ASC 606, Revenue From Contracts With Customers, has been like a slow building hurricane, leaving some in tatters while others are completely untouched. Companies with recurring revenue from services have tended to get a positive benefit from the rules, while it has largely been a nonevent for product companies. Earnings release headlines and coverage of the impact haven’t been consistent, sell-side models have gone haywire and the bots reporting news headlines have rarely gotten it right. As we are right in the middle of the earnings season, Clermont Partners looked at the strategies of 100 companies that have already reported to determine who did it right.
From our perspective, the first half of earnings season makes it clear that companies better help analysts (and big machines) more easily understand how much of the Revenue and EPS shift is due to the change in accounting and how much is due to a growth/decline in the business. Those that do that well – and in a very visible way – tend to have more accurate reporting from the media and sell-side analysts, as well as less disparity in adjusted sell-side analyst models.
In practice, companies have been all over the board in the first half of earnings season, some putting the impact (or lack thereof) front and center in the release, and others hiding it in a footnote. Most companies mention their adoption of the standard in the CFO commentary, and the more material it is, the more likely it is to make its way into the earnings release. However, the placement within the earnings release was mixed, with some including it in a footnote, while others placed it in the commentary of the results.
Based on these results, and discussions with sell-side analysts, here is what we believe to be best practices for covering this topic:
- Frame the discussion. Incorporate commentary in the press release whether you have adopted the modified or full historical retrospective. Explain whether the impact will be material or not. This same language should be provided in the CFO commentary for those who only listen or read the published transcript later.
- Explain the impact on annual guidance. If the impact is simply either a shift in timing or an offset between revenue and earnings per share that doesn’t impact annual guidance, put this commentary in both the earnings release and the CFO commentary and consider the discussion done. If your company provides quarterly guidance, a discussion must be included in the outlook section. And, just for this quarter, show the guidance before and after the impact of the standard. Best practices would include handling this in an earnings slide as well, an accounting footnote, and the CFO commentary.
- Set aside some time (possibly a lot of time) to review consensus numbers across FactSet, Bloomberg and Ipreo. All are likely to have different numbers, and at a minimum, confirm they are reporting the sell-side estimates consistently.
Best Practice Example #1
Sabre’s slide from its earnings deck showing how the shift doesn’t impact free cash flow.
Best Practice Example #2
Heidrick’s release explanation as to why revenue growth was higher than expected because of ASC 606.
Body of Release:
On January 1, 2018, the company adopted ASC 606, Revenue from Contracts with Customers, and applied the modified retrospective method, which involves recognizing the cumulative effect of applying the guidance at the date of initial application with no restatement of the comparative periods presented. This adoption increased consolidated net revenue in the 2018 first quarter by $2.5 million compared to the historical method of revenue recognition. Additional information about the impact of the adoption of ASC 606 is provided at the end of the release.
Impact of Adoption of ASC 606 On January 1, 2018, the company adopted ASC 606, Revenue from Contracts with Customers, and applied the modified retrospective method, which involves recognizing the cumulative effect of applying the guidance at the date of initial application with no restatement of the comparative periods presented. This adoption increased consolidated net revenue in the 2018 first quarter by $2.5 million compared to the historical method of revenue recognition. The new guidance primarily impacts the company’s revenue recognition methodology for executive search upticks and for enterprise licenses to use its culture shaping proprietary tools, referred to as enterprise agreements. The company now estimates uptick revenue and recognizes this revenue over the life of the executive search as opposed to recognition upon the placement of a candidate. Enterprise agreements are now recognized over a longer term due to certain renewal options included in the contract. The following is a summary of the impact on revenue by segment:
- Executive Search – The adoption of the new revenue recognition standard increased revenue in the 2018 first quarter by approximately $3.5 million, with approximately $1.8 million in the Americas, $1.1 million in Europe, and $0.6 million in Asia Pacific.
- Heidrick Consulting – The adoption of the new revenue recognition standard decreased enterprise revenue in the 2018 first quarter by approximately $1.0 million. For the year ending December 31, 2018, the company anticipates that the change in revenue recognition will not be material to consolidated net revenue, subject to variability in the number, timing and value of Executive Search confirmations as well as enterprise license agreements.
For other related articles, please see Addressing the Go-Forward Impact of Tax Reform in the Upcoming Earnings Season and More Active Investors Rely on Non-GAAP vs. GAAP Reporting in Analyzing Stocks .