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i-flex: Top drowns bottom
Aug 2, 2007

Performance summary
  • Topline declines 15% QoQ on the back of rupee appreciation – product sales down 9% QoQ and services sales down 7% QoQ.

  • Operating margins contract by 12% QoQ - impacted by rupee. Higher offshore component of revenues has, however, reduced some pressure from the operating profitability.

  • Bottomline declines by 72% QoQ – operating margin pressure and lower other income key culprits.

  • Products tank size (order backlog of license fee) stands at US$ 75 m.

Consolidated financial performance: A snapshot…
(Rs m) 4QFY07 1QFY08 Change
Sales 6,011 5,133 -14.6%
Expenditure 4,464 4,440 -0.5%
Operating Profit 1,547 693 -55.2%
Operating Profit margin (%) 25.7% 13.5%  
Other income 78 (83)  
Depreciation 182 164 -9.9%
Profit before tax 1,443 446 -69.1%
Tax 119 79 -33.6%
Profit after tax/(loss) 1,324 367 -72.3%
Net profit margin (%) 22.0% 7.1%  
No. of shares (m) 81.4 83.8  
Diluted earnings per share (Rs)*   40.2  
P/E ratio (x)*   52.1  
* on a trailing twelve months basis

What is company’s business?
i-flex is India’s premier software products company, focused on the banking and financial services (BFSI) vertical. The company’s portfolio of offerings comprises products (54% of FY07 consolidated 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 (46% of revenues) like application software development and deployment, maintenance and business and IT consulting. For the year 2007, International Banking Systems (IBS) ranked the company’s flagship product, Flexcube, as the number one selling wholesale as well as retail back-office banking solution in the world for the fifth year running. In fact, Flexcube has been rated among the top-selling banking solutions for the last seven years.

What has driven performance in 1QFY08?
Rupee takes the toll: The rupee’s 6% appreciation against the US dollar during 1QFY08 took its toll on i-flex revenues, much in line with its peers. The company recorded a 15% QoQ decline in revenues during the quarter, led by 9% QoQ and 7% QoQ decline in products and services revenues. However, investors need to know that i-flex has a very lumpy business model wherein the first and the last quarters are the weakest and strongest respectively. i-flex’s tank size (unexecuted license fee revenues) stood at US$ 75 m at the end of June 2007.

In terms of revenues contribution by geographies, the share of US increased from 33% in 4QFY07 to 38% in 1QFY08. However, due to a huge decline in topline in the current quarter, the growth in US revenues was only 2% QoQ. While the share of consolidated revenues from Middle East, Asia Pacific, Europe and Latin American markets showed a big decline, these regions recorded a 41%, 24%, 12% and 37% QoQ decline in revenue.

In terms of categories of revenue by products segment, license fees and implementation fees recorded a decline of 12% QoQ and 11% QoQ respectively. Annual maintenance charges recorded a marginal 1% QoQ growth. On the clientele front, the company added 11 new clients in the products segment and the total addition of new clients stood at 12. The company now has active operations in 130 countries. It added a net of 465 employees during the quarter but the attrition rate on LTM increased from 19% in 4QFY07 to 21% in 1QFY08, which is concerning.

Margins go for a toss: i-flex’s operating margins contracted by whopping 12% QoQ largely due to appreciation of the rupee against the US dollar and a muted topline. Margins of the products segment contracted by 3% QoQ while the decline in margins in the services segment stood at 5%.

Segmental analysis
(Rs m) 4QFY07 1QFY08 Change 4QFY07 1QFY08 Change
Revenue 3,206 2,912 -9.2% 2,445 2,277 -6.9%
Cost of revenue 1,456 1,513 3.9% 1,626 1,662 2.2%
Selling and marketing expense 596 458 -23.2% 113 69 -38.8%
General and administration expense 261 214 -18.2% 125 127 1.7%
Total cost 2,313 2,184 -5.6% 1,864 1,858 -0.3%
Operating margins 27.9% 25.0%   23.8% 18.4%  

Lower other income impacts bottomline: i-flex’s net profits declined by 72% QoQ on the back of lower other income, operating margin contraction higher effective tax rates (which have more than doubled during the quarter largely because most of the profits were derived from units, which are not exempt under the STP scheme).

What to expect?
At the current price of Rs 2,095, the stock is trading at a multiple of 22.3 times of our estimated FY10 earnings, which we believe is fair. The fact that the management has acknowledged a strong opportunity of cross-selling its offerings to Oracle’s (promoter) clients is what we believe a long term positive for the company. Secondly, the company has already invested heavily in Islamic banking, which is slowly beginning to yield results and it expects to become a leader in providing Islamic banking solutions going forward. Barring valuations, we remain positive on the company’s business from a long-term perspective.

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