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Geometric Software: The algebra for growth!

Jan 19, 2005

Introduction to results
Geometric Software Solutions (GSS) has announced robust consolidated results for the quarter and nine month period ending December 2004. Strong sequential growth in topline and an unmatched growth in operating expenses has helped the company improve margins for the quarter. The performance has been equally strong for the 9mFY05 period.

Financial performance (Consolidated): A snapshot...
(Rs m) 2QFY05 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 399 435 9.1% 751 1,183 57.5%
Expenditure 288 291 1.2% 547 847 55.0%
Operating profit (EBDIT) 111 143 29.5% 204 336 64.1%
Operating profit margin (%) 27.8% 33.0%   27.2% 28.4%  
Other income 10 (5) -155.3% 52 25 -52.3%
Interest 0 - -100.0% 0 0 -72.7%
Depreciation 30 32 5.7% 58 91 57.1%
Profit before tax 90 106 17.5% 199 269 35.6%
Tax 17 17 0.6% 20 46 130.6%
Minority interest 11 10 -5.2% 24 30 25.7%
Profit after tax/(loss) 63 80 25.8% 155 194 25.0%
Net profit margin (%) 15.9% 18.3%   20.6% 16.4%  
No. of shares 11.1 11.1   11.1 11.1  
Diluted earnings per share (Rs)* 22.8 28.7   18.6 23.3  
P/E ratio (x)         17.4  
(* annualised)            

Leading PLM solutions provider
Geometric specializes in providing product lifecycle management (PLM) technologies and solutions to the global mechanical design, manufacturing and industrial markets. The company's presence in the domain of geometry provides it with a competitive advantage in the form of high entry barriers on account of high-levels of technical skill-set requirements.

What has driven performance in 3QFY05?
Products business drives revenues: While the past few quarters have witnessed strong growth in project revenues, the product business has remained stagnant. However, this quarter has been a different story altogether with projects and products revenues growing sequentially 7% and 31% respectively. The quarter marked GSS' acquisition of TekSoft and Cimtronics for a consideration of US$ 1.75 m, which is likely to be completed by the middle of 4QFY05. GSS already has an 8-year old relationship with TekSoft and we believe that this acquisition is a right initiative towards growing product revenues to US$ 15 m by FY07, despite it being an arduous task for the quantum of growth required in the remaining period. This quarter also saw revenues from industrial customers grow to 35% of GSS' consolidated revenues (30% in 2QFY05).

Lower employee costs aid margin expansion: Apart from the growth in product revenues (that are margin accretive), lower employee costs (as % of sales) have also helped GSS in expanding operating margins by a strong 520 basis points in 3QFY05. However, while we expect margins to remain stable going forward, the big expansion in this quarter was more a result of one-time expense that were incurred in the previous quarter and the fact that a large part of the employee addition came towards the end of this quarter. Apart from this, higher utilisation levels (89%, from 85% in 2QFY05) have also helped the improvement in margins.

Forex losses subdue profits: Despite the growth in net profits outperforming the topline growth by a wide margin, the picture could have been better but for the Rs 14.2 m of forex losses that GSS incurred in 3QFY05. These losses were then a consequence of a 3% appreciation of the rupee vis--vis the US dollar in the quarter.

Performance in the recent past...
  4QFY04 1QFY05 2QFY05 3QFY05
Sales (QoQ growth, %) 13.3 13.0 14.1 9.1
Employee costs (% of sales) 51.6 58.9 55.4 52.3
Onsite revenues (% of sales) 19.0 22.0 24.0 26.0
Profits (QoQ growth, %) (8.8) (4.4) 23.9 25.8
Operating margins (%) 27.4 23.3 27.8 33.0
Employee base (nos.) 710 801 872 1,035

What to expect?
At the current price of Rs 405, the stock is trading at a price to earnings multiple of 17.4 times annualised 9mFY05 earnings and 7.0 times our FY07 earning estimates. The management of GSS has indicated that while it expects to exceed the 35%-40% YoY revenue growth target for FY05, the profit growth target of 27% to 31% is likely to be impacted by the exchange rate volatility. As indicated above, we believe that the initiatives that GSS is taking to reach the target of US$ 100 m revenues by FY07 are in the right direction. However, we expect the company to reach US$ 72 m in revenues by FY07 and the engineering services and product businesses to play critical roles in the same. Also, the fact that GSS is derisking its business from the OEM customers (65% of revenues) towards industrial customers (35%) is a move in the right direction.

We maintain our recent recommendation of a Buy' on the stock with a target price of Rs 750 in the long-term. This implies an upside of 86.0% point-to-point from the current levels, or CAGR returns of around 31.8% by FY07. This price target is based on a price to earnings multiple of 13.0 times FY07 expected EPS.

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