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Geometric Software: ‘Engineering’ all the way - Views on News from Equitymaster
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Geometric Software: ‘Engineering’ all the way
May 3, 2007

Performance summary
Geometric Software Solutions (GSS) announced strong results for the fourth quarter and full year ended March 2007. For FY07, the consolidated topline (including Modern Engineering) has grown at a robust rate of 72% YoY. On an organic basis (excluding Modern Engineering), the growth was 42% YoY. The company’s consolidated bottomline (including Modern) have, however, witnessed a 480 basis points (4.8%) contraction, chiefly owing to losses made by Modern at the operating level. Due to the pressure on operating margins and despite higher other income, the net profit growth has underperformed growth in topline during FY07. As a matter of fact, the consolidated results include five months of Modern Engineering revenues.

Consolidated financial performance: A snapshot…
(Rs m) FY06 FY07 Change
Sales 2,234 3,831 71.5%
Expenditure 1,746 3,181 82.1%
Operating profit (EBDIT) 488 650 33.2%
Operating profit margin (%) 21.8% 17.0%  
Other income 50 92 84.9%
Depreciation 147 203 38.0%
Interest - 31  
Profit before tax 390 507 29.9%
Tax 69 68 -1.0%
Minority interest 64 64 1.3%
Profit after tax/(loss) 258 374 45.2%
Net profit margin (%) 11.5% 9.8%  
No. of shares (m)   63.6  
Diluted earnings per share (Rs)   5.9  
P/E ratio (x)   21.2  

Leading PLM solutions provider
GSS operates in the highly niche area of providing product lifecycle management (PLM) technologies and solutions to the global mechanical design, manufacturing, hi-tech 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. The company has acquired Modern Engineering, which has a predominant position in the engineering space to cater to the widely unpenetrated engineering market. The company has bought back the remaining stake in Modern Engineering and now the latter is a 100% subsidiary.

What has driven performance in FY07?
Organic growth leads the way: The organic growth strategy of the company is yielding results where the topline has grown by 42% YoY and the bottomline has grown by 45% YoY. The operating margins have however contracted by 180 basis points mainly due to higher operating expenses resulting from increase in staff cost and selling expenses. The bottomline was boosted by higher other income (due to higher forex gains) as also lower tax outflow (due to an increase in percentage of work done in 10A units which qualifies for tax exemption).

Organic financial performance: A snapshot…
(Rs m) FY06 FY07 Change
Sales 2,234 3,176 42.1%
Expenditure 1,746 2,541 45.5%
Operating profit (EBDIT) 488 634 30.0%
Operating profit margin (%) 21.8% 20.0%  
Other income 50 84 70.3%
Depreciation 147 196 33.6%
Interest - 21  
Profit before tax 390 501 28.3%
Tax 69 62 -9.5%
Minority interest 64 64 1.2%
Profit after tax/(loss) 258 374 45.1%
Net profit margin (%) 11.5% 11.8%  

Change in strategy getting favourable: GSS was initially focusing on its business partners (OEMs) for its revenue contributions but over the last year there has been a marked shift in the strategy of the company on focusing on Direct Industrial (DI) customers. And this is reflected in increased contribution of DI customers. The company has also initiated efforts to cross leverage Modern’s base of DI customers to sell its entire portfolio of offerings. As a result of this strategy, the revenue contribution from business partners have come down over the last few quarters. The operating revenues have grown in line with the strategy to increase penetration of DI accounts and software development services.

Revenue by customer profile
Customer segment Q4FY07 Q3FY07 Q4FY06 FY07
Software Product 30.0% 34.0% 50.0% 37.0%
Business Partners 16.0% 22.0% 26.0% 23.0%
Direct Industrial 54.0% 44.0% 24.0% 40.0%

Engineering leads the way: GSS’ engineering division has once again been the star performer for the company and its contribution to revenue has increased with consolidation of Modern for the entire quarter. Although PLM solutions have shown flattish trend in FY07, GSS’ partnership with leading PLM vendors such as Dassault Systems, UGS PLM Solutions and Matrix One gives it a unique advantage of providing cost effective solutions. In FY07, the products have been the major disappointment and have lagged company’s topline growth but the company is taking measures by leveraging its sales team and adding new channel partners.

Revenue by service line
Service line Q4FY07 Q3FY07 Q4FY06 FY07
Software 53.0% 59.0% 77.0% 64.0%
Engineering 39.0% 31.0% 8.0% 25.0%
Product 8.0% 10.0% 15.0% 11.0%

Margin contraction: GSS’ operating margins contracted by 480 basis points during FY07. The main factors to the margin contraction are higher onsite component of revenues. Secondly, Modern’s revenues and profits were lower then expectations due to project launch delays in Detroit. This impacted the overall profitability of GSS during the fourth quarter as well as the fiscal.

Cost of financing Modern impacts bottomline: The profitability of GSS was impacted negatively due to increase the cost of financing Modern acquisition along with its working capital requirement and new facilities taken on lease also dragged down profitability. The impact of consolidation of Modern was almost 2%. On the positive side 85% YoY rise in other income provided the much-required impetus to the bottomline.

On the clientele front, the company added 47 new clients during the fiscal with 1 client contributing more than US$ 10 m in annual revenues. The employee hiring was a net of 1,071 this fiscal. Staff strength at Modern was 511 and that of 3D PLM (JV with Dassault Systems) was 567. Utilisation rates stood at 87% including trainees and 90% excluding them. Attrition rates decreased to 18.6% (annualised) in FY07, from 20.2% in FY06. This is undoubtedly a positive sign for the company as large players in the industry has not been able to control the attrition.

What to expect?
At the current price of Rs 125, the stock is trading at 9.4 times our estimated FY09 consolidated (excluding Modern) earnings. This makes the stock attractive for long-term holding. For FY08, the management has given its revenue guidance of 50% YoY growth in its topline and 30% to 35% YoY growth in the bottomline. As for FY07, the company has outperformed our revenue estimates by a marginal 2% while its net profits are lower by 5% as compared to what we had projected. While we are enthused about the company’s prospects in the engineering services and PLM space, scalability is what we are concerned about, considering that the company has faced similar problems in the past when it had to revise downwards its guidance a few times. We maintain out positive view on the stock from a long-term perspective.

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