By Eric Mersch
The Remaining Performance Obligation (RPO) reporting requirement arose from the adoption of ASC 606. This SaaS metric is defined as the sum of Deferred Revenue and Backlog. Deferred Revenue for SaaS companies is the contractual obligation to deliver the SaaS product for the period invoiced. The term Backlog refers to future contractual obligations (not to be confused with a backlog of unsigned opportunities). Public companies report this metric in their filings, but the use of the RPO as a key performance indicator is sporadic.
The RPO Reporting Requirement
The reporting guidance on Remaining Performance Obligations originated with the official adoption of Accounting Standards Update No. 2014-09, Accounting Standards Codification (ASC) number 606: “Revenue From Contracts With Customers,” which was required for public companies with annual periods that began after December 15th, 2017.
A company’s Remaining Performance Obligation (RPO) represents the total future performance obligations arising from contractual relationships. More specifically, RPO is the sum of the invoiced amount and the future amounts not yet invoiced for a contract with a customer. The former amount resides on the balance sheet as Deferred Revenue and has always been reported as required by GAAP. The latter obligation, also referred to as Backlog, makes up the non-invoiced amount of the Total Contract Value metric. Thus, RPO equals the sum of Deferred Revenue and Backlog.
Now, let’s us take a look at an example. We will use an Enterprise SaaS company for our example because these companies typically have contract terms greater than one year’s duration. In this case, assume that our theoretical company closes a SaaS deal with an average Annual Contract Value (ACV) of $120,000. The company closes a three-year contract that requires a one-year upfront payment. On the Billings date, the company debits Accounts Receivable (AR) and credits Deferred Revenue (DR) for $120,000. On the payment date, the company credits AR and debits Cash for the $120,000 payment. At this point, the company has a contractual obligation to deliver the SaaS product for three years. But only the economic activity of the first year is accounted for on its books. The Backlog, which is the dollar value of the remaining two years of the contract, is the sum of the contract’s second two years, or $240,000. The Remaining Performance Obligation is the sum of the Deferred Revenue ($120,000) and the Backlog ($240,000), or $360,000.
Venture-backed companies have long tracked this dynamic, though not with RPO. We use average Total Contract Value (TCV) and the ratio between TCV and ACV as metrics to measure future revenue opportunity. In the example above, TCV is the value of the three-year deal or $360,000 and the TCV/ACV metric is 3.0.
As we saw in the example above, RPO is not a GAAP number and, therefore, does not appear on the balance sheet. Instead, companies report it in the Revenue from Contracts with Customers section of the public filings. The amounts are reported in millions, so not at the same level of detail as GAAP numbers. Companies often report RPO by revenue line item. For example, the work management and collaboration software provider Smartsheet breaks out RPO from subscription and from professional services. Additionally, companies report the RPO amount that it is expected to be recognized in the next 12 months.
Most public SaaS companies include information on the Billings associated with the period. Billings is a non-GAAP metric defined as the dollar value of the New or Renewal Subscription Bookings amount invoiced on the date dictated by the contract terms, i.e., the Billings Date. The purpose of Billings as a metric is to provide an indication of future revenue. If using Billings as a key metric, the company will provide a reconciliation of Billings to Revenue using the change in Deferred Revenue. For example, cybersecurity company Tenable Holdings, Inc. (NASDAQ: TENB) uses a metric it calls Calculated Billings and uses the change in Deferred Revenue to reconcile this non-GAAP metric to GAAP revenue.
However, some investors find the Billings metric confusing. RPO potentially solves this issue because it can be easier to comprehend while still demonstrating future revenue potential. For this reason, Tenable has begun to report RPO as well. In its most recent 10-K filing for the fiscal year ending December 31, 2019, Tenable added this section on RPO: Remaining Performance Obligations: At December 31, 2019, the future estimated revenue related to unsatisfied performance obligations was $367.3 million, with approximately 75% expected to be recognized as revenue over the succeeding twelve months, and the remainder expected to be recognized over the four years thereafter.
One of the early SaaS adopters was Splunk Inc., which implemented ASC 606 on February 1, 2018, and provides a good reference for RPO. For the fiscal year ended January 31, 2019, Splunk reported Total Revenues of $1.80B, Deferred Revenue of $0.88B and RPO of $1.26B. For the following fiscal year, Splunk reported Total Revenues of $2.36B, Deferred Revenue of $1.00B and RPO of $1.80B. Year-over-year growth in RPO was 43% and this exceeded the growth in Total Revenues by 12 points. Since RPO serves as a proxy for future revenue, the RPO growth rate provides a leading indicator of growth. In Splunk’s case, the RPO growth indicates that the company will show Total Revenue growth in fiscal year 2021.
Splunk’s Senior Vice President, Finance, David Conte, emerged as a big proponent of RPO. In the company’s fiscal year 2019 earnings call on May 24th, 2020, his last as CFO, David had this to say about the RPO metric during Q&A:
“I’ve been beating the drum for quite a while about RPO being a more comprehensive metric than billings. And for a model like ours in particular, much of our contract value doesn’t flow through deferred [revenue]. So the billings calculation, the historic billings calculation is not as comprehensive as RPO, and you can see that in terms of the dynamic…it really doesn’t capture the full breadth of [it] in terms of the scale of the business, as does the RPO calculation.”
When David mentioned that much of their contract value does not flow through deferred revenue, he’s referring to the fact that Splunk sells perpetual software licenses as well as term licenses. And the sale of perpetual licenses do not generate deferred revenue. This revenue mix may mean that RPO is not the best metric for Splunk or, at least, a metric to be provided in addition to Billings.
In fact, Splunk’s use of RPO as a key performance metric did seem to cause some confusion among analysts. This was apparent in Piper Jaffray analyst Alex Zukin’s question on RPO as a proxy for business momentum versus billings, “So I guess, maybe the first question is that a better metric to look at the overall kind of momentum or the growth of the business, than RPO stand-alone or billings.” David responded that he thought RPO was a good metric. Jefferies analyst John DiFucci pushed back on Splunk’s use of RPO during the same call, saying that in wanting to look at the momentum of the business, “RPO for me just doesn’t do it.” The incoming CFO, Jason Child, acknowledged this concern replying,
“I think, theoretically RPO makes a lot of sense. But if I were to kind of step back and say, what do I think the value is going to be going forward, where do we see the value right now, I think overall software growth at 54% year-on-year. But that’s the number that is probably the one that I think is the one I think will be most indicative of the growth that we’re creating.”
The differences in opinion on RPO reporting between the outgoing and incoming CFO may be just philosophical in nature, or maybe competitive, but this is one data point indicating how an equity analyst feels about RPO.
Two years later, for the fiscal year ending January 31, 2020, Splunk still reported on RPO, but dropped billings as a metric. The public filing mentioned billings in the description of business activity but did not give a billings number and did not show a reconciliation like the one above. Analyst reaction was completely different this time in that not a single question even mentioned RPO. This shows that equity analysts understand RPO, but perhaps do not fully agree that it is the best metric for business momentum.
I reached out to JMP Securities Analyst Erik Suppiger, who covers 20 public companies in the Cybersecurity and IT Infrastructure sectors. His coverage universe includes Splunk, Nutanix, FireEye, new Relic, and Palo Alto Networks among others. In Erik’s view, Billings has been used for a long time and has always been a “very clear-cut metric.” RPO is a new metric and analysts don’t have a lot of confidence in RPO, especially when it includes different revenue streams. So, if the choice is between Billings, a well-known and understood metric built into existing financial models, and the new RPO concept, analysts seem to choose Billings, at least for now.
The Remaining Performance Obligation (RPO) metric is a valuable key performance indicator for the momentum of the business. However, the Billings metric also provides a measure of future performance, especially when combined with average ACV and TCV / ACV metrics. With most public companies choosing to stick with Billings for now, you are best served by using Billings for benchmarking.
 Tenable Holdings, Inc. form 10-K for fiscal year ended December 31, 2019; www.sec.gov