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Cranes Software: Strong start to FY07
Aug 9, 2006

Introduction to results
Cranes Software recently announced its financial results for the first quarter ended June 2006. Continuing strong growth in its major products and new product launches led to strong growth in the company’s topline during the quarter. However, due to considerably higher costs, particularly material and general and administrative (G&A) costs, operating margins were under some pressure. Despite this, higher other income and lower taxes led to strong growth in the company’s bottomline.

Financial performance (Consolidated): A snapshot
(Rs m) 1QFY06 1QFY07 Change
Sales 471 621 31.6%
Expenditure 187 302 61.4%
Operating profit (EBDITA) 284 319 12.0%
Operating profit margin (%) 60.3% 51.4%  
Other income - 16  
Interest 20 11 -43.0%
Depreciation 67 96 43.7%
Profit before tax 197 227 15.0%
Tax 68 37 -45.8%
Profit after tax/(loss) 130 190 46.8%
Net profit margin (%) 27.5% 30.7%  
No. of shares (m) 50.8 113.7  
Diluted earnings per share (Rs)*   6.0  
P/E ratio (x)*   16.9  
* On a trailing 12-month basis.

What is the company’s business?
Cranes Software is a specialised software products company, focussed on providing products and solutions to address the needs of scientists and engineers globally. The company started off in the early 1990s as a distributor of third party products and has since metamorphosed into a company that derives a majority of its revenues from proprietary products. Over the years, Cranes has followed an ‘Acquire, Enhance, Expand’ strategy i.e. acquiring under-valued scientific software products with strong and established user bases, enhancing them by adding more modules, and then expanding the market through deeper vertical penetration and cross-selling opportunities. The company’s main focus areas are data visualisation and presentation, statistical and analytical software and engineering. In FY06, the Proprietary products business constituted nearly 80% of sales. Cranes has a presence in 39 countries and a user base of over 360,000 scientists and engineers. The company has grown its sales and net profits at compounded rates of 58% and 67% respectively over the period FY02 to FY06.

What has driven performance in 1QFY07?
New product launches drive the topline: During 1QFY07, Cranes’ topline witnessed a strong 32% YoY growth. This was led by increased traction in the company’s suite of engineering and scientific software products, particularly in the international markets. Geography-wise, Cranes’ international revenues saw a strong 37% YoY growth, while domestic revenues grew at a relatively muted 5% YoY. International business contributed to as much as 97% of the incremental revenues this quarter, and given the management’s globalisation strategy, we expect this to be the major driver of growth in future as well.

Cranes launched a number of new products during the quarter, underlining the company’s strengths in research and development (R&D). New versions of its major products – NISA (focusses on computer-aided engineering, CAE), SigmaPlot (scientific graphing and data analysis package) and SYSTAT (statistical analysis software) – led to strong growth in the company’s proprietary products business.

In continuation with the process kicked off recently, Cranes merged the operations of its wholly owned subsidiary, EMRC India, with itself, effective April 1, 2006. The company has also completed the acquisition of EMRC’s US operations. EMRC is the developer of the NISA suite of products, operating in the CAE space. It can be recalled that Cranes had acquired EMRC in May 2005 for a consideration of US$ 1.5 m.

Higher costs subdue margins: During 1QFY07, Cranes witnessed a near-900 basis points (9%) decline in its operating margins. This was primarily a result of considerably higher material and G&A costs. These costs increased as a percentage of sales, from 9.2% to 15.9% and from 10.9% to 18.4% respectively. It should be noted that the nature of Cranes’ business leads to the company making certain purchases of software at various points during the fiscal. This could vary from quarter-to-quarter. Given the substantial increase in material costs, it does seem that the company made a significant part of its software purchases in this quarter, leading to the jump in these expenses. However, overall, we believe that operating metrics must be looked at from a full-year perspective rather than quarter-to-quarter.

Cost details…
(Rs m) 1QFY06 1QFY07 Change
(Increase)/Decrease in stock 27 2 -92.2%
% of sales 5.7% 0.3%  
Material cost 43 98 127.3%
% of sales 9.2% 15.9%  
Personnel expenses 66 87 33.0%
% of sales 13.9% 14.1%  
General and administrative expenses 51 114 122.2%
% of sales 10.9% 18.4%  
Total expenses 187 302 61.4%
% of sales 39.7% 48.6%  

Other income, lower taxes power bottomline: During 1QFY07, Cranes reported an impressive 47% YoY growth in bottomline. This was despite the lower operating margins, and was enabled due to other income (nil in 1QFY06) and considerably lower taxes paid. The effective tax rate for Cranes fell significantly this quarter, from 34.3% of PBT in 1QFY06 to just 16.2% this quarter.

What to expect?
At the current price of Rs 102, the stock is trading at a price to earnings multiple of 11.3 times our estimated FY08 earnings. The company continues to witness strong traction in its IP-led business model. The continuous launch of newer versions of its proprietary products is a factor that enthuses us, since we believe that in order to sustain growth in a product-led business model, it is necessary to have a strong R&D set-up in place, as well as a strong marketing network. The company is also in the process of launching its ‘Solutions’ business, which will drive the topline going forward. This initiative will give Cranes an end-to-end solution suite in the niche area of engineering and scientific software products.

Nonetheless, certain risk factors need to be taken into account as well, such as the relatively small size of the company, lower margins (estimated) due to the people-intensive solutions business and the capital-intensive nature of the products business, where constant investments need to be made in order to drive growth. However, considering that the company failed to display the intended performance over our investment horizon of 2-3 years we discontinue our coverage on the stock.

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