GettingYourNon-PublicSaaSBusinessPreparedfortheNewRevenueRecognitionStandards(ASC606)

Presentedby:SteveSehy,CPA,MBASponsors:SaaSCapital,SaaSOpticsSeptember20,2017

Welcome– AboutSaaSOptics…

David RyanFounder and COO

350Customers

$2.8B+ManagedRevenue

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Welcome– AboutSaaSCapital…

43CompaniesFunded

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Todd GardnerFounder and Managing Director

Welcome– AboutSteveSehy,CaaSforSaaSProvidingfractionalCFOservicestoSaaScompanies• PreparingforSeriesA/Professionalfinancing• ImplementingGAAP(currentandnew)• Upgradingaccountingprocesses/systems• HandlingfinancefortheCEO

Bio:• StartedcareerinSoftwareDevelopment• MovedtoProductManagementandProductDevelopmentManagement• Auditor/CPAatRSM(previouslynamedMcGladrey)• Recentclient:ProvidedfinancialleadershipforSaaScompanyHaiku

Learningfortwoyearsoffinancialimprovements,endinginacorporateacquisitionbyaPrivateEquityfirm

Steve SehyCaaS for SaaS CFO Services

To Begin:

TakeaDeepBreath…

• ComparedtocurrentGAAP,allofthenewstandardschangethetimingbutnot theamountofrevenue

• MostnonPublicSaaScompanieswillhavea+/-5%orlessimpactonrevenuein2019basedonthechanges

• Unfortunately,theremaybealotofunderlyingworktogetthenewnumbers.

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Agenda

• BackgroundandKeyConceptsforthenewRevenuerecognitionstandards(ASC606)(alsocalledASU2014-09)

• KeySaaSrevenuesourcesandhowtotreatthem

• ChangestoCustomeracquisitioncosts

• Allocatingtheprice

• Actionitems:Whattodoby12/31/17

• AdditionalResources

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PollingQuestion

Whichtitlebestdescribesyourcurrentrole?(Selectone)

q Auditor/Serviceproviderq CEO/CFOofaSaaSCompanyq ControllerofaSaaSCompanyq AccountantofaSaaSCompanyq Other

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NewRevenueRecognition- Background

AccountingName(ASUNo.2014-09,ASCTopic606)–RevenuefromContractswithCustomers:• Affectsallindustries• Attemptingtohaveasingleprocessfordeterminingrevenueinall

situations/industries• Principlesvs.Rules• ConvergencebetweenU.S.GAAPandInternationalGAAP• Fornon-publiccompaniesneedstobeinplaceforCalendaryear2019.(For

SaaScompaniesthiswillincludeannualandmulti-yearagreementsmadein2018).

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NewRevenueRecognition

Thisstandardisamovingtargetbecause:• Principlesvs.Rules– “judgement”usedtodeterminemethods

• SECrulesmay“interpret”thestandards

• Precedentsmaybesetby“firstimplementations”

• U.S.LegalEnvironment– lawsuitsmayimpactstandards

• AuditFirmpositions– may“interpret”thestandards.

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NewRevenueRecognition

RevenueRecognitionChangesWeareNOTcovering:• Collectibility

• Softwarelicenses(oldschoolsoftware)

• Hardware

• Usagefees(e.g.#oftransactions,#ofGigs)

• Contractmodifications*

• Disclosures/Footnotesfornon-publiccompanies*

*Everyoneshouldprobablylearnthis,wejustdon’thavetime.

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KeyConcepts

CorePrincipleSteps

1. Identifythecontractwithacustomer

2. Identifytheperformanceobligationsinthecontract

3. Determinethetransactionprice

4. Allocatethetransactionpricetotheperformanceobligations

5. Recognizerevenuewhen(oras)eachperformanceobligationissatisfied.

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KeyConceptsPerformanceobligationtiming

• Pointintime(aftertrainingisprovided&invoiced– recognizerevenuethen)• Satisfiedovertime(recognizerevenueonasinglebasisovertime)

OverTime:Output-basedMethods• Appraisalsofresultsachieved

(e.g.%complete)• Milestonesreached• Timeelapsed

OverTime:Input-basedMethods• Resourcesconsumed• Costsincurred• Time-based• Laborhoursexpended.

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KeyConcepts

CommonPerformanceobligationsforSaaS(Thisisnotbasedonhowyoubillyourcustomers.Itisbasedontheservicesyouprovide.)

1. Subscription(Accesstothehostedsoftware)

2. Installation(vs.Setup/initiationfees)

3. Training

4. OngoingSupport

5. OngoingUpgradestothesoftware

6. CustomDevelopment/“PromisedFeatures”

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Revenuebytype

ExamplesofCommonPerformanceobligationsforSaaS• KeyChangesfromcurrentGAAPwillbehighlighted• Note:Thenewstandardsmayresultinrevenuebeingtreatedthesameas

currentGAAP.

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SaaSRevenueRecognition- Subscriptions

UsuallysatisfiedovertimeCalculatedusingtheTimeElapsed- Outputmethod

Ingeneral,theGAAPtreatmentissimilar:• Spreadtherevenueovertheperiod,buttheperiodmaychange• Optionstorenewmayimpactcurrentrevenue• Paycloseattentiontomajorcustomers!.

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PollingQuestion

WhattypeofSubscriptionsdoyouprovideatyourcompany?(Selectallthatapply)q Monthlyq Singleyearq Singleyearwithoptiontorenewq Multi-yearq Noneoftheabove/OrnotaSaaSCompany

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SaaSRevenueRecognition- Subscriptions

SingleYear:Customerisprovidedwithaoneyearagreementwithanoptiontorenewforasecondyearatthesameterms.• Revenueisrecognizedasaoneyearcontract.

Multi-YearMajorCustomerisprovidedaoneyearagreementwithanoptiontorenewforasecondyearata15%discount.• Revenueisrecognizedasatwoyearcontract.(becausecustomerisincentivizedtorenew)(ChangefromcurrentGAAP).

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SaaSRevenueRecognition- SubscriptionsExamplesoftheImpactofDelivery

CustomerisprovidedwithaoneyearagreementstartingonJanuary1.Customerpays$1,200upfront.• Revenueisrecognizedas$100permonthstartingonJanuary1

CustomerisprovidedwithaoneyearagreementstartingonJanuary1andgoingtoDecember31.Customerpays$1,200upfront.InstallationtookthreemonthssocustomerstartsusingthesoftwareonApril1• Revenueisrecognizedas$1200/9permonthstartinginAprilsincecustomerdidnotreceivetheproductuntilthen.(ChangefromcurrentGAAP.)

• Customerdoesn’thaveto“signforacceptance”,butyouneedsomeverificationthattheyhave“access”

Moral– contractandactualdeliverytermsimpactrevenuerecognition.18

SaaSRevenueRecognition- Installation

UsuallysatisfiedovertimeoratcompletionDependingonyourcontract,thiscouldbecalculatedusingthe:

• TimeElapsed- Outputmethod:(e.g.Installdoneinfirst30days)

• AppraisalsofResultsAchieved– Outputmethod(e.g.%complete)

• Laborhoursexpended– InputMethod(e.g.xhoursoutof20)

• PointinTimemethod(e.g.finishedinthe3rd month)

Ifthisisamaterialcomponentofyourserviceandyoudonotchargeseparately,butnowneedtoseparatetheperformanceobligation,thiscouldimpactyourMRR(installfeesarenotrecurring).

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SaaSRevenueRecognition- Training

SatisfiedovertimeoratapointintimeDependingonyourcontract,thiscouldbecalculatedusingthe:

• TimeElapsed- OutputMethod

• Laborhoursexpended– InputMethod

• PointinTimeMethod.

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SaaSRevenueRecognition- TrainingExample– Revenuerecognizedovertime:Customerisprovidedwith3trainingwebinarsperweekforthefirstthreemonths.Customerpays$1,200upfront.• Revenueisrecognizedas$400permonthfor3months

Example– Revenuerecognizedashoursareexpended:Customerispromised24traininghoursoftraining.Customerpays$1,200upfront.Attheendofthefirstmonthoftheproject8traininghourshavebeendelivered.• Revenueisrecognizedas$400(8*$50)forthefirstmonth

Example– Revenuerecognizedattimeofcompletion:Customerischarged$1,000foreachon-sitedayoftraining.Attheendofthefirstmonth,twodaysoftraininghavebeenprovided.• Revenueisrecognizedas$2,000(2*$1,000)forthefirstmonth.

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SaaSRevenueRecognition- Support

SatisfiedovertimeoratapointintimeDependingonyourcontract,thiscouldbecalculatedusingthe:

• TimeElapsed- OutputMethod,

• Laborhoursexpended– InputMethod

• PointinTimeMethod.

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SaaSRevenueRecognition- SupportExample– Revenuerecognizedovertime:Customerisprovidedwithongoingphoneandothersupportduringaoneyearagreement.Customerpays$1,200upfront.• Revenueisrecognizedas$100permonth

Example– Revenuerecognizedashoursareexpended:Customerispromised24hoursofsupport.Customerpays$1,200upfront.Attheendofthefirstmonthoftheproject8supporthourshavebeendelivered.• Revenueisrecognizedas$400forthefirstmonth

Example– Revenuerecognizedatcompletion:Customerisinvoiced$100foreachhourofsupportprovided.Attheendofthefirstmonth,6hoursofsupporthavebeenprovided.• Revenueisrecognizedas$600forthefirstmonth.

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SaaSRevenueRecognition- Upgrades

SatisfiedovertimeThiscouldbecalculatedusingtheTimeElapsed- Outputmethod

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SaaSRevenueRecognition- Upgrades

Example– StandardagreementwithongoingupdatesCustomerisprovidedwithongoingupgradesduringaoneyearagreement.Customerpays$2,400upfront.• Revenueisrecognizedas$200permonth

Example– StandardagreementwithsignificantupdatesCustomerisprovidedwithongoingupgradesduringaoneyearagreement.Customeralsowaspromisedasignificantupgradewouldbedeliveredafter6monthsbasedonaroadmaponthewebsite.Customerpays$2,400upfront• Revenueisrecognizedas$100permonthforthefirstsixmonthsand$300permonthforthesecondsixmonths.(Theupgradewasdeterminedtobeworth$1,200andisrecognizedovertherestofthecontract.)(ChangefromcurrentGAAP).

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SaaSRevenueRecognition– CustomDevelopment

CustomDevelopmentFees(or“promisedfeatures”)SatisfiedovertimeThiscouldbecalculatedusingtheTimeElapsed- Outputmethod

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Example- Modificationiscriticaltotheoveralldeal

MajorCustomerisprovidedwithoneyear’saccessstartingJanuary1.CustomerisprovidedwithacriticalcustommodificationonMarch1.Thecustomercouldcanceltheagreementifthemodificationswerenotdoneproperly.Customerpays$2,400upfrontforthemodification

• Revenueisrecognizedas$2,400/10permonthstartingonMarch1.ThestandardsubscriptionrevenuewouldalsonotstartuntilMarch1.(ChangefromcurrentGAAP)

Example- ModificationisNOTcriticaltotheoveralldeal

MajorCustomerisprovidedwithoneyear’saccessstartingJanuary1.Customerisprovidedwithanon-criticalcustommodificationonMarch1.Thecustomerwouldjustreceivetheircustomdevelopmentfeebackifthemodificationswerenotdoneproperly.Customerpays$2,400upfrontforthemodification

• Revenueisrecognizedas$2,400/10permonthstartingonMarch1.ThestandardsubscriptionrevenuewouldstartonJanuary1.(ChangefromcurrentGAAP).

SaaSRevenueRecognition– CustomDevelopment

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SaaSRevenueRecognition– Costs

CustomerAcquisitionandSetupCosts(Huh?IthoughtthiswasaRevenuerecognitionchange…)

• ThiswasanoptionincurrentGAAP.Itisnowrequiredandappliestoallincrementalcosts,notjustdirectcosts.

• Ingeneral:Thestandardindicatesthatthesecostsshouldbeconsistentwiththerevenuerecognitionwhichgenerallymeanscapitalizingandamortizing

• CreatesanAsset:Deferredcosts(orDeferredcommissions)• Practicalexpedient– Iftheagreementisforoneyearorless,youcanjustexpense.• Costsincrementaltoacquiringthiscustomer(notgeneralmarketingorpre-sales)

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SaaSRevenueRecognition– Costs

CustomerAcquisitionCosts• Incremental• Commissions(couldincludesalesperson,manager,regionalmanager)• Bonus(iftotallybasedonsales,ifbasedonotherfactorswouldprobablynotqualify)

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SaaSRevenueRecognition– Costs

CustomerSetupCostsandCostAmortization

• SetupCosts:Capitalizeifdirectlyrelatedtoacontract,itcreatesacompanyresource,costsareexpectedtoberecoverable

• SetupCosts:Couldincludethesalariesofanimplementationteam

• AmortizationofCosts:Couldbebasedonacontract,aspecificperformanceobligationoranticipatedrenewals.Managementdeterminestheamortizationperiod.

• Amortizationwouldnotincludeanticipatedrenewalsifcostsarethesameforeachagreement(e.g.2%commissiononfirstyearandeachrenewal)

• Amortizationwillincludeanticipatedrenewalsifcostsaredifferent(e.g.8%commissiononsaleand2%commissionforrenewals)(Amortizeovermanagementestimateofcustomerlife)(Eitherthetotal8%ortheamountovertherenewalamount6%).

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SaaSRevenueRecognition– Costs

CustomerAcquisitionandSetupCosts(Balancesheet- Deferredcosts)

Example- Commissions:Customerisprovidedwithtwoyear’saccesstothesystemstartingJanuary1.Salescommissionforthetwoyearagreementis$2,400• Salescommissioniscapitalizedasanasset.Costisrecordedas$100permonthstartingonJan1

Example– SetupCosts:Customerisprovidedwithoneyear’saccesstothesystemstartingJanuary1.Incrementalcostofcustomersetupis$3,600.Managementdeterminesthatcustomerisexpectedtorenewforatleasttwomoreyears• Customercostiscapitalizedasanasset.Costisrecordedas$100permonthstartingonJanuary1.Spreadoverthethreeyearexpectedlifeoftheasset.

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AllocatingthePrice

ThetransactionisallocatedbasedonStand-alonesellingpriceorEstimatedStand-alonesellingprice.(SeeAdditionalResourcesformoreinfo)

Stand-alonesellingpricecanbeestablishedifitemsaresoldseparately.Example:Annualphonesupportissoldseparatelyfor$1,200peryear.

Iftheitemisneversoldbyitself,thestandalonesellingpriceneedstobeestimated.Example:Phonesupportisalwaysincludedwithasubscription.

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AllocatingthePriceSimpleoption:IfallofthePerformanceObligationswillbetreatedthesame,thenyoudon’tneedtoallocatetheprice.

Example– Allperformanceobligationsrecognizedthesameway:AnnualSubscription,phonesupportandupgradesarealwayssoldtogetherandwillallbeallocatedovertheyear.Theycanbetreatedasoneitemforpriceallocation.• Subscription,phonesupportandupgradesaresoldfor$3,600forayear.Theseitemswouldnotneedtobeallocated

Example– Performanceobligationsrecognizeddifferently:AnnualSubscription,phonesupportandupgradesarealwayssoldtogether,howeverphonesupportisbasedonhourswhiletheotheritemswillallbeallocatedovertheyear.Theycannotbetreatedasoneitemforpriceallocation• Subscription,phonesupportandupgradesaresoldfor$3,600forayear.Theseitemswouldneedtobeallocatedbetweenthesubscription/upgradesandphonesupport.

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ComprehensiveexampleGoldproductAnnualPlan:Includeshosting,support,ongoingsoftwareupdates,90dayinstallationservicesand5hoursoftraining.Salespersongets10%commissiononnewbusinessand5%onrenewals.Clientissentalogin/passwordonthefirstdayoftheagreement

Performanceobligations:• Subscription,Support,Upgrades,Installation,Training• Overtime– oneyear:Subscription,Support,Upgrades• Overtime– 90days:Installation• Overtime– laborhours:TrainingAcquisitioncosts:• 5%“extra”commissionallocatedover3yearestimatedlifeofasset.

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WhatYouNeedToDoBy12/31/17

1. Assembleyourteam

2. Identifyhowyouwilltreateachofyourtypesofrevenue,includinghowyouwillgroupthemforpriceallocation

3. Identifyhowyouwilltreatcustomeracquisitioncosts

4. Determinehowyouwillallocatethepriceindealswithmultipleperformanceobligations

5. ReviewyourstandardcontractsandTermsofService(Basedontheabove.Shouldbeinplaceon1/1/18.).

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WhatYouNeedToDoBy12/31/176. Implementaprocessofpre-approvalorreviewofanycustomerspecificcontract

modificationsfornewandexistingdeals7. Contactyourauditororduediligencereviewer(oraconsultant)andconfirmyour

documentedconclusionsforthestepsabove.8. Determinehowyouwilltransition:Youcanselecteitherthefullretrospective(recast

allnumbersforprioryears)ormodifiedretrospectivemethod.(disclosekeyprioryearchanges)

9. Prepareastatementforinvestors,potentialinvestors,orbankers:Ideallythisshouldbesomethinglike…“Wehavereviewedtheimpactofthenewrevenuerecognitionrulesfortheirimpactonourfinancials.Basedonourreview,from1/1/2019our(typeofrevenue..)revenuewillbeaffectedandthechangewillaccelerate/delaytherecognitionofthisrevenue.Currentlythisrevenueisonlyxx%ofourtotalrevenue.”Theywillnotwanttohear“Wedon’tknow”whentheyask thisquestion.

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CalltoAction/ToDoList10. Identifyifyourcurrentfinancialsystemswillsupportyourchangeswhenneeded

By1/1/19youshouldableto:• Recordnew/renewingcontractsundernewstandards• Re-castexistingcontractsintonewstandards• Collectinformationneededfordisclosures.

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PollingQuestion

ForSaaScompanyemployees,whatrevenuerecognitionchangepreparationstepshaveyoualreadycompleted?(Selectallthatapply)

q IdentifiedPerformanceObligationsandpriceallocationq Determinedacquisitioncostpolicyq ReviewedcurrentcontractsandTermsofServiceq Determinedimplementationplanq AttendedaWebinar

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AdditionalResourcesNote:SomedonotdifferentiatebetweenthestandardsforPublicvs.Privatecompanies.

• Sehy - 10StepsToPrepareForTheNewRevenueRecognitionStandards– SoftwareExecutiveMagazine–OctoberIssue

• pwc NewRevenueguidance–Implementationinthesoftwareindustry– July2017,31pages• http://www.pwc.com/us/en/cfodirect/publications/in-depth/revenue-implementation-guidance-

technology-industry.html

• RSMRevenueRecognition:AWholeNewWorld– Jan2017,43pages• http://rsmus.com/what-we-do/services/assurance/revenue-recognition-a-whole-new-world.html

• RSMChangestorevenuerecognitioninthetechnologyindustry– Jan2017,18pages• http://rsmus.com/what-we-do/services/assurance/financial-reporting-resource-center/financial-reporting-

resource-center-revenue-recognition/changes-to-revenue-recognition-in-the-technology-industry.html

• KPMGRevenueforSoftwareandSaaS– March2017,648pages• https://frv.kpmg.us/reference-library/2017/03/revenue-for-software-and-saas.html

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NewRevenueRecognitionStandards

Questions?

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SteveSehy630.452.4170steve.sehy@yahoo.comwww.linkedin.com/in/stevesehy

DavidRyan678.710.8262info@saasoptics.com

ToddGardner513.368.4814tgardner@saas-capital.com

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