i-flex: Powered by all-round growth!

Performance Summary

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i-flex solutions (i-flex) has reported impressive results for the quarter and full year ending March 2005. For 4QFY05, topline has grown by a scorching 71% YoY, while for FY05, the figure is a strong 45% YoY. The bottomline performance has been equally impressive, with net profit up by as much as 90% YoY during 4QFY05 and 30% YoY for the fiscal. However, higher cost of revenues during FY05 have taken a toll on operating margins, which have declined by 230 basis points YoY during the fiscal. For 4QFY05, margins have expanded by as much as 540 basis points mainly due to the robust topline growth aided by lower than proportionate rise in expenses.

Consolidated financial performance: A snapshot

(Rs m)	4QFY04	4QFY05	Change	FY04	FY05	Change
Net sales	2,093	3,586	71.3%	7,881	11,386	44.5%
Expenditure	1,465	2,318	58.2%	5,655	8,384	48.3%
Operating profit (EBDITA)	628	1,268	101.9%	2,227	3,001	34.8%
Operating profit margin (%)	30.0%	35.4%		28.3%	26.4%
Other income	18	121	572.2%	139	259	87.1%
Depreciation	(47)	99	-310.6%	51	309	510.3%
Profit before tax	693	1,290	86.1%	2,315	2,951	27.5%
Tax	146	252	72.6%	527	627	19.0%
Profit after tax/(loss)	547	1,038	89.8%	1,788	2,324	30.0%
Net profit margin (%)	26.1%	28.9%		22.7%	20.4%
No. of shares (m)	76.9	77.1		76.9	77.1
Diluted earnings per share (Rs)*	28.4	53.9		23.2	30.2
P/E ratio (x)					20.0
(* annualised)

What is the company's business?

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i-flex is India's premier software products company, focussed on the banking and financial services (BFSI) vertical. The company's portfolio of offerings comprises products (53% of revenues) like Flexcube, an end-to-end product suite for retail, corporate and investment banking, asset management and treasury. The company also provides software services (47% of revenues) like application software development and deployment, maintenance and business and IT consulting. During FY05, i-flex acquired a company called Equinox Corporation, which provides BPO services. For the year 2004, the company's flagship product, Flexcube, was ranked as the number one selling wholesale as well as retail back-office banking solution in the world by International Banking Systems (IBS) for the third year running. In fact, Flexcube has been rated among the top-selling banking solutions for the last six years.

What has driven performance in 4QFY05?

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Growth across the board: i-flex's services segment (47% of revenues) has once again led the growth in the company's consolidated topline. In 4QFY05, revenues from this segment have increased by as much as 82% YoY, while the products division has also shown a healthy 45% YoY growth.This strong growth in both these segments is a big positive for the company that has been trying to cross-sell its offerings across its customer base. The strong growth also seems to have been aided by the effect of the various acquisitions that the company made during the course of FY05. The robust growth in the services segment is also a fallout of the management's consistent push for faster growth of the segment, as it acts as an incubator for developing new technology that will further help the company in improving its product offerings.

Services revenue growth (on a YoY basis) was aided mainly by an increase in volumes. As far as billing rates are concerned, management has indicated in the conference call that by and large, throughout the year, billing rates remained stable. In 4QFY05, i-flex added 16 customers in the products and services businesses totally. The company has been showing good traction in its product business, with three big order wins during FY05 from tier-1 financial institutions. The tank size of i-flex has, for the first time, hit the US$ 50 m level. This, when compared to US$ 27 m three years ago, shows the strong pace of growth that the company has maintained and the big strides taken during the period.

Segment-wise performance…

(Rs m)	FY04	% of total	FY05	% of total	Change
Products
Revenue	4,794	60.8%	5,979	52.5%	24.7%
OP	2028	80.9%	2347	68.2%	15.7%
OPM	42.3%		39.2%
Services
Revenue	3085	39.2%	5,347	47.0%	73.3%
OP	479	19.1%	1092	31.8%	127.8%
OPM	15.5%		20.4%
Total
Revenue	7,879		11,386		44.5%
OP	2508		3439		37.1%
OPM	31.8%		30.2%

* including inter-segment adjustments

Margin blues: i-flex has added a net of 2,540 employees in the last year, which is the largest YoY addition in its history. The results can be clearly observed, as there has been a considerable rise in employee costs, which have increased as a percentage of revenues from 40% during FY04 to 47% during FY05. This is the main factor that has impacted margins for FY05, which have fallen by 230 basis points. However, for 4QFY05, the picture is completely different. Margins have expanded by as much as 540 basis points due to the scorching pace of revenue growth aided by a lower than proportionate rise in expenditure. As regards segmental margins, product margins fell by 310 basis points, but services margins expanded by an impressive 490 basis points, powered by the strong revenue growth.

Lower margins, higher depreciation restricts net profit growth: Apart from the contraction in operating margins, higher depreciation has dented net profit growth during FY05. However, it must be seen in the context of the fact that net profit growth is 30% YoY, which is good by most standards, but revenue growth is 45%, and therefore, net profit growth has been restricted relative to revenue growth, which is clearly much higher. However, during 4QFY05, net profit growth has been a scorching 90%, aided by considerably higher operating margins and other income.

Performance in the recent past

	1QFY05	2QFY05	3QFY05	4QFY05
Sales growth (%, YoY)	22.2	36.8	44.0	71.3
Operating margins (%)	23.0	22.0	21.9	35.4
Profits growth (%, YoY)	8.9	(16.3)	27.4	89.8
Products (YoY, %)	6.0	13.5	27.8	24.7
Services (YoY, %)	52.6	72.0	67.9	73.3

Key events in this quarter

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1. The company announced the availability of Flexcube on Oracle's 10G infrastructure software that has been designed specifically for grid computing, which is likely to reduce the total cost of operations and improve profitability for clients.

2. The company has signed a marketing agreement with Fundtech Ltd., providers of technology solutions to the global financial services industry, to offer total payment solutions to financial institutions around the world.

3. i-flex Solutions has appointed ComputerLand SA as "Privileged Partner" for sales and implementation of Flexcube in 16 countries, including Poland, Russia, the Baltic republics and Ukraine.

What to expect?

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At the current price of Rs 604, the stock is trading at a price to earnings multiple of 20.0 times FY05 earnings, which is at the higher end of the valuation spectrum. The company has exceeded our earning expectation for FY05 by a significant 24%. This has mainly been due to a scorching performance during 4QFY05. Such are the vagaries of a software product company. The strong growth in services has been the major growth driver during the past few quarters. There has also been an increase in margins of this business, though those for products have fallen by 310 basis points. The company has indicated that it spends about 12%-15% of product revenues on R&D, which, we believe, could be the main reason for this decline. But we also believe that it is an investment for the long haul that will benefit i-flex, going forward. The board has recommended a dividend of Rs 5 per share for the year (dividend yield of 0.8%).

We shall soon update our research report on the company.