insights        ON
                        Comparing your company’s financial ratios to those
                         of other high-tech companies can only go so far in
                         analyzing your corporation’s financial health. One
                         high-tech industry sector cannot necessarily be
                       compared with another sector.

                                  By Warren Culpepper, Culpepper and Associates Inc.

                 Often, executives who change                  percent or higher gross profit margins.
                 companies and move from one high-tech         The reality is that most software compa-
                 sector to another judge their new firm’s      nies have a significant proportion of rev-
                 financial ratios as out-of-line. Using past   enues flowing from professional services
                 experience for benchmarks, these trans-       and/or maintenance. The cost of provid-
                 planted executives may not account for        ing these services is much higher than
                 some of the valid differences between         those associated with new software
                 industry sectors.                             licenses. Services costs notwithstanding,
                    Drawing from Culpepper and                 software companies do indeed enjoy
                 Associates’ new “High-Tech Boardroom          higher profit margins. However, the dif-
                 Benchmarks,” we can explore some of           ferences are not as great as one might
                 the interesting differences among four        expect. The median profit margin for
                 high-tech industry sectors: software,         software companies is currently 66 per-
                 hardware, IT services and semiconductor.      cent, compared with margins of roughly
                    Gross profit margin: The gross profit      40 percent in other high-tech sectors.
                 margin is, of course, what is left of the     (See Key Ratios by Industry Sector.)
                 revenue dollar after deducting cost of           Actually, in the software and IT serv-
                 goods sold (COGS). Most technology            ices sectors, the so-called COGS is more
                 industry executives know this metric dif-     often referred to as cost of sales (COS).
                 fers significantly by industry sector.        This naming difference is appropriate as
                    Since software is supposed to have         there is a minimal amount of goods or
                 quite minimal COGS, one might expect          materials that goes into the products or
                 to find software companies enjoying 90        services sold in the software and IT serv-

22 |   UPGRADE                                                                  AUGUST/SEPTEMBER 2003
ices sectors. Rather, within these two       none of which has anything to do with                  Price-to-sales ratio: Because the price-
sectors, the cost is primarily that of the   the buyer’s financial stability. DSOs will          to-sales (P/S) ratio is established by the
labor required to provide the service in     rise when any of the following occur:               stock market and not the product-buyers
connection with a sale.                      • Newly delivered products are bug-rid-             market, the P/S ratio provides a view of
   Net profit margin: Given the sub-            den, and buyers refuse to pay until the          prospective, not retrospective, results.
stantial problems reported in the past          problems are resolved.                           Although the semiconductor sector may
three years by many of the IT services       • Products have been oversold, and buy-             be drowning in red ink from the past
companies, this sector presents a               ers refuse to pay until the unfulfilled          year’s results, investors are obviously far
pleasant surprise. At 3.3 percent, its          promises have been met.                          more bullish on its future than they are
median net profit margin is the highest      • Customization has been sold and any               for the other sectors. Semiconductor
of the four sectors. All of the other           lack of clarity in specifications results        firms enjoy an impressive median P/S
three sectors post results in the red,          in the buyer not only refusing to pay            ratio of 2.6. Yet, IT services, the only sec-
with the semiconductor sector bleeding          for the modifications but for the basic          tor enjoying profits, suffers with the low-
badly at -8.8 percent.                          product or service as well until the             est valuation at a mere 1.2 times sales.
   Revenue per headcount: Since sales           issue is resolved.                                  Keeping these various key indicators
in all tech sectors have remained at         • Extended payment terms may be                     of financial success in mind – and how
anemic levels and expenses have not             offered that allow the buyer to delay            they differ across the high-tech sectors –
yet been brought in line, revenue per           full payment long after everything               will help you in comparing apples to
headcount remains low. Of the four              necessary has been done for the ven-             apples rather than apples to oranges
tech sectors, software has the lowest           dor to earn the revenue.                         when you move from one high-tech sec-
revenue per headcount at $187,000.           • Channel stuffing occurs at quarter                tor to another.
However, since software has such a              end, and the vendor pushes off more
low COS, it enjoys a much higher gross          product on its resellers than they will          Warren L. Culpepper is founder and CEO
profit margin than the hardware and             ever sell or pay for.                            of Culpepper and Associates Inc., which
semiconductor sectors. Thus, software        • Other aggressive revenue recognition              provides compensation survey and financial
can afford to run at a lower revenue            practices, in addition to the ones               benchmarks to high-tech industry execu-
per headcount ratio.                            implicit above, also result in higher            tives. Founded in 1979, Culpepper and
   At first it may seem odd that at             DSOs.                                            Associates focuses exclusively on the needs
$191,000, the IT services sector has only    Although none of the above problems                 of software IT services, hardware, semicon-
a slightly higher revenue per headcount      is unique to the software sector, the               ductor, electronics and telecom companies.
than software. Since IT services has the     first four are subject to far more abuse            Source: Culpepper eBulletin, June 2003.
lowest gross profit margin, you might        within that sector than in any of the               Complimentary subscriptions at:
expect this sector would require much        other sectors.                                      www.culpepper.com/eBulletin/.
higher revenue per headcount in order
to post a positive net income. However,
remember that its gross profit calculation
includes a substantial amount of labor in     Key Ratios by Industry Sector
its deduction for cost of sales. If that      (Medians for Q1 2003, Trailing Four Quarters)
COS headcount were backed out of the
revenue per headcount calculation, you
would see a far higher revenue per head-                                  Software          IT Service        Hardware        Semiconductor
count for IT services. In an upcoming         Financial Ratio             (n=118)           (n=73)            (n=84)          (n=58)
article in our eBulletin, we plan to show
how several ratios like revenue per head-     Gross Profit Margin         68%               42%               38%             40%
count can be normalized between sectors
when measured as a percentage of gross        Net Profit Margin           (1.3%)            3.3%              (0.8%)          (8.8%)
profit instead of total revenue.
                                              Revenue per Headcount       $187,000          $191,000          $279,000        $227,000
   Days sales outstanding: Compared
with other high-tech sectors, the soft-       Days Sales Outstanding      66                54                51              50
ware sector has an unduly high days sales
outstanding (DSO). Although software          Price-to-Sales Ratio        1.8               1.2               1.6             2.6
DSOs have come down substantially to
66 days, they still run higher than in        Source: Financial statement data on 333 companies in the Culpepper “High-Tech
other sectors. The DSO issues and their       Boardroom Benchmarks” database who had filed by June 17, 2003, their 10k’s or
significance are worth examining. DSOs        10Q’s for the first calendar quarter of 2003.
may rise due to a number of reasons,

W W W. S I I A . N E T                                                                                                                UPGRADE    | 23

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