The Hindu Business Line : Aztec Software: Hold

INVESTORS can retain their holdings in the Aztec Software (Aztec) stock. Since our last recommendation at Rs 33 in end-August, the stock price has nearly doubled. Our latest `hold' recommendation stands bolstered by the robust earnings performance in the second quarter of 2004-05, sustained improvement in demand prospects and the recent acquisition of Pune-based Disha Technologies, a software product testing company.

Over the next few quarters, the other key triggers for Aztec can be greater control over selling, general and administrative (SG&A) expenses, high offshore component, cross-selling opportunities arising from the Disha acquisition and stable billing rates with a positive bias. On the downside, however, the risks stem from high client concentration, threat of customers moving product engineering services in-house and a slower-than-anticipated integration of the latest acquisition.

The top five and ten clients of Aztec contributed 54 per cent and 81 per cent of revenues in the latest quarter, marginally lower than the previous quarter. Though in line with some of its mid-sized/small-cap peers, it exposes the company to risks arising from R&D spending slowdown by Independent Software Vendors (ISV) in different stages of the cycle.

Impressive second quarter

Aztec has clocked another solid performance for the period ended September 30, 2004. Operating from a small base, the highlights of the latest quarter are:

On a sequential basis, Aztec's revenues grew 26 per cent to Rs 20.3 crore. As the manpower utilisation levels have remained fairly stable along with billing rates, gross margins improved by 2.7 percentage points to 41.9 per cent.

The operating profit margin jumped by 8 percentage points to 21.6 per cent. For the second successive quarter, the reduction in SG&A expenses by 5.3 percentage points to 20.3 per cent of revenues has helped this sharp rise in margins.

The post-tax earnings also rose sequentially by 37 per cent to Rs 3.8 crore.

A complementary acquisition

In September 2004, Aztec Sofware acquired Disha Technologies, a software product testing company for $12.1 million, with $9.6 million payable in cash and $2.5 million in stock. Disha will be a 100 per cent subsidiary of Aztec.

For the first half of 2004-05, Disha recorded revenues of Rs 19.3 crore, operating margin of 23.2 per cent and post-tax earnings of Rs 3.2 crore.

With this acquisition, Aztec will be in a position to strengthen its existing service offerings by adding software product testing to the portfolio. This is bound to add greater predictability to its overall revenue stream and open up cross-selling opportunities among the existing Disha clientele.

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