| Basis of Presentation | Note 1–Basis of Presentation
The accompanying condensed consolidated financial statements of PC Connection, Inc. and its subsidiaries (the “Company,” “we,” “us,” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States of America. Such principles were applied on a basis consistent with the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (the “SEC”), other than the adoption of Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers” (“ASC 606”) under the modified retrospective method as of January 1, 2018 as discussed below. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements contained in our Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods reported and of the Company’s financial condition as of the date of the interim balance sheet. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of issuance of these financial statements. The operating results for the three months ended March 31, 2018 may not be indicative of the results expected for any succeeding quarter or the entire year ending December 31, 2018.
Revenue Recognition
On January 1, 2018, we adopted ASC 606, which replaces existing revenue recognition rules with a comprehensive revenue measurement and recognition standard and expanded disclosure requirements. See Adoption of Recently Issued Accounting Standards in this footnote for additional information.
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. We account for a contract when it has approval and commitment from both parties, the rights are identified, the contract has commercial substance, and collectability of consideration is probable. We generally obtain oral or written purchase authorizations from our customers for a specified amount of product at a specified price, which constitutes a contract. Revenue is recognized at the amount expected to be collected, net of any taxes collected from customers, which are subsequently remitted to governmental authorities. We generally invoice for our products at the time of shipping, and accordingly there is not a significant financing component included in our contracts.
Nature of Products and Services
Information technology (“IT”) products typically represent a distinct performance obligation, and revenue is recognized at the point in time when control is transferred to the customer which varies based on terms of the contract. We recognize revenue as the principal in the transaction with the customer (i.e., on a gross basis), as we control the product prior to delivery to the customer and derive the economic benefits from the sales transaction given our control over customer pricing.
We do not recognize revenue for goods that remain in our physical possession before the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from the products, the goods are ready for physical transfer to and identified as belonging to the customer, and when we have no ability to use the product or to direct it to another customer.
Licenses for on premise software provide the customer with a right to take possession of the software. Customers may purchase perpetual licenses or enter into subscriptions to the licensed software. We are the principal in these transactions and recognize revenue for the on premise license at the point in time when the software is made available to the customer and upon the commencement of the term of the software or when the renewal term begins, as applicable.
For certain on premise licenses for security software, the customer derives substantially all of the benefit from these arrangements through the third-party delivered software maintenance which provides software updates and other support services. We do not have control over the delivery of these performance obligations and accordingly we are the agent in these transactions. We recognize revenue for security software net of the related costs of sales at the point in time when our vendor and customer accept the terms and conditions in the sales contract. Cloud products allow customers to use hosted software over the contractual period without taking possession of the software and are provided on a subscription basis. We do not exercise control over these products and therefore are an agent in these transactions. We recognize revenue for cloud products net of the related costs of sales at the point in time when our vendor and customer accept the terms and conditions in the sales contract.
Certain software sales include on premise licenses that are combined with software maintenance. Software maintenance conveys rights to updates, bug fixes and help desk, and other support services transferred over the underlying contract period. On premise licenses are considered distinct performance obligations when sold with the software maintenance, as we sell these separately. We determine the stand-alone selling price (“SSP”) of the license and the software maintenance and allocate the transaction price amongst the performance obligations. We recognize revenue related to the software maintenance as the agent in these transactions because we do not have control over the on-going software maintenance service. Revenue allocated to software maintenance is recognized at the point in time when our vendor and customer accept the terms and conditions in the sales contract.
Certain of our larger customers are offered the opportunity by vendors to purchase software licenses and maintenance under enterprise agreements (“EAs”). Under EAs, customers are considered to be compliant with applicable license requirements for the ensuing year, regardless of changes to their employee base. Customers are charged an annual true-up fee for changes in the number of users over the year. With most EAs, our vendors will transfer the license and bill the customer directly, paying resellers, such as us an agency fee or commission on these sales. We record these agency fees as a component of net sales as earned and there is no corresponding cost of sales amount. In certain instances, we invoice the customer directly under an EA and account for the individual items sold based on the nature of each item. Our vendors typically dictate how the EA will be sold to the customer.
We also offer extended service plans (“ESP”) on IT products, both as part of the initial arrangement and separately from the IT products. When sold as one transaction, we determine the SSP of the IT products and the ESP and allocate the transaction price amongst the separate performance obligations. We recognize revenue related to ESP as the agent in the transaction because we do not have control over the on-going ESP service. Revenue allocated to ESP is recognized at the point in time when our vendor and customer accept the terms and conditions in the sales contract.
All amounts billed to a customer in a sales transaction related to shipping and handling, if any, represent revenues earned for the goods provided, and these amounts have been included in net sales. Costs related to such shipping and handling billing are classified as cost of sales. Sales are reported net of sales, use, or other transaction taxes that are collected from customers and remitted to taxing authorities.
We use our own engineering personnel in projects involving the design and installation of systems and networks, and we also engage third-party service providers to perform warranty maintenance, implementations, asset disposal, and other services. Service revenue is recognized in general over time as we perform the underlying services and satisfy our performance obligations. We evaluate such engagements to determine whether we are the principal or the agent in each transaction. For those transactions in which we do not control the service, we act as an agent and recognize the transaction revenue on a net basis at a point in time when the vendor and customer agree on the sales contract.
Significant Judgments
Our contracts with customers often include promises to transfer multiple products or services to a customer. Determining whether we are the agent or the principal and whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
Estimates may be required to determine SSP for each distinct performance obligation. We maximize the use of observable inputs in the determination of the estimate for SSP for the items that we do not sell separately, including on-premises license sold with software maintenance, and IT products sold with ESP. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs.
We provide our customers with a limited thirty-day right of return generally limited to defective merchandise. Revenue is recognized at delivery and a reserve for sales returns is recorded. We make estimates of product returns based on significant historical experience and record our sales return reserves as a reduction of revenues and either as reduction of accounts receivable or, for customers who have already paid, as accrued expenses.
Description of Revenue
We disaggregate revenue from the contracts with customers by types of products and services, as we believe it best depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.
The following table represents a disaggregation of revenue from contracts with customers for the three months ended March 31, 2018 and 2017, along with the reportable segment for each category.
For the three months ended March 31, 2018
Business Solutions
Enterprise Solutions
Public Sector Solutions
Total
Software
$
34,424
$
28,441
$
6,863
$
69,728
Notebooks/Mobility
71,729
63,438
23,898
159,065
Servers/Storage
31,501
24,543
17,139
73,183
Net/Com products
27,026
12,368
12,758
52,152
Other hardware/services
98,598
128,454
43,715
270,767
Total net sales
$
263,278
$
257,244
$
104,373
$
624,895
For the three months ended March 31, 2017
Business Solutions
Enterprise Solutions
Public Sector Solutions
Total
Software
$
59,803
$
54,882
$
14,626
$
129,311
Notebooks/Mobility
72,878
50,000
26,290
149,168
Servers/Storage
26,503
21,654
12,186
60,343
Net/Com products
22,969
16,471
17,524
56,964
Other hardware/services
91,480
109,911
73,417
274,808
Total net sales
$
273,633
$
252,918
$
144,043
$
670,594
Contract Balances
The following table provides information about contract liability from contracts with customers as of March 31, 2018 and January 1, 2018 (in thousands):
March 31, 2018
January 1, 2018
Contract liability, which are included in "Accrued expenses and other liabilities"
3,087
2,914
Significant changes in the contract liability balances during the three months ended March 31, 2018 are as follows (in thousands):
Contract Liabilities
Balances at January 1, 2018
$
2,914
Reclassification of the beginning contract liability to revenue, as the result of performance obligations satisfied
(1,146)
Cash received in advance and not recognized as revenue
1,319
Balances at March 31, 2018
$
3,087
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the amounts reported in the accompanying condensed consolidated financial statements. Actual results could differ from those estimates.
Comprehensive Income
We had no items of comprehensive income, other than our net income for each of the periods presented.
Adoption of Recently Issued Accounting Standards
On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued ASC 606, which amends the existing accounting standards for revenue recognition and expanded our disclosure requirements. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
On January 1, 2018 we adopted ASC 606 using the modified retrospective transition method which resulted in an adjustment at January 1, 2018, to retained earnings for the cumulative effect of applying the standard to all contracts not completed as of the adoption date. Upon adoption we recorded $1,197 as an increase retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
The adoption resulted in acceleration of the timing of revenue recognized for certain transactions. For example;
IT product revenue was previously recognized revenue at the time of delivery to the customer. We have determined that control of the product may transfer prior to delivery to the customer for transaction where we have a legal right to payment upon shipment of the goods; title and risk of loss of/damage to the shipped goods are transferred to the customer, and the seller transfers physical possession of the shipped goods, and shipping terms do not affect customer acceptance. In addition, certain transactions where product remains in our possession has been recognized as of the transaction date when all revenue recognition criteria have been met.
The following table presents the effect of the adoption of ASC 606 on our condensed consolidated balance sheet as of January 1, 2018:
Adjustments
Balance at
Due to ASU
Balance at
December 31, 2017
2014-09
January 1, 2018
Balance Sheet
Assets
Accounts receivable, net
$
449,682
$
14,568
$
464,250
Inventories
106,753
(10,869)
95,884
Prepaid expenses and other current assets
5,737
(132)
5,605
Long-term accounts receivable
—
1,890
1,890
Other assets
5,638
(3,914)
1,724
Liabilities
Accounts payable
194,257
(62)
194,195
Accrued expenses and other liabilities
31,096
(312)
30,784
Accrued payroll
22,662
291
22,953
Deferred income taxes
15,696
429
16,125
Stockholders' Equity
Retained earnings
$
383,673
$
1,197
$
384,870
In addition to the timing of revenue recognition impacted by the above described transactions, upon adoption of ASC 606, the amount of revenue to be recognized prospectively is affected by the presentation of revenue transactions as an agent instead of principal in the following transactions:
Revenue related to the sale of cloud products as well as certain security software will be recognized net of costs of sales as we have determined that we act as an agent in these transactions. These sales are recorded on a net basis at a point in time when our vendor and the customer accepts the term and conditions in the sales contract. In addition, we sell third-party software maintenance that is delivered over time either separately or bundled with the software license. We have determined that software maintenance is a distinct performance obligation that we do not control, and accordingly, we act as an agent in these transactions and will recognize the related revenue on a net basis under ASC 606. We previously recognized revenue for cloud products, security software, and software maintenance on a gross basis (i.e., acting as a principal). This change will reduce both net sales and cost of sales with no impact on reported gross profit as compared to our prior accounting policies.
The following tables present the effect of the adoption of ASC 606 on our condensed consolidated income statement and balance sheet as of and for the three-months ended March 31, 2018 and as of March 31, 2018, respectively:
For the three months ended March 31, 2018
Balances without
As
Adoption of
Reported
Adjustments
ASC 606
Income statement
Revenues
Net sales
$
624,895
$
75,558
$
700,453
Costs and expenses
Cost of sales
528,523
76,168
604,691
Income from operations
15,472
(497)
14,975
Income before taxes
15,588
(497)
15,091
Net income
$
11,300
$
(362)
$
10,938
March 31, 2018
Balances without
As
Adoption of
Reported
Adjustments
ASC 606
Balance Sheet
Assets
Accounts receivable, net
$
408,334
$
(17,182)
$
391,152
Inventories
85,582
13,503
99,085
Prepaid expenses and other current assets
6,437
247
6,684
Long-term receivables
1,890
(1,890)
—
Other assets
1,714
3,914
5,628
Liabilities
Accounts payable
$
152,115
$
(234)
$
151,881
Accrued expenses and other liabilities
23,434
1,277
24,711
Accrued payroll
17,207
(327)
16,880
Deferred income taxes
16,125
(564)
15,561
Stockholders' Equity
Retained earnings
$
396,170
$
(1,559)
$
394,611
We have elected the use of certain practical expedients in our adoption of the new standard, which includes continuing to record revenue reported net of applicable taxes imposed on the related transaction and the application of the new standard to all contracts not completed as of the adoption date. We have also elected to use the practical expedient to not account for the shipping and handling as separate performance obligations. Adoptions of the standard related to revenue recognition had no net impact on our condensed consolidated statement of cash flows.
Recently Issued Financial Accounting Standards
In February 2017, the FASB issued ASU 2017-02, Leases . The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than twelve months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently assessing the potential impact of the adoption of ASU 2017-02 on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment , which simplifies the accounting for goodwill impairments by eliminating step two from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. ASU 2017-04 also clarifies the requirements for excluding and allocating foreign currency translation adjustments to reporting units related to an entity's testing of reporting units for goodwill impairment and clarifies that an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 is effective for the Company beginning January 1, 2020 for both interim and annual reporting periods. We are currently assessing the potential impact of the adoption of ASC 2017-04 on our consolidated financial statements. |
