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i-flex : Sour times!

Oct 29, 2004

Introduction to results
i-flex solutions (i-flex) has reported poor results for the quarter and half year ending September 2004. While topline growth for both the periods has been good, rising expenditure and consequent decline in operating margins has taken toll on profits, which have declined on a YoY basis.

Consolidated financial performance: A snapshot
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 1,870 2,558 36.8% 3,705 4,800 29.6%
Expenditure 1,282 1,995 55.6% 2,619 3,722 42.1%
Operating profit (EBDITA) 588 563 -4.2% 1,086 1,078 -0.8%
Operating profit margin (%) 31.4% 22.0%   29.3% 22.4%  
Other income 75 48 -35.7% 58 152 161.0%
Depreciation 35 74 113.2% 67 130 93.3%
Profit before tax 628 538 -14.5% 1,077 1,100 2.1%
Tax 130 121 -7.4% 199 268 34.4%
Profit after tax/(loss) 498 417 -16.3% 878 832 -5.2%
Net profit margin (%) 26.6% 16.3%   23.7% 17.3%  
No. of shares (m) 76.8 76.4   76.8 76.4  
Diluted earnings per share (Rs)* 26.1 21.8   23.0 21.8  
P/E ratio (x)         27.5  
(* annualised)            

What is the company’s business?
i-flex is a focused player in the banking and financial services vertical. The company’s portfolio of offerings comprises products (50% of revenues), like Flexcube, an end-to-end product suite for retail, corporate and investment banking and asset management. Also, the company provides software services (50% of revenues) like application software development and deployment, maintenance and business and IT consulting. In FY04, 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 second year in running. In fact, Flexcube had been rated among the top-selling banking solutions for the last five years.

What has driven performance in 2QFY05?
Services drive topline growth: Topline growth in 2QFY05 was a consequence of a strong growth in i-flex’s services division (grew by 72%). Importantly, this segment contributed to 50% of the company’s consolidated topline in 2QFY05, an increase from 40% in 2QFY04. Services revenues were aided by strong YoY growth in billing rates. Onsite and offshore rates improved by 6% and 7% respectively. The company has stated in the past that it would consistently push for faster growth of its services business, as the same acts as an incubator for developing new technology that will further help the company in improving its product offerings. However, a consistent rise in contribution from the services business, without a ‘much to be cheered about‘ growth in the products business has taken toll on i-flex’s profitability.

Revenues from the products segment have grown YoY by almost 14% in 2QFY05. While this is a faster growth than what was seen in 1QFY05, it is much slower than what the company had achieved in the past. And this is quite concerning as i-flex has been spending aggressively on promoting its products, which include the flagship Flexcube, Reveleus and now, Daybreak (through acquisition of Super Solutions). In 2QFY05, i-flex added 9 and 15 customers in the products and services businesses respectively (12 and 17 in 1QFY05).

High employee costs dent margins: i-flex has added a net of 1,350 employees in the past year, with the maximum 1,000 being added in the company’s services business. Out of this 1,000 in services, almost 460 were added in this quarter itself, indicating the company’s increased focus on this business segment. As a result of this addition, employee costs has shot up from 37% of sales in 2QFY04 to 49% in 2QFY05. This effect is clearly indicated in the rise in cost of revenues (from 42% of 2QFY04 sales to 55% in this quarter). This rise in cost of revenues has significantly affected margins for both the services and products business. As a matter of fact, while operating margins for services declined from 23% in 2QFY04 to 17% in 2QFY05, contraction in product margins was from 45% to 49%.

Currency plays spoilsport fro profits: Apart from rising costs, a substantial loss on the foreign exchange front has led to a dip in i-flex’s bottomline for 2QFY05. Depreciation of the Indian rupee vis-à-vis the US dollar has led to translation loss of Rs 14 m for the company in this quarter (forex gains of Rs 19 m in 2QFY04). Strong rise in depreciation costs has also affected the profit decline in this quarter.

Performance in recent times
  3QFY04 4QFY04 1QFY05 2QFY05
Sales growth (%, YoY) 28.3 25.7 22.2 36.8
Operating margins (%) 24.6 30.0 23.0 22.0
Profits growth (%, YoY) (31.5) 42.8 8.9 (16.3)
Products (YoY, %) 21.2 21.2 6.0 13.5
Services (YoY, %) 38.6 42.1 52.6 72.0

What to expect?
At the current price of Rs 598, the stock is trading at a P/E multiple of 27.5 times annualised 1HFY05 earnings, which is at the higher end of the valuation spectrum. Despite strongly growing its topline, i-flex has continued to witness pressure on its profits and this is concerning. While we believe that consistent spending on growth initiatives would help the company in tiding over competition and penetrating wider markets, the fact that performance of the high-margin products front has been sedate in the past two quarters might cause a bit of concern. However, while meeting short-term targets and achieving a consistent quarterly growth does not seem to be possible for a product company like i-flex, we believe that the low penetration and increasing acceptance of third-party core banking solutions in the global banking industry promises high growth potential for the company going forward.

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