Getting Your SaaS Business Prepared for the New Revenue Recognition Rules (ASC 606)

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1 Getting Your SaaS Business Prepared for the New Revenue Recognition Rules (ASC 606) Presented by: Steve Sehy, CaaS for SaaS Moderator: Chris Weber, SaaSOptics June 20, 2017

2 Welcome 30 seconds about us SaaSOptics provides both: SaaS Financials SaaS Metrics Customers have collectively raised ~$2B in VC and PE Untold hours of due diligence and audit scrutiny

$Steve Sehy, CaaS for SaaS Providing fractional CFO services to SaaS companies Implementing GAAP Preparing for Series A/ Professional financing$ Product Development Management Auditor at RSM (previously McGladrey) Key client: Provided financial leadership for SaaS company Haiku Learning

Product Development Management Auditor at RSM (previously McGladrey) Key client: Provided financial leadership for SaaS company Haiku Learning

3 Steve Sehy, CaaS for SaaS Providing fractional CFO services to SaaS companies Implementing GAAP Preparing for Series A/ Professional financing Upgrading accounting processes/systems Handling finance for the CEO Started career in Software Development Moved to Product Management and Product Development Management Auditor at RSM (previously McGladrey) Key client: Provided financial leadership for SaaS company Haiku Learning for two years of financial improvements, ending in a corporate acquisition by a Private Equity firm Find Steve on LinkedIn or at steve.sehy@yahoo.com

4 Why We re Here SaaS Company Accountants/Management: To help you to start the process of converting to the new revenue recognition rules. Auditors/Accounting Service providers: To help you to work with your clients through the process of converting to the new revenue recognition rules.

5 Agenda Background and Key Concepts for ASC 606 Key SaaS revenue sources and how to treat them Allocating the price To Do List/ Call to Action Q&A

6 Polling Question Which title best describes your current role? (Select one) q Auditor/ Service provider q CEO/CFO of a SaaS Company q Controller of a SaaS Company q Accountant of a SaaS Company q Other

7 New Revenue Recognition - Background Accounting Name (ASU No , ASC Topic 606) Revenue from Contracts with Customers: Affects all industries Attempting to have a single process for determining revenue in all situations/industries Principles vs. Rules Convergence between U.S. GAAP and International GAAP For non-public companies needs to be in place for Calendar year (For SaaS companies this will include annual and multi-year agreements made in 2018)

8 New Revenue Recognition Disclaimers: Principles vs. Rules judgement SEC rules Precedents set by first implementations U.S. Legal Environment Auditor conclusions 50 Minutes

9 New Revenue Recognition We are NOT covering: Collectibility Public companies Software licenses (old school software) Hardware Usage fees Contract modifications* Disclosures/Footnotes for non-public companies* *You should probably learn this, we just don t have time.

10 Polling Question What is your main reason for attending this webinar? q Better reporting of revenue q Clearer depiction of company health q Because we have to in order to be in compliance with GAAP (which most Series A type financing sources will require).

11 Key Concepts Core Principle Steps 1. Identify the contract with a customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations 5. Recognize revenue when (or as) each performance obligation is satisfied

12 Key Concepts Common Performance obligations for SaaS Subscription (Access to the software) Installation (vs. Setup/initiation fees) Training Ongoing Support Ongoing Upgrades to the software Custom Development

13 Key Concepts Performance obligation timing Point in time (at moment of sale in a store recognize revenue at that time) Satisfied over time (recognize revenue on a single basis over time) Output-based Methods Appraisals of results achieved (e.g. % complete) Milestones reached Time elapsed Input-based Methods Resources consumed Costs incurred Time-based Labor hours expended

14 Revenue by type Common Performance obligations for SaaS We will present how they can be treated under the new GAAP Showing examples of various situations

15 SaaS Revenue Recognition - Subscriptions Subscriptions Usually satisfied over time Calculated using the Time Elapsed - Output method

16 SaaS Revenue Recognition - Subscriptions Examples: Customer is provided with access to the SaaS product with a one year agreement. Customer pays $1,200 up front. Revenue is recognized as $100 per month. Customer is provided with access to the SaaS product with a one year agreement. Customer pays $100 per month. Revenue is recognized as $100 per month. Customer is provided with access to the SaaS product with a one year agreement. Customer pays $300 per quarter. Revenue is recognized as $100 per month. Moral timing of payments does not impact revenue recognition.

17 SaaS Revenue Recognition - Subscriptions Examples: Customer is provided with access to the SaaS product with a one year agreement with an option to renew for a second year at the same terms. Revenue is recognized as a one year contract. Customer is provided with access to the SaaS product with a one year agreement with an option to renew for a second year at a 15% discount. Revenue is recognized as a two year contract. (because customer is incentivized to renew)

18 SaaS Revenue Recognition - Subscriptions Impact of Delivery Examples: Customer is provided with access to the SaaS product with a one year agreement starting on January 1. Customer pays $1,200 up front. Revenue is recognized as $100 per month starting on January 1. Customer is provided with access to the SaaS product with a one year agreement starting on January 1. Customer pays $1,200 up front. Installation takes three months so customer starts using the software on April 1. Revenue is recognized as $1200/9 per month starting in April since customer did not receive the product until then. Customer is provided with access to the SaaS product with a one year agreement starting after installation. Customer pays $1,200 up front. Installation takes three months so customer starts using the software on April Revenue is recognized as $100 per month starting on April 1. Moral contract terms impact revenue recognition.

19 SaaS Revenue Recognition - Installation Installation Fees Usually satisfied over time Depending on your contract, this could be calculated using the: 1. Time Elapsed - Output method, 2. Appraisals of Results Achieved Output method 3. Labor hours expended Input Method 4. Point in Time method

20 SaaS Revenue Recognition - Installation Examples: Customer is provided with installation services for the first 60 days. This process is predictable and consistent for all customers. Customer pays $1,200 up front. Revenue is recognized as $600 per month for 2 months. Customer is provided with installation services until the installation is complete. This process is trackable and predictable. Customer pays $1,200 up front. At the end of the first month the project is estimated to be 33% complete. Revenue is recognized as $400 for the first month. Customer is provided with installation services as a bundle of hours. Customer pays $1,200 up front for 12 hours. At the end of the first month the project has consumed 8 hours. Revenue is recognized as $800 for the first month.

21 SaaS Revenue Recognition - Installation Examples (cont.): Customer is provided with installation services until the installation is complete. Many steps in the process are not under the control of the SaaS vendor so the amount of time or labor involved cannot be estimated. Customer pays $1,200 up front. After three months, the installation is completed. Revenue is recognized as $0 per month for 2 months and $1,200 for the third month.

22 SaaS Revenue Recognition - Training Training Fees Satisfied over time or at a point in time Depending on your contract, this could be calculated using the 1. Time Elapsed - Output method, 2. Labor hours expended Input Method 3. Point in Time method

23 SaaS Revenue Recognition - Training Examples: Customer is provided with 3 training webinars per week for the first three months. Customer pays $1,200 up front. Revenue is recognized as $400 per month for 3 months. Customer is promised 24 training hours of training. Customer pays $1,200 up front. At the end of the first month of the project 8 training hours have been delivered. Revenue is recognized as $400 for the first month. Customer is charged $1,000 for each on-site day of training. At the end of the first month, two days of training have been provided. Revenue is recognized as $2,000 for the first month.

24 SaaS Revenue Recognition - Support Support Fees Satisfied over time or at a point in time Depending on your contract, this could be calculated using the 1. Time Elapsed - Output method, 2. Labor hours expended Input Method 3. Point in Time method

25 SaaS Revenue Recognition - Support Examples: Customer is provided with ongoing phone and other support during a one year agreement. Customer pays $1,200 up front. Revenue is recognized as $100 per month. Customer is promised 24 hours of support. Customer pays $1,200 up front. At the end of the first month of the project 8 support hours have been delivered. Revenue is recognized as $400 for the first month. Customer is charged $100 for each hour of support. At the end of the first month, 6 hours of support have been provided. Revenue is recognized as $600 for the first month.

26 SaaS Revenue Recognition - Upgrades Upgrade Fees Satisfied over time This could be calculated using the Time Elapsed - Output method, Examples Customer is provided with ongoing upgrades during a one year agreement. Customer pays $2,400 up front. Revenue is recognized as $200 per month. Customer is provided with ongoing upgrades during a one year agreement. Customer also was promised a significant upgrade would be delivered after 6 months. Customer pays $2,400 up front. Revenue is recognized as $100 per month for the first six months and $300 per month for the second six months. (The upgrade was determined to be worth $1,200 and is recognized over the rest of the contract.)

27 SaaS Revenue Recognition Custom Development Custom Development Fees Satisfied over time This could be calculated using the Time Elapsed - Output method

28 SaaS Revenue Recognition Custom Development Custom Development Fees Examples: Customer is provided with one year s access to the system starting January 1. Customer is provided with a critical custom modification on March 1. The customer could cancel the agreement if the modifications were not done properly. Customer pays $2,400 up front for the modification. Revenue is recognized as $240 per month starting on March 1. The standard subscription revenue would also not start until March 1. Customer is provided with one year s access to the system starting January 1. Customer is provided with a non-critical custom modification on March 1. The customer would just receive their custom development fee back if the modifications were not done properly. Customer pays $2,400 up front for the modification. Revenue is recognized as $240 per month starting on March 1. The standard subscription revenue would start on January 1.

29 SaaS Revenue Recognition Costs Customer Acquisition and Setup costs (Huh? I thought this was a Revenue recognition change) In general: These costs should match the revenue recognition Quick answer If one year or less, can just expense Costs directly related to acquiring this customer (not general marketing or pre-sales) Creates an Asset: Deferred costs Satisfied over time This could be calculated using the Time Elapsed - Output method

30 SaaS Revenue Recognition Costs Customer Acquisition and Setup Costs Examples: Customer is provided with two year s access to the system starting January 1. Sales commission for the two year agreement is $2,400. Sales commission is capitalized as an asset. Cost is recorded as $100 per month starting on Jan 1. Customer is provided with one year s access to the system starting January 1. Direct costs of customer setup is $3,600. Customer is expected to renew for at least two more years. Customer cost is capitalized as an asset. Cost is recorded as $100 per month starting on January 1. Spread over the three year expected life of the asset.

31 Allocating the Price The deal does not matter for allocating the price Customer 1 Gold Plan includes subscription, hosting, support and upgrades for one year. Customer charged $4,800. Customer 2 Customer charged by item: subscription $2,000, hosting $800, support $1,000, upgrades $1,000. Total of $4,800. Customer 3 Customer charged for some items, Others are free : subscription $2,800, hosting free, support free, upgrades $2,000. Total of $4,800. All are the same for GAAP total price of $4,800

32 Allocating the Price The transaction is allocated based on Stand-alone selling price or Estimated Stand-alone selling price. Stand-alone selling price can be established if items are sold separately. Example: Annual phone support is sold separately for $1,200 per year. If the item is never sold by itself, the stand alone selling price needs to be estimated. Example: Phone support is always included with a subscription. There are a lot of issues to consider when estimating a stand-alone selling price. Lots more reading you can do. However, for some situations, this can be avoided (next slide)

33 Allocating the Price Simple option: If all of the Performance Obligations will be treated the same, then you don t need to allocate. Example #1: Annual Subscription, phone support and upgrades are always sold together and will all be allocated over the year. They can be treated as one item for price allocation. Subscription, phone support and upgrades are sold for $3,600 for a year. These items would not need to be allocated. Example #2: Annual Subscription, phone support and upgrades are always sold together, however phone support is based on hours while the other items will all be allocated over the year. They cannot be treated as one item for price allocation. Subscription, phone support and upgrades are sold for $3,600 for a year. These items would need to be allocated between the subscription/upgrades and phone support.

34 Allocating the Price - Discounting If the transaction is less than the sum of the stand-alone selling prices, it should generally be spread across the items evenly. (Note there are exceptions where you would not.) Example: An agreement with Installation, Annual Subscription, phone support and upgrades is sold for $4,800. The sum of the stand-alone selling prices is $6,000. The $1,200 discount would be evenly spread across the items. Example: An agreement with Installation, Annual Subscription, phone support and upgrades is sold for $4,800. The sum of the stand-alone selling prices is $3,600. This is not expected to happen, but if it occurs the $1,200 extra would be evenly spread across the items. (It might happen with a customer that is smaller than what is expected in the stand-alone price.)

35 Call to Action / To Do List What you need to do by 12/31/17: Identify all of your Performance Obligations and how you will recognize the revenue including how you will group them Determine how you will allocate the price Review your standard contracts/terms of Service and make sure the contract is consistent with how you want to treat the revenue. Implement a process of pre-approval or review of any contract modifications. Contact your auditor (or a consultant) and review conclusions Determine how you will implement the new standard, (starting 1/1/18 or 1/1/19) using full retrospective or modified retrospective method

36 Polling Question For SaaS company employees, what revenue recognition change preparation steps have you already completed? (Select all that apply) q Identified Performance Obligations q Determined price allocation process q Reviewed current contracts and Terms of Service q Determined implementation plan q None of the above/ Or not a SaaS Company

37 Selected Further Reading 1. FASB Codification ASC RSM Revenue Recognition: A Whole New World Jan 2017, 43 pages 3. RSM Changes to revenue recognition in the technology industry Jan 2017, 18 pages 4. KPMG Revenue for Software and SaaS March 2017, 648 pages 5. Early Adopter: Workday Form 10-Q dated April 30, 2017

38 New Revenue Recognition Rules Q&A

39 Thank you for joining us! Steve Sehy CaaS for SaaS CFO Consulting Chris Weber SaaSOptics

Presented by: Steve Sehy, CPA, MBA Sponsors: SaaS Capital, SaaSOptics September 20, 2017

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