Investor perspectives on ASC 606

for software and SaaS

May 2017

Initial views on how investors will analyze financial statements of software

and software-as-a-service (SaaS) companies under the ASC 606 revenue
recognition standard.
While it once seemed like a long way off, the 2018 effective Optional exemptions
date of the new revenue recognition standard (Topic 606) is
fast approaching, and some software and SaaS companies are
early adopting ASC 606. The new standard provides investors
with incremental disclosure such as revenue backlog, and
Directly
additional transparency is generally welcome. Investors also allocable
believe, however, that it is incumbent upon the companies Sales-based variable
to communicate which metrics they feel are most relevant in Short-term Invoice or consideration
evaluating their business. contracts method usage-based to wholly
royalty unsatisfied
Investors think that even though ASC 606 changes could impact performance
the short-term optics on financial performance, leadership teams obligation
should exercise caution before changing how they manage and
operate their business. Some investors even strongly believe
that overall, ASC 606 does not change the fundamentals nor When would an investor consider ASC 606 backlog
should it change how companies manage and operate their disclosure to be a primary metric versus a disclosure to
business for the long term. comply as per regulatory requirements?
Investors would consider ASC 606 backlog disclosure a primary
ASC 606 Backlog Disclosure Requirements metric in cases of single revenue model and the company does
The disclosure about the remaining performance obligation is not generate significant fixed fee professional services revenue.
based on ASC 606 determination of the transaction price for Annual contracts may also play a significant role as to whether
unsatisfied (or partially unsatisfied) performance obligations, ASC backlog disclosure could become a primary metric.
and therefore it may differ from the disclosure of bookings or
backlog, because it does not include orders for which neither Investors may not consider ASC 606 backlog disclosure a
party has performed and each party has the unilateral right to primary metric in cases of a mixed business model (i.e.,
terminate a wholly unperformed contract without compensating aggregate disclosure of the backlog versus disaggregation of
the other party. The transaction price used in the remaining the backlog disclosure). For example, aggregate disclosure of
performance obligations disclosure is the constrained amount. backlog with mixed SaaS, maintenance, and services revenue
An entity also explains qualitatively whether any consideration streams with no standard contract terms.
is not included in the transaction price (e.g., constrained variable
consideration) and therefore is not included in the remaining Would investors focus more on contractual Annual
performance obligations disclosures. The practical expedient Contract Value (ACV) or ASC 606 backlog/Annual
allows an entity to exclude from the remaining performance Recurring Revenue (ARR)?
obligations disclosures contracts that have an original expected Investors prefer a standardized ASC 606 definition and would
duration of one year or less. However, an entity is not precluded most likely ignore contractual ACV since most companies do not
from including all contracts in the disclosure. provide contractual ACV (or investors do not have visibility into
this metric).

©2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative(“KPMG
International”), a Swiss entity. All rights reserved.
Investors would look at ASC 606 revenue backlog and ASC 606 It is likely for SaaS that this ASC 606 revenue backlog metric
ARR and ignore unbilled deferred revenue/contractual ACV and becomes relied upon more than the current unbilled metric. For
look at the quarter-over-quarter change to determine the net new non-SaaS, this metric might be ignored.
addition to ASC 606 revenue backlog.
How are investors going to analyze ASC 606 revenue
If companies try to focus investors on contractual ACV by backlog disclosure when it is considered to be a primary
highlighting unbilled deferred revenue, investors may: metric?
– Look to ASC 606 revenue backlog/ARR disclosures; or ASC 606 revenue backlog disclosure is required only for the most
recent period presented in the financial statements.
– Compute ASC 606 revenue backlog by reducing unbilled
accounts receivable from unbilled deferred revenue and Investors look at this disclosure as total contract value (TCV) less
consider average duration of backlog (if time bands are not split revenue recognized.
between current and long term).
Select metrics:
For example, in a price ramp deal at the end of year 1, investors
would focus on ASC 606 revenue backlog of $4 million versus $5 – Next twelve months (NTM): Investors would prefer
million contractual unbilled deferred revenue. companies to disclose NTM on a quarterly basis versus the
fiscal period view of the time bands.
Additional background of a price ramp deal with the difference
in accounting and metrics is noted below: – Revenue coverage ratio = ASC 606 backlog NTM/ Annual
Revenue Guidance: Investors also understand that there
ABC Corp enters into a cloud-based service contract with the is seasonality to this coverage ratio, much like if investors
customer for a three-year period and the customer is obligated calculate this today using deferred revenue.
to pay for Year 1 - $1 million, Year 2 - $2 million and Year 3 - $3
million. The nature and quantity of service provided for all three – Trend analysis of ASC 606 backlog disclosure with time
years is the same and due to cash flow reasons the payment bands compared to prior-period comparatives for growth
terms are back end loaded (i.e., price ramp deal). rates. During the transition period, investors may continue
to focus on calculated billings metric. For companies that
Revenue recognition under current and new revenue guidance provide deferred revenue growth rates guidance, investors may
is noted below: continue to focus on that metric during the transition period.
For companies adopting ASC 606 on a retrospective method,
Year 1 Year 2 Year 3
investors might prefer ASC 606 backlog disclosure with
Current GAAP 1 2 3 prior-period comparatives split between NTM and long-term.
ASC 606 2 2 2 Investors do not believe companies would provide
annual backlog/booking guidance. However, some
investors would prefer companies to provide annual
Metrics as of end of the year backlog/booking guidance in certain circumstances.
Current GAAP Year 1 Year 2 Year 3 Some might believe that companies should provide annual
booking guidance due to the following:
Unbilled Deferred Revenue 5 3 0
– Keep investors focused on annual targets versus quarter-over-
quarter volatility
Metrics as of end of the year – Take away customers being able to use that end-of-quarter
ASC 606 Year 1 Year 2 Year 3 leverage to pressure bigger discounts, and remove the
temptation for management teams to allow bad deals to make
Unbilled Accounts Receivable 1 1 0 one metric look good
ASC 606 Revenue Backlog 4 2 0 – Company has a limited number of enterprise deals that could
slip between quarters
– Reduce volatility on the stock
This view may be applicable only for companies that have
software license revenue and generally may not be applicable for
SaaS companies.

©2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative(“KPMG
International”), a Swiss entity. All rights reserved.

2 Investor Perspectives on ASC 606 for Software and SaaS

Company A’s sales commission amortization period Does ASC 606 impact any fundamentals such as
is 3 to 5 years, and Company B’s sales commission cash flow?
amortization period is 5 to 9 years. Both companies have Accounting impact to earnings would be offset by changes to
the same customer churn rate per annum. How should working capital in the statement of cash flows. However, we
we think about the stock valuation of Company A versus would need to think about any impact to earnings as a result of
Company B? acceleration of revenue and deferral of expense (which might be
Factors companies consider in the determination of the sales the case for software and SaaS companies), which may result in
commission amortization period are: customer life, product incremental earnings for tax purposes resulting in cash taxes for
technology life, expected renewal of “the contract,” and factors any incremental income.
considered in determination of customer relationship in valuation
of intangible assets in a business combination. Treatment of sales commission for tax purposes could be
different for tax purposes as compared to financial reporting.
View A (Company A): If churn for both companies is equal, then For example, deduction can be recognized when liability is
Company A stock may be more valuable since the customer is incurred as opposed to recognition of expense in the financial
potentially paying incremental consideration at the end of year statements.
3 to 5 for an upgraded product. Potential “land and expand”
opportunities exist for Company A’s portfolio of products with
higher margin and stickiness of one-stop-shop for diverse
products.
View B (Company B): Company B may look more profitable
through the growth period and this could make it GAAP or
NG profitable earlier. Most investors look at cash-flow-based
valuation for these growth stocks, and as such, is not likely to
have significant impact.

Author: KPMG’s influence in the software and SaaS space:

Prasadh Cadambi
Partner, Transforming your SaaS
Software and Cloud Industry Revenue for software business: A strategic guide
650-793-4129 and SaaS for optimizing business
[email protected] performance

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Investor Perspectives on ASC 606 for Software and SaaS 3