out as cash dividends, moreover, providing shareholders with a superior return comprised of both income and appreciation.

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