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Geometric Software: Top down, bottom up
Jul 17, 2007

Performance summary
  • Topline declines by 9% QoQ, largely impacted by rupee appreciation.
  • Services revenue decline by 1% QoQ and product revenues decline by 9% QoQ.
  • Operating margins contract by 5.6%. Rupee appreciation, offshore wage hikes and Modern’s losses take toll.
  • Productivity gains on better offshore mix and SG&A reduction helps partially offset the impact of rupee appreciation on operating margins.

    Consolidated financial performance: A snapshot…
    (Rs m) 4QFY07 1QFY08 Change
    Sales 1,243 1,129 -9.1%
    Expenditure 1,086 1,050 -3.3%
    Operating profit (EBITDA) 157 79 -49.8%
    Operating profit margin (%) 12.6% 7.0%  
    Other income 63 135 113.6%
    Depreciation 57 59 4.4%
    Interest 17 16 -5.4%
    Profit before tax 147 139 -5.2%
    Tax 23 3 -88.6%
    Minority interest 19 20 2.7%
    Profit after tax/(loss) 105 117 11.4%
    Net profit margin (%) 8.4% 10.3%  
    No. of shares (m)   63.6  
    Diluted earnings per share (Rs)*   6.7  
    P/E ratio (x)*   18.6  
    * On a trailing 12 months basis

    Leading PLM solutions provider
    Geometric (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 1QFY08?
    All round pressure: Geometric recorded a 1% QoQ decline in services revenues and 9% QoQ decline in products revenues during 1QFY08. This could largely be attributed to the appreciation of the rupee, as the decline in revenues in dollar terms was only 1.4% QoQ when compared with 9.1% QoQ fall in rupee terms. Revenues from the outsourced product development business grew by 9% QoQ but the overall software segment revenues remained flat. The growth in PLM solutions was hampered by delays in contract though the company expects that this revenue will come from 2QFY08 onwards. The topline was also impacted due to pressure on Modern Engineering’s business, which was affected by program delays and long sales cycle in new verticals.

    In terms of geographies, GSS’ dependence on US has increased over the years. Sales from the US market contribute to 71% of the company’s 1QFY08 consolidated revenues (up from 70.6% in 4QFY07 and 59.7% in 1QFY07). This could be a big risk going forward as the industry is battling rupee appreciation against the US dollar. While the contribution of Europe has decreased due to lag in direct industrial customer penetration along with reduction in revenues from existing business partners, Asia Pacific showed a 13% QoQ growth mainly due to traction in large strategic accounts.

    In terms of client’s acquisition, GSS added 13 new clients during the quarter and its revenues from the top clients reduced to 25% from 28% in 4QFY07. The company added 77 (gross 187) net employees during the quarter and its consolidated strength now stands at 2,628 employees. The company also increased its utilisation by 100 basis points.

    Rupee appreciation, wage hike dents margins: The operating margins of GSS contracted by 5.6% QoQ largely due to wage hikes effected in Q1FY08. The rupee appreciation also played a major role in impacting the company’s margins during the quarter. The rupee shaved off 3% of the operating margins while the salary hike took away 4% from it. However, the overall pressure on margins was pared (the net impact on operating margins was reduced to 5.6%) by way of improved utilisation and pricing. The blended salary increase was 14.7%. Since the company is trying desperately to bring about 35% to 40% of Modern’s work offshore, going forward the utilisation rates might decrease and this will again take its toll on the margins

    Other income, lower taxes saves the day: Despite the pressure on topline and operating margins, GSS still managed to grow its bottomline at a rate of 11% QoQ. This was brought about by a doubling of other income, which was a consequence of large forex gains. The company now hedges 12 months of its earnings and currently has a forex hedge of US$ 36 m at Rs 45 to dollar. This higher other income along with lower taxes helped the company to expand its net margins by almost 2% QoQ. The taxes were lower during this quarter mainly because most of the profits were derived from units, which are exempt under section 10A. A tax write-back of Rs 2 m also lowered the total tax paid by the company during 1QFY08. The management expects the tax rates to stabilise at near 10% of profits before taxes in FY08.

    What to expect?
    At the current price of Rs 118, the stock is trading at 8.9 times our estimated FY09 consolidated earnings. For FY08, the management had given its revenue guidance of 50% YoY growth in its topline and 30% to 35% YoY growth in the bottomline, which now looks an uphill task considering the performance in 1QFY08. The company will incur capex of Rs 500 m in FY08 for setting up additional development centres. The repayment of debt, which was taken for acquiring Modern Engineering, will start from 1QFY09 onwards which will again impact net profitability. On the positive side, revenues from the Enterprise products division are expected to flow in from FY09 onwards, which will help the company to improve its margins, which are currently under pressure. However, in the medium term, the real test will be to make Modern a profitable company at the EBITDA level and to successfully bring the work offshore.

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