Geometric guidance revision: Part 2! - Views on News from Equitymaster

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Geometric guidance revision: Part 2!

Oct 4, 2005

Geometric Software Solutions (GSS), the PLM specialist software company, has in a press release, mentioned that it expects a below-par performance in 2QFY06. Specifically, the company expects revenue growth to be in mid-single digits, as compared to a double-digit growth originally anticipated by it. What now?
It must be noted that this is the second consecutive quarter in which the company has given such a profit warning. Once again, the main reasons attributed by the management are delays in the ramp-up of a few projects. Numerous projects, including a large engineering services project, were expected to commence at the beginning of the quarter. However, they were only able to commence towards the middle or end of September, as a result of which the overall impact on the quarter as a whole is very limited, if at all.

GSS is also facing issues relating to the launch of its CAD-PDM product. This was a problem that the management had alluded to even after 1QFY06 results were announced. The company has mentioned in the press release that it is ‘trying to get alignment between partners’, implying that it is having problems getting the distribution set-up in place. We view this as a typical example of the problems that a company with a small size such as GSS can face with regards to launching products.

This should be viewed in context of the fact that products is a key facet of GSS’ strategy over the next two years and the company expects products to contribute between 13% to 16% of revenues by FY07. Products are an inherently risky business and given GSS’ small size, this enhances the risk profile.

The ultimate effect of this on GSS’ bottomline for 2QFY06 is undoubtedly going to be adverse. The company had recruited personnel and added facilities in order to implement these delayed projects. Consequently the utilisation levels have been affected and margins thus, are expected to take a big hit. In 1QFY06, operating margins crashed by 900 basis points, partly due to the revised guidance, as also the salary revisions.

However, over the longer term, the management has said that it believes that it is on the right track and that its strategy is correct. The company has a robust order pipeline and the demand environment is strong. Given GSS’ established position in the PLM market and strong relationships formed with major PLM OEMs like Dassault Systemes and UGS, it appears to be well positioned to take advantage of the growth opportunities available.

Nonetheless, we believe that this move warrants us to have a re-look at our forward projections over the next couple of years. GSS has said that the company will not be able to recover the lost revenues in FY06 over the next couple of quarters. The management is also not planning to give the revised guidance numbers. It would rather wait and deliver good performances over the next two quarters and then give guidance numbers, as then, the credibility of the numbers would be better.

Our current estimates show GSS achieving a 43% YoY revenue growth and a 48% YoY profit growth in FY06 over FY05. The EPS works out to Rs 7.3 a share. We would be revising these numbers downwards after a conference call with the management. At the current market price of Rs 99, the stock trades at 13.6 times our estimated FY06 earnings. We had recommended the stock at Rs 78 in January 2005 with a price target of Rs 143, which we believe needs a downward revision, the magnitude of which will only be post our conference call with the management. Nevertheless, over the next two to three years, we maintain our positive outlook on the company, irrespective of the warnings. Our valuation band adequately reflects this nature of the business.

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