Revenue recognition and leasing A private equity perspective Michael Nesta Partner, Accounting Advisory Services KPMG LLP Steve Thompson Partner, Accounting Advisory Services KPMG LLP
Introduction Agenda The clock is ticking on adoption of the new revenue and leasing standards. The implications on M&A activities are here and real. Deal teams should understand the financial and operational implications and adjust their diligence, modeling and integration plans. Implications on sell-side activities and exit plans are real. 1. Accounting change horizon 2. Deal considerations 3. Q&A 2
1. Accounting change horizon
1. Revenue recognition ASC 606 Purpose More robust framework: Fewer bright lines ; more judgment and estimation. Comparability: Improve comparability by replacing 100+ sources of current rev rec guidance. Enhanced disclosures: Expand disclosures related to revenue and related balance sheet positions. Timeline Public companies: Beginning of FY 2018 Private companies: Beginning of FY 2019 Adoption methods Retrospective method: restate the prior two years leading up to the adoption date. Modified retrospective method: apply new standard from the adoption date with an adjustment to opening equity. 4
1. Revenue recognition Implementation challenges Complex, principles-based standard requires significant judgment Review of large volume of customer contracts Disclosure requirements are comprehensive Many companies are implementing system changes The implementation effort can be a long process plan appropriately Transition reporting 5
1. Leases ASC 842 Purpose To provide financial statement users with more information about an entity s leasing activities. - Lessees will recognize all leases, including operating leases, with a term greater than 12 months on-balance sheet - Lessees and lessors will disclose key information about their leasing transactions Timeline Public companies: Beginning of FY 2019 (annual periods beginning after December 15, 2018) Private companies: Beginning of FY 2010 (annual periods beginning after December 15, 2019) Early adoption is permitted immediately Adoption methods Modified retrospective: Restate the prior two years under modified guidance leading up to adoption (modified retrospective has a different meaning between the revenue and leasing standards). 6
1. Leases Implementation challenges Completely new accounting model Identifying and controlling the population of leases Abstraction of data from individual lease agreements System changes Transition reporting 7
2. Deal considerations
2. Buy side considerations These new accounting standards have implications across the investment cycle Transaction identification Evaluation Integration/ separation Value creation Value realization Diligence process - Does the target have a good handle on the effort required for implementation? - Have non-recurring implementation costs been identified? - Can the target explain how upcoming accounting changes for rev rec and leases will impact its trends? Integration - Will the target be able to meet the buyer s timeline for compliance? Value creation - Is the company approaching the implementation process wisely? - Has management prioritized the implementation effort? Not addressing the changes is not an option; delay can lead to costly inefficiencies. - Are outside advisors being leveraged wisely? Reliance on experienced advisor can accelerate the process. 9
2. Sell side considerations Compliance with the new revenue standard could impact EBITDA and Revenue trends, deal financing and execution of exit strategy Modeling impact Potential impact on trends may affect modelling Revenue could in some cases be recorded net instead of gross (reduced revenue) Revenue could be accelerated in other cases Upon adoption, deferred revenue could be reduced EBITDA will increase if significant sales commissions or setup costs are capitalized Can impact on trends be articulated to a potential buyer? Deal financing Exit strategy Lack of compliance by a portfolio company could impede deal financing Delay in a lender s ability to register debt Application of the new standard could result in trend changes possibly impacting debt covenants Lack of compliance could result in qualified audit opinion Lack of compliance by a portfolio company could delay an exit strategy or impact exit multiples Hinder a sale to a corporate buyer, or erode value (as the cost of implementation and related compliance issues would be passed on to the buyer) 10
2. What to do? Augment your deal team Revise your diligence playbook Adjust deal model as appropriate Revisit integration and value creation playbook Leverage upside potential 11
2. Augment deal team; adjust diligence game plan Assume that your private company target does not have a robust plan for adopting the new rev rec and leasing standards. Many private companies have not begun or are in the initial assessment phase. This places a higher burden on deal teams to evaluate the implications. Deal team capabilities and the diligence efforts may need to be augmented. Deal team capabilities Augment your diligence to ensure the right people are asking the right questions. Perform accounting analysis to identify key impacts on revenue and EBITDA trends, balance sheet presentation and disclosures. Review the target s implementation plans and evaluate availability of adequate internal resources and timeline for completion. Understand implementation costs including system changes 12
2. Adjust your deal model Deal teams need to consider impacts on their model: Changes to revenue growth rates and increased volatility Potentially greater dislocation between EBITDA and cash flow New net working capital dynamics (unbilled AR, new capitalized costs, less deferred revenue) Deferred revenue haircuts decline following adoption (principally due to less deferred revenue) Impact of transition options on comparability across periods Future implementation costs (one-time costs and run-rate changes) Risk to the timing and extent of planned cost synergies Impacts to earn-out structures and other covenants linked to GAAP performance Impact to debt covenants by bringing leases on balance sheet Deal negotiations and the SPA may be impacted 13
2. Step three: Revisit integration and value creation playbook Corporate buyers Prepare for added complexity, disruption and time to integrate Consider whether target s implementation plan places in buyers implementation in jeopardy Enhanced communication with stakeholders and analysts will be needed to build consensus on nonrecurring implementation costs PE investors Plan for post-deal implementation costs Lack of financial statement comparability and trending data could complicate exit Anticipated exit paths and timelines may impact your approach to adoption For IPO exit scenarios, consider need for accelerating implementation date 14
2. Step four: Leverage the upside potential Beyond the challenges for companies and deal teams, the new revenue standard can present opportunity. Product and sales teams could have greater flexibility Revenue recognition may be accelerated, particularly for many software companies that deferred large portion of their license revenue For companies with deficiencies or manual processes related to revenue recognition or leasing, use this as an opportunity to improve underlying systems and processes Enhanced automation can create efficiencies and drive greater operational insights into unit economics and business performance 15
3. Q&A
Contact us Michael Nesta Partner, Accounting Advisory Services KPMG LLP T: 214-840-2730 E: mnesta@kpmg.com Steve Thompson Partner, Accounting Advisory Services KPMG LLP T: 303-382-7970 E: sgthompson@kpmg.com
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