As the 2017 Q2 filings drip in, we’re starting to go into the full swing of filings season. What have we learned so far about the early adopters of Topic 606? Up until now, we’ve identified some interesting examples of these early adopters. But, let’s take a step back and look at some interesting overall statistics and takeaways from these companies.
For starters, going through thousands of companies to identify who is an early adopter is no mean feat. Companies varied significantly in the manner in which they disclosed that they have early adopted the new revenue recognition standard. This ranged from the predictable “the Company has early adopted the new standard”, to “there was no impact to the Company’s financial position, results of operations, or cash flows as a result of the adoption”. One company indicated that “there was no accounting impact to previously issued financial statements based on our adoption of ASC Topic 606."
Defining Search Criteria: We began our search logically with a textual search through footnote disclosures and MD&A sections for the key term “Revenue from Contracts with Customers”.
We limited our search to company filings made to the SEC from 2016 onward. This initial search identified 35,970 cases of companies mentioning the new standard by name (for example, a company could mention “Revenue from Contracts with Customers” in the MD&A in the 2016 10-K and in the new accounting policies footnote of the same filing and this would be counted as 2) . In fact, 4680 unique companies mentioned “Revenue from Contracts with Customers” in 2016 and 2017. Naturally, not all of these cases were instances where the company specifically disclosed early adopting the new standard. Based on Further filtering and drill-down on our search criteria (for instance, determining who mentioned “adopted” within the search distance of words from Topic 606), identified a population of 27 companies that early adopted the new revenue recognition standard.
The following diagram shows that the early adopters are primarily in the Chemical and Allied and Business Services industries.
Method of Adoption
Under the new standard, companies can adopt early using either the full retrospective method or the modified retrospective method. Under the full retrospective method, companies recast the amount by which each financial statement line item presented in the current filing is affected as if the new guidance has always existed. For instance, a company in its 2017 10-K would show the impact of Topic 606 on each financial statement line item in 2016 and 2015. Obviously, this is helpful to investors since it improves comparability across periods. Under the modified retrospective method, companies have some breathing room in that the prior year financial statements would not need to be restated. Instead, companies would apply the cumulative effect of initially applying the new standard as an adjustment to the opening retained earnings balance. Disclosures under previous GAAP would also be required for the initial year of adoption, which would require companies to maintain two sets of record keeping for that year.
The method of adoption of Topic 606 is evenly split between the full and modified retrospective methods, with some companies being ambiguous in terms of which method they employed (see following diagram).
At the time of the first adoption of the new standard, the average Total Assets of the company is $38B. This, of course, is highly skewed by larger early adopting companies like Ford, Microsoft and Alphabet. In fact, the median Total Assets of companies at the time of first adoption is $588M. The smallest company that we have identified so far that has early adopted Topic 606 is DS Healthcare Group, Inc, with Total Assets of only $4.9M.
What is interesting to consider about smaller companies adopting the new revenue recognition standard is that, despite the increase in the complexity on processes, recordkeeping and disclosure requirements that the standard requires, smaller, perhaps less complex companies, may not be as severely impacted. This may be because their revenue transactions are straightforward and/or the number of transactions can reasonably be examined by existing staff without undue burden.
In fact, upon closer examination of the sample of firms, there are 3 additional companies that have Total Assets less than $20M at the time of adoption. They are: Aradigm Corp ($19.9M), Lifeloc Technologies ($8.1M), Inc, and Ener-Core Inc ($6.6M).
The average Revenues for early adopting companies is $11B, with the median at $142M.
Again, this is interesting where the larger revenue companies are skewing the revenues distribution upwards, but we also see evidence of the ‘smaller’ revenue companies early adopting. In fact, something notable is that some of the early adopting companies are ‘pre-revenue’. For instance, Mirati Therapeutics, Inc. did not have revenues in 2017 Q2, yet adopted the new revenue recognition standard using the full retrospective method.
It appears that Mirati is early adopting in anticipation that if they were to enter into new revenue contracts, the contracts will be accounted for from the inception of the contract. We observed two other companies (Strongbridge Biopharma plc and Radius Health, Inc) that were pre-revenue until the most recent Q2, when they first early adopted Topic 606 and started generating revenues.
The average Net Income for early adopters is $1.2B, with the median Net Income at $78K. In fact, all companies below the median generated losses in the first period in which they early adopted Topic 606. This is consistent with the notion that smaller revenue or loss-generating companies are early adopting the new standard.
Whilst the larger companies like Microsoft, Workday, Alphabet, and Ford make the headlines for early adopting Topic 606, the much smaller companies (both in terms of Total Assets and Revenues) often fly under the radar.
This new standard is encompassing, even if you think it doesn’t impact your company since it may not be generating any revenues. If your company falls into this group, you can take comfort in the fact that other similar companies have already adopted the standard and that you can learn from them. Like Mirati Therapuetics, Inc, you can jump ahead and be fully ready to comply. Why wait until you start generating revenues to consider the impact of Topic 606? Be fully prepared to adopt the standard as soon as you sign your first revenue contract, which hopefully is in the not-too-distant future.