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i-flex: Back to basics...

Mar 23, 2005

i-flex Solutions is a mid-sized software company that operates in a highly specialised area. It is a niche player in the sense that its strategy is to focus exclusively on the banking and financial services industry. It provides software products, services and consulting to the banking, financial services, investment banking, brokerage and insurance industries. It is the only software company in India to derive most of its revenues from software products, accounting for 61% of revenues in FY04. Its flagship product, Flexcube, has been ranked as the world's largest selling wholesale and retail banking back-office solution by International Banking Systems (IBS) for the last three years in a row. Flexcube provides back, middle and front office solutions for corporate, retail and investment banking, as well as asset management and broking operations.

In this article, we attempt to "go back to the basics" with reference to i-flex, in terms of demystifying important terms. We also explore margins in different business segments and analyse the reasons as to why the company enjoys those margins. The ultimate aim is to provide a sound foundation about i-flex to the layperson.

Untangling the 'jargon web'
There are certain terms and jargons used in the industry in which i-flex operates, which can be quite confusing at times. This is especially true for the layperson, who may not be technically inclined. These terms frequently come up at times such as declaration of the quarterly and yearly results, as also acquisition of new clients or acquisition of a company. It can be difficult for the layperson to understand what the management is trying to say, and the implications of their actions. We try to analyse some of these terms, and their place in the overall scheme of things.

  1. License fees: These are fees payable by clients of i-flex for the use of the product (Flexcube) that the company licenses to them. It is a part of the product revenues of i-flex. License fees would depend upon factors such as number of users supported, copies sold, number of geographical locations, and so on.

  2. Tank size: In simple terms, this means the unbilled license fees. i-flex, during the course of the year, is constantly acquiring new customers and new business. As and when it enters into contracts with new clients, it records the license fees that it will charge them for use of its product. These unbilled fees are added to the 'tank size'. It is more or less similar to the 'order book' that is used in the engineering industry.

  3. Implementation and enhancement fees: After licensing the product to the client, i-flex provides services relating to the implementation of the product at the client's site, as well as integration with other systems of the client and enhancement to the product, in order to satisfy the unique needs and requirements of each client. These fees are charged on the basis of two methods. One is on a fixed contract basis, where the company has a specified deadline for implementation, and receives payments on the completion of certain milestones. The other is on a time and materials basis, where the company earns revenues based on the number of hours completed, and the corresponding completion of the implementation. It is more flexible.

  4. Annual maintenance contracts (AMC): These contracts involve the company providing after-sales support to the client. Services such as technical support, maintenance of the systems, upgrades and trouble shooting would be provided under these contracts.

It should be understood that the 'tank size' consists of only unbilled license fees, and not implementation and enhancement fees, or revenues from AMCs. Thus, the tank size is an indicator of a part of the revenues that the company is expecting in the course of the next six to twelve months. Rapid growth in the tank size would indicate strong growth in business for the company, from existing clients and new client acquisition. As an investor, this is one of the key parameters to use while trying to judge the expected growth of the company.

Implementation fees are based upon the time taken for the company to fully implement the product on the client's systems, and the timeframe for completion can vary between twelve to eighteen months.

Where's the profitability coming from?
i-flex divides its revenues into two segments: products and services. The products business enjoys impressive operating margins of over 40%. The main reason for this is that the products business is not a people-intensive business like services. The main costs that the company incurs are the costs of developing the products, and implementation and enhancement, apart from research and development, and sales and marketing expenses. As soon as these costs are recovered, the balance income goes straight to the bottomline. However, it must be noted that revenues from products tend to be volatile, as it depends upon time taken by the company in implementing the product. Every quarter might not see a major implementation and milestone achieved, therefore, revenues fluctuate quarter-on-quarter. It would, therefore, make more sense to compare revenues from products on a year-on-year basis.

The services business on the other hand, is a people-intensive business. Given the fact that i-flex is growing this business at a fast clip, and that employee costs have put pressure on it, operating margins are considerably lower than in products, at around 17%. PrimeSourcing, the services brand of i-flex, has been a bit of a laggard compared to peers like Infosys, TCS and Wipro. Management has indicated that this business will serve as an incubator for the company in order to tap opportunities for its products business.

Products v/s Services: Who calls the shots!
(Rs m) FY01 FY02 Change FY03 Change FY04 Change
Net Sales 1729 2529 46.3% 3855 52.4% 4794 24.4%
Operating profit (EBDITA) 848 1148 35.4% 1850 61.1% 2081 12.5%
EBDITA margin (%) 49.0% 45.4% 48.0% 43.4%
Net Sales 1511 1669 10.5% 2286 37.0% 3085 35.0%
Operating profit (EBDITA) 568 464 -18.3% 448 -3.4% 550 22.8%
EBDITA margin (%) 37.6% 27.8% 19.6% 17.8%

We have understood a few terms that are frequently used with reference to i-flex. These terms give us some idea of the possible future growth that the company is likely to maintain going forward. Any investor current and potential - should have some understanding of these terms if he/she wants to understand the company and its growth prospects better. The margins of the company in its business segments and the reasons as to why the company enjoys those margins have also been understood. One must constantly keep an eye on factors affecting the business segments of the company, such as tank size, growth in employee costs and S&M costs, billing rates charged, percentage of onsite to offshore revenues, new client growth, and so on. Thus, an investor can get a better understanding of the company through understanding these terms well. This is a sort of a guide to enable greater clarity about the company. It is definitely not a foolproof method of making money from the stock, but it adds value in terms of providing a solid base, on which the investor can build for future decision-making.

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