With a healthy order book position, i-flex solutions seems a good buy in the software sector
The past quarter seems to be encouraging for i-flex solutions, the Mumbai-based software products major. In the recent past, the management has made substantial investment to increase its global marketing presence in key markets such as Singapore, Latin America, Europe and the US.
And the good news is that the initiatives have started to yield results. i-flex managed to bag three contracts for its moneyspinner product 'Flexcube' from the fairly under-penetrated but important US market.
Until March 2001, the company was unable to operate in the US markets due to Regulation 'K' that disallowed non-US based software companies with majority holding by a US company. This apart, orders worth $8-10 million (around Rs 40 crore) from two prominent banks in Egypt for their retail products will open the gates for the company to tap huge opportunities in the Middle East.
The company has built a strong order pipeline of $29 million (Rs 135 crore). And mind you, this is excluding the enterprise-wide rollout of its products in 100 countries across the world for its promoters Citigroup entities. The company has already started the rollout in western Europe and has also signed up Latin American Citibank entities in Paraguay and the Dominican Republic.
Metrics in the services business are not so rosy: It is often touted that the company's services business complements its products business and offers cross-selling opportunities.
But the fact is that the non-Citigroup services business continues to remain far too small, and over 81 per cent of the revenues come from the Citigroup. This exceptionally high client concentration doesn't augur well for the company.
The concerns were clearly visible in the first-quarter results where, in spite of a robust increase in volumes, I-flex's services revenue declined sequentially by 7.33 per cent to Rs 43.97 crore.
This was primarily due to the steep billing rate cut of 20 per cent by Citigroup in the fourth quarter of last fiscal. Clearly, being over-dependent on one source for revenue, even though that source is its parent, has downside risks.
i-flex's operating margins of 26 per cent in the services business are quite lower than that of top-rung companies such as Infosys (30 per cent) and Wipro (33 per cent).
Also, billing rates are also lower by about 15 per cent compared with Infosys and Wipro. But interestingly, despite the rate reduction, gross margins were higher by around 470 basis points in the last quarter.
The improvement in utilisation (to 76 per cent from 72 per cent in the last fiscal) and saving of 10 per cent commission charges given to intermediary company used earlier to acquire services business in US seems to have partially made up for the loss due to reduction in billing rates.
It is important for i-flex to create a strong non-Citigroup client base for services business also, as the scaling up of relatively stable revenues from services business will provide better visibility to quarterly revenues.
"The lumpiness or erratic flow of product revenues is one of the key concerns that tend to impact valuations of companies such as i-flex, which have bulk of their revenues coming from products," said Amit Khurana, research analyst at Birla Sun Life Securities.
Financials: i-flex has shown steady growth in the past few years, with revenues and earnings growing at a compounded annual rate of 46 per cent to Rs 435.7 crore and 22 per cent to Rs 105.3 crore, respectively, as per the US Generally Accepted Accounting Practices (Gaap).
The bottomline, however, took some beating in the last fiscal. It grew marginally by two per cent despite a robust growth of over 34 per cent in the topline. Operating margins also declined by over 600 basis points to 26.2 per cent largely on the back of much higher expenses due to the company's efforts to expand its marketing infrastructure.
For the first quarter of FY03, the company has reported a sequential growth of 9 per cent to Rs 132.5 crore and 23 per cent to Rs 44.23 crore in revenues and earnings, respectively. This was largely driven by the 10.8 per cent jump in revenues from its products division.
The scenario was not so encouraging in case of results under the US Gaap where the revenues grew at a much lower rate of 3.18 per cent and earnings actually fell 13 per cent to Rs 28.16 crore.
On the positive side, the company has shown a considerable improvement in the debtor outstanding days, which has been brought down by 20 per cent to 128 days in the last quarter. However, this is still high compared with peers.
"Being a growing company, we concentrated on market penetration and client acquisition. Besdies, since our operations spread across 80 different countries with peculiar regulations related to foreign exchange transactions in some places, the receivables days are higher than those of plain vanilla IT services companies," points out Deepak Ghaisas, chief executive officer, Indian operations, and chief financial officer, i-flex solutions.
