The Cure for the Revenue Recognition Nightmare?

A new class of software is helping CFOs deal with one of their toughest responsibilities.
Jennifer CaplanJuly 25, 2001

Michael Tidd, CFO of Callidus Software, a privately-held incentive- compensation management software vendor based in San Jose, Ca., is not the sort of person who shies away from technology. When his company was founded in 1998, he took on the challenge of building the back office from scratch.

Since Tidd is the CFO, it’s not surprising that the first thing he did was install an accounting system. In this case, it was Great Plains Dynamics 6.0. But it might seem peculiar that contract automation software was his second priority.

“I wanted to make sure that whatever we built would last and could be leveraged as we continued to grow the company,” Tidd says. “That is what gets companies off track and causes them to trip and fall.” Serious reporting problems can also ensue when a company’s sales contracts are not closely managed, Tidd stresses.

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“I also focused in this area because revenue recognition is fundamentally critical to any software company,” he comments.

This is true, in large part, because revenue recognition rules are more specific and stringent for software companies than for firms in other industries, and Tidd wanted to mitigate his company’s risk as much as possible. The rules specify the guidance for allocating between license revenue and service revenue including implementation services, customization, and post contract support.

Tidd researched the market, and opted for diCarta Contracts, from diCarta, a three-year-old privately held firm based in Redwood City, Ca. Its clients tend to be medium-sized and large technology firms.

“I decided that their product made a lot of sense for our company,” Tidd says. “In our business, nearly all of our customer contracts are heavily negotiated, so I wanted a tool that covered the negotiation of the contract, as well as the recognition, renewal and maintenance.”

The diCarta series includes Contract Manager, a data warehouse for storing information about the terms of all present and past contracts; Revenue Manager, which provides an online account of the present and deferred revenue of the client, and can be altered as the terms of a contract change; Renewal Manager, which notifies the client when a contract is due to expire, and determines the best time for issuing revised contract terms; and Negotiator, which sets up templates for drafting contracts and facilitates online discussion and contract revision.

Thus far, Callidus has rolled out Revenue Manager and Renewal Manager, and the company plans to implement Negotiator in the fourth quarter.

“Typically, information was stored in a hodgepodge of places, including loose paper in file cabinets and Excel spreadsheets,” says Larry Cheng, financial reporting manager at Callidus, explaining why Callidus uses Contract Manager as a central repository. “It really wasn’t very well organized.”

The system allows users to mine information in contracts, and run ad hoc queries during audits, for example. “We can pull information out of the system to determine, for example, how much we are charging for maintenance on average,” says Cheng.

Without Revenue Manager, the scheduling of revenue would have been done in an ad hoc fashion on multiple spreadsheets, says Tidd, which can be dangerous, particularly in the software industry where multiple revenue recognition methods can apply.

“We were recognizing revenue initially under a percentage of completion methodology, and then we migrated to a subscription methodology and finally a sales methodology of revenue accounting,” he says. “Each one of those requires a different scheduling of product license revenue, and since we have 60 customers, it can get very cumbersome.”

DiCarta’s revenue management software automates the revenue scheduling process by extracting information from the contracts.

“The information that is stored in the system feeds into our revenue manager, which lets us schedule out how the revenue is supposed to be recognized according to the contracts,” says Cheng.

“If we have a 12-month maintenance contract, for instance, for $12,000 which we need to break out on a prorated basis, the revenue manager will schedule out the revenue appropriately,” he comments.

On a monthly basis, when the books are closed, users can use the diCarta system to determine the amount of license and maintenance revenue that should be recognized that month. Cheng says, “We can then take that data and feed it directly into our accounting software.”

The Renewal Manager allows the company to anticipate when different contracts expire, and kicks off the renewal process.

“This is a very important means of maintaining a more consistent cash flow for a company like ours,” Tidd explains.

Finally Callidus plans to roll out diCarta’s contract Negotiator module, which it intends to use primarily for negotiating its numerous non-disclosure agreements.

“For a company like ours that is intellectual-property intensive, non-disclosure agreements (NDA) are necessary to protect our interests,” says Tidd.

In addition, because the nature of Callidus’s product requires that it acquire confidential information from its customers, NDA agreements are a necessary part of its business.

“We have to enter into so many of these agreements, and must maintain good control over them,” Tidd comments.

What’s more, Tidd opted to outsource diCarta’s applications in order to bypass the high cost of hiring additional staff.

Tidd says he paid diCarta approximately $20,000 up front for the software, but he declined to comment on the subsequent hosting and maintenance costs.

DiCarta CEO Scott Martin tells that the license fee depends on the number and types of users. Licenses for the Revenue Manager and Renewal modules go for $2,000 per user, and Negotiator licenses sell for $500 per user.

Once customers license the product, he explains, they have the option to either host the applications or install them internally. All customers pay an annual maintenance fee equal to 20 percent of the cost of the license. Customers that chose the hosted option pay an additional annual fee equal to 30 percent of the software license for those services.

So how did Tidd justify the investment in diCarta’s software, and decide to take the plunge?

“I knew I was going to have to make the investment anyway, either by making my own solution, which would eventually have to be either rebuilt or replaced, or I could adopt a product and grow with it,” he explains. “Anytime you can get a new product for few man-months of time, you’re better off.”