| Basis of Presentation | Note 1–Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of PC Connection, Inc. and its subsidiaries (the “Company,” “we,” “us,” or “our”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting and 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 audited consolidated 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 and six months ended June 30, 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 replaced 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. In most instances, when several performance obligations are aggregated into one single transaction, these performance obligations are fulfilled at the same point of time. We account for an arrangement 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 an arrangement. 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 arrangements.
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 arrangement. 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 arrangement. 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 arrangements.
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 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 arrangements.
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. 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 arrangement.
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 accept the terms and conditions in the sales arrangement.
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.
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.
We estimate SSP for each distinct performance obligation when a single arrangement contains multiple performance obligations and the fulfillment occurs at different points of times. 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 which is 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 our arrangements with customers by type of products and services, as we believe this method 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 arrangements with customers for the three months ended June 30, 2018 and 2017, along with the reportable segment for each category.
Three Months Ended June 30, 2018
Business
Enterprise
Public Sector
Total
Notebooks/Mobility
$
81,999
$
68,545
$
35,261
$
185,805
Software
38,375
37,363
11,043
86,781
Desktops
28,399
30,006
18,762
77,167
Servers/Storage
27,303
24,295
16,499
68,097
Net/Com products
29,140
20,124
11,115
60,379
Other hardware/services
64,826
120,732
42,783
228,341
Total net sales
$
270,042
$
301,065
$
135,463
$
706,570
Three Months Ended June 30, 2017
Business
Enterprise
Public Sector
Total
Notebooks/Mobility
$
75,900
$
49,964
$
34,340
$
160,204
Software
70,075
80,815
22,179
173,069
Desktops
29,685
24,171
21,321
75,177
Servers/Storage
30,304
19,120
13,994
63,418
Net/Com products
24,777
19,999
16,186
60,962
Other hardware/services
65,679
108,008
43,275
216,962
Total net sales
$
296,420
$
302,077
$
151,295
$
749,792
The following table represents a disaggregation of revenue from arrangements with customers for the six months ended June 30, 2018 and 2017, along with the reportable segment for each category.
Six Months Ended June 30, 2018
Business
Enterprise
Public Sector
Total
Notebooks/Mobility
$
153,728
$
131,983
$
59,159
$
344,870
Software
72,799
65,804
17,906
156,509
Desktops
56,690
61,232
28,836
146,758
Servers/Storage
58,804
48,838
33,638
141,280
Net/Com products
56,166
32,492
23,873
112,531
Other hardware/services
135,133
217,960
76,424
429,517
Total net sales
$
533,320
$
558,309
$
239,836
$
1,331,465
Six Months Ended June 30, 2017
Business
Enterprise
Public Sector
Total
Notebooks/Mobility
$
148,778
$
99,964
$
60,630
$
309,372
Software
129,878
135,697
36,805
302,380
Desktops
56,145
50,142
61,176
167,463
Servers/Storage
56,807
40,774
26,180
123,761
Net/Com products
47,746
36,470
33,710
117,926
Other hardware/services
130,699
191,948
76,837
399,484
Total net sales
$
570,053
$
554,995
$
295,338
$
1,420,386
Contract Balances
The following table provides information about contract liability from arrangements with customers as of June 30, 2018 and January 1, 2018:
June 30, 2018
January 1, 2018
Contract liability, which are included in "Accrued expenses and other liabilities"
$
8,433
$
2,914
Significant changes in the contract liability balances during the three and six months ended June 30, 2018 are as follows (in thousands):
Three Months Ended
June 30,
Balances at April 1, 2018
$
3,087
Reclassification of the beginning contract liability to revenue, as the result of performance obligations satisfied
(1,830)
Cash received in advance and not recognized as revenue
7,176
Balances at June 30, 2018
$
8,433
Six Months Ended
June 30,
Balances at January 1, 2018
$
2,914
Reclassification of the beginning contract liability to revenue, as the result of performance obligations satisfied
(2,976)
Cash received in advance and not recognized as revenue
8,495
Balances at June 30, 2018
$
8,433
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 to 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 an acceleration of the timing of revenue recognized for certain transactions where product that remained 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 was 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 is now being recognized net of costs of sales as we 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 accept the terms and conditions in the sales arrangement. 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 reduced 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 and for the three and six months ended June 30, 2018 and as of June 30, 2018, respectively:
Three Months Ended June 30, 2018
Six Months Ended June 30, 2018
Balances without
Balances without
As
Adoption of
As
Adoption of
Reported
Adjustments
ASC 606
Reported
Adjustments
ASC 606
Income statement
Revenues
Net sales
$
706,570
$
113,199
$
819,769
$
1,331,465
$
188,757
$
1,520,222
Costs and expenses
Cost of sales
599,102
111,797
710,899
1,127,625
187,965
1,315,590
Income from operations
24,947
1,081
26,028
40,419
584
41,003
Income before taxes
25,129
1,081
26,210
40,717
584
41,301
Net income
18,226
784
19,010
29,526
422
29,948
June 30, 2018
Balances without
As
Adoption of
Reported
Adjustments
ASC 606
Balance Sheet
Assets
Accounts receivable, net
$
463,994
$
(11,014)
$
452,980
Inventories
107,449
10,301
117,750
Prepaid expenses and other current assets
6,279
125
6,404
Long-term receivables
1,890
(1,890)
—
Other assets
1,831
3,464
5,295
Liabilities
Accrued expenses and other liabilities
$
28,915
$
2,613
$
31,528
Accrued payroll
23,458
(134)
23,324
Deferred income taxes
16,125
(267)
15,858
Stockholders' Equity
Retained earnings
$
414,396
$
(775)
$
413,621
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 arrangements 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 2016, the FASB issued ASU 2016-02, 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 2016-02 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. The new standard is effective for fiscal years 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. |
