| Summary of Significant Accounting Policies | 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We are a leading solutions provider of a wide range of information technology, or IT, solutions. We help our customers design, enable, manage, and service their IT environments. We provide IT products, including computer systems, software and peripheral equipment, networking communications, and other products and accessories that we purchase from manufacturers, distributors, and other suppliers. We also offer services involving design, configuration, and implementation of IT solutions. These services are performed by our personnel and by first-party service providers. We operate through three sales segments: (a) the Business Solutions segment, which serves small- to medium-sized businesses, through our PC Connection Sales subsidiary, (b) the Enterprise Solutions segment, which serves large enterprise customers, through our MoreDirect subsidiary, and (c) the Public Sector segment, which serves federal, state, and local governmental and educational institutions, through our GovConnection subsidiary.
The following is a summary of our significant accounting policies:
Principles of Consolidation
The consolidated financial statements include the accounts of PC Connection, Inc. and its subsidiaries, all of which are wholly-owned. Intercompany transactions and balances are eliminated in consolidation.
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 reported amounts and disclosures of assets and liabilities and the reported amounts and disclosures of revenue and expenses during the period. By nature, estimates are subject to an inherent degree of uncertainty. Actual results could differ from those estimates and assumptions.
Reclassification of Prior Year Presentation
Certain prior year amounts have been reclassified for consistency with current year presentation. Restructuring and other charges have been separated from selling, general, and administrative expenses on the Consolidated Statements of Income. These charges amount to $967, $3,636, and $3,406 for the years ending December 31, 2018, 2017, and 2016, respectively. This change in classification does not affect previously reported net income or earnings per share figures in the Consolidated Statements of Income.
Revenue Recognition
On January 1, 2018, we adopted ASC 606, Revenue from Contracts with Customers (“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 within 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 in 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.
Prior to the adoption of ASC 606, revenue on product sales was recognized at the point in time when persuasive evidence of an arrangement existed, the price was fixed or determinable, delivery had occurred, and there was a reasonable assurance of collection of the sales proceeds. Service revenue was recognized over time as the services were performed. We evaluated such engagements to determine whether we or the third party assumed the general risk and reward of ownership in these transactions. This evaluation was the basis by which we determined that revenue from these transactions would be recognized on a gross or a net basis.
In multiple-element revenue arrangements, each service performed and product delivered was considered a separate deliverable and qualified as a separate unit of accounting. For material multiple element arrangements, we allocated revenue based on vendor-specific objective evidence of fair value of the underlying services and products. In the absence of vendor-specific objective evidence, we would utilize third-party evidence to allocate the selling price. If neither vendor-specific objective evidence nor third-party evidence was available, we would estimate the selling price based on market price and company specific factors.
Cost of Sales and Certain Other Costs
Cost of sales includes the invoice cost of the product, direct employee and third party cost of services, direct costs of packaging, inbound and outbound freight, and provisions for inventory obsolescence, adjusted for discounts, rebates, and other vendor allowances.
Cash and Cash Equivalents
We consider all highly liquid short-term investments with original maturities of 90 days or less to be cash equivalents. The carrying value of our cash equivalents approximates fair value. The majority of payments due from credit card processors and banks for third-party credit card and debit card transactions process within one to five business days. All credit card and debit card transactions that process in less than seven days are classified as cash and cash equivalents. Amounts due from banks for credit card transactions classified as cash equivalents totaled $2,651 and $6,776 at December 31, 2018 and 2017, respectively.
Accounts Receivable
We perform ongoing credit evaluations of our customers and adjust credit limits based on payment history and customer creditworthiness. We maintain an allowance for estimated doubtful accounts based on our historical experience and the customer credit issues identified. Our customers do not post collateral for open accounts receivable. We monitor collections regularly and adjust the allowance for doubtful accounts as necessary to recognize any changes in credit exposure. Trade receivables are written off in the period in which they are deemed uncollectible. Recoveries of trade receivables previously charged are recorded when received.
Inventories
Inventories (all finished goods) consisting of software packages, computer systems, and peripheral equipment, are stated at cost (determined under a weighted-average cost method which approximates the first-in, first-out method) or net realizable value, whichever is lower. Inventory quantities on hand are reviewed regularly, and allowances are maintained for obsolete, slow moving, and nonsalable inventory.
Vendor Consideration
We receive funding from merchandise vendors for price protections, discounts, product rebates, and other programs. These allowances are treated as a reduction of the vendor’s prices and are recorded as adjustments to cost of sales or inventory, as applicable. Allowances for product rebates that require certain volumes of product sales or purchases are recorded as the related milestones are probable of being met.
Advertising Costs and Vendor Consideration
Costs of producing and distributing catalogs are charged to expense in the period in which the catalogs are first circulated. Other advertising costs are expensed as incurred.
Vendors have the ability to place advertisements in our catalogs or fund other advertising activities for which we receive advertising consideration. This vendor consideration, to the extent that it represents specific reimbursements of incremental and identifiable costs, is offset against SG&A expenses. Advertising consideration that cannot be associated with a specific program or that exceeds the fair value of advertising expense associated with that program is classified as an offset to cost of sales. Our vendor partners generally consolidate their funding of advertising and other marketing programs, and accordingly, we classify substantially all vendor consideration as a reduction of cost of sales rather than a reduction of advertising expense. Advertising expense, which is classified as a component of SG&A expenses, totaled $16,244, $14,437, and $16,083, for the years ended December 31, 2018, 2017, and 2016, respectively.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization is provided for financial reporting purposes over the estimated useful lives of the assets ranging from three to seven years. Computer software, including licenses and internally developed software, is capitalized and amortized over lives generally ranging from three to seven years. Depreciation is recorded using the straight-line method. Leasehold improvements and facilities under capital leases are amortized over the terms of the related leases or their useful lives, whichever is shorter, whereas for income tax reporting purposes, they are amortized over the applicable tax lives.
Costs incurred to develop internal-use software during the application development stage are recorded in property and equipment at cost. External direct costs of materials and services consumed in developing or obtaining internal-use computer software and payroll-related costs for employees developing internal-use computer software projects, to the extent of their time spent directly on the project and specific to application development, are capitalized.
When events or circumstances indicate a potential impairment, we evaluate the carrying value of property and equipment based upon current and anticipated undiscounted cash flows. We recognize impairment when it is probable that such estimated future cash flows will be less than the asset carrying value.
Goodwill and Other Intangible Assets
Our intangible assets consist of (1) goodwill, which is not subject to amortization; (2) an internet domain name, which is an indefinite-lived intangible not subject to amortization; and (3) amortizing intangibles, which consist of customer lists, trade names, and customer relationships, which are being amortized over their useful lives.
Note 4 describes the annual impairment methodology that we employ each year in calculating the recoverability of goodwill and non-amortizing intangibles. This same impairment test is performed at other times during the course of a year should an event occur or circumstance change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Recoverability of amortizing intangible assets is assessed only when events have occurred that may give rise to impairment. When a potential impairment has been identified, forecasted undiscounted net cash flows of the operations to which the asset relates are compared to the current carrying value of the long-lived assets present in that operation. If such cash flows are less than such carrying amounts, long-lived assets including such intangibles, are written down to their respective fair values.
Concentrations
Concentrations of credit risk with respect to trade account receivables are limited due to the large number of customers comprising our customer base. No single customer accounted for more than 3% of total net sales in 2018, 2017, and 2016. While no single agency of the federal government comprised more than 3% of total sales, aggregate sales to the federal government as a percentage of total net sales were 5.4%, 7.8%, and 7.5% in 2018, 2017, and 2016, respectively.
Product purchases from Ingram Micro, Inc. (“Ingram”), our largest supplier, accounted for approximately 22% of our total product purchases in both 2018 and 2017 and 21% in 2016. Purchases from Synnex Corporation (“Synnex”) comprised 12%, 12%, and 13%, of our total product purchases in 2018, 2017, and 2016, respectively. Purchases from Tech Data comprised of 10%, 11% and 8% in 2018, 2017, and 2016, respectively. Purchases from Hewlett-Packard Company, or HP, accounted for approximately 7% of our total product purchases in 2018, 11% in 2017, and 9% in 2016. No other vendor supplied more than 10% of our total product purchases in 2018, 2017, or 2016. We believe that, while we may experience some short-term disruption if products from Ingram, Synnex, HP and/or Tech Data become unavailable to us, alternative sources for products obtained directly from Ingram, Synnex, HP and Tech Data are available to us.
Products manufactured by HP represented approximately 18% of our net sales in 2018 and approximately 20% in both 2017 and 2016. We believe that in the event we experience either a short-term or permanent disruption of supply of HP products, such disruption would likely have a material adverse effect on our results of operations and cash flows.
Restructuring and other charges
During 2018, we began presenting restructuring and other charges separately from SG&A expenses. Costs incurred were as follows:
Year Ended December 31,
2018
2017
2016
Employee separations
$
967
$
640
$
1,766
Acquisition costs
—
—
570
Relocation expenses
—
84
291
Re-branding costs
—
—
596
Employee compensation
—
2,800
—
Other
—
112
183
Total restructuring and other charges
$
967
$
3,636
$
3,406
The net restructuring charges recorded in 2018 were related to a reduction in workforce at our Business Solutions, Public Sector Solutions, and Headquarter segments and included cash severance payments and other related benefits.
The net restructuring and other charges recorded in 2017 were primarily driven by a reduction in workforce at our Headquarters segment, along with costs related to the Softmart business, which was acquired in 2016, including expenses to retain certain key personnel brought over in the acquisition. Also in 2017, we incurred additional expense of $2,700 related to a one-time cash bonus paid to all non-executive employees at the end of the year.
The net restructuring and other charges recorded in 2016 were primarily driven by a reduction in workforce after the Softmart acquisition and other employee severance expenses incurred throughout the business. We also incurred costs associated with the acquisitions and IT transitions of Softmart and GlobalServe, along with other costs associated with a company-wide rebranding campaign.
Overall, restructuring and other charges consist primarily of employee termination benefits, which are accrued in the period incurred and paid within a year of termination. Included in accrued expenses at December 31, 2018, 2017, and 2016 were $784, $2, and $417, respectively, related to unpaid employee termination benefits. The amount accrued as of December 31, 2018 is expected to be paid in 2019.
Other restructuring-related charges such as acquisition costs, relocation expenses and significant marketing campaigns are expensed and paid as incurred.
All planned restructuring and other charges were incurred as of December 31, 2018 and we have no ongoing restructuring plans.
Earnings Per Share
Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributable to nonvested stock units and stock options outstanding, if dilutive.
The following table sets forth the computation of basic and diluted earnings per share:
2018
2017
2016
Numerator:
Net income
$
64,592
$
54,857
$
48,111
Denominator:
Denominator for basic earnings per share
26,717
26,771
26,528
Dilutive effect of employee stock awards
137
120
191
Denominator for diluted earnings per share
26,854
26,891
26,719
Earnings per share:
Basic
$
2.42
$
2.05
$
1.81
Diluted
$
2.41
$
2.04
$
1.80
For the years ended December 31, 2018, 2017, and 2016, we did not exclude any outstanding nonvested stock units or stock options from the computation of diluted earnings per share because including them would have had an anti-dilutive effect.
Other Income (Expense), Net
Other income, net for the year ended December 31, 2018 consisted of $2,255 related to a gain, net of costs incurred of $745, that was realized upon execution of a favorable $3,000 cash resolution of a contract dispute that arose in 2017. We included the $3,000 owed to us in other assets as of December 31, 2018. Also included in other income, net for the year ended December 31, 2018 was interest income of $868, offset partially by interest expense of $145.
Other income, net for the year ended December 31, 2017 consisted of interest income of $224, which was partially offset by interest expense of $126. Other expense, net for the year ended December 31, 2016 consisted of interest expense of $107, which was partially offset by interest income of $40.
Comprehensive Income
We had no items of comprehensive income, other than our net income for each of the periods presented.
Adoption of Recently Issued Financial Accounting Standards
On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued ASC 606, which amended the
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 consolidated balance sheets as of January 1, 2018:
Adjustments
Balance at
due to
Balance at
December 31, 2017
ASC 606
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 certain transactions. Specifically, revenue related to the sale of cloud products, as well as certain security software, is now being recognized net of costs 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 recognized 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 consolidated income statement and balance sheet for the year ended December 31, 2018 and as of December 31, 2018, respectively:
Year Ended December 31, 2018
Balances without
As
Adoption of
Reported
Adjustments
ASC 606
Income statement
Revenues
Net sales
$ 2,699,489
$ 404,690
$ 3,104,179
Costs and expenses
Cost of sales
2,288,403
403,737
2,692,140
Income from operations
85,686
750
86,436
Income before taxes
88,664
750
89,414
Net income
64,592
526
65,118
December 31, 2018
Balances without
As
Adoption of
Reported
Adjustments
ASC 606
Balance Sheet
Assets
Accounts receivable, net
$ 447,698
$ (6,949)
$ 440,749
Inventories
119,195
4,798
123,993
Prepaid expenses and other current assets
9,661
148
9,809
Other assets
1,211
3,914
5,125
Liabilities
Accrued expenses and other liabilities
$ 33,840
$ 2,904
$ 36,744
Accrued payroll
24,319
(116)
24,203
Deferred income taxes
17,184
(219)
16,965
Stockholders' Equity
Retained earnings
$ 441,010
$ (657)
$ 440,353
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 consolidated statement of cash flows.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting . The Company adopted this standard on January 1, 2017. The new standard simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under this guidance, a company recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. This change eliminates the notion of the additional paid-in capital pool and reduces the complexity in accounting for excess tax benefits and tax deficiencies. The primary impact of our adoption was the recognition of excess tax benefits related to equity compensation in our provision for income taxes rather than paid-in capital, which is a change required to be applied on a prospective basis in accordance with the new guidance. There were no unrecognized excess tax benefits at implementation. Accordingly, we recorded discrete income tax benefits in the consolidated statements of income of $1,054 in the year ended December 31, 2017, for excess tax benefits related to equity compensation. The corresponding cash flows were reflected in cash provided by operating activities instead of financing activities, as was previously required. We adopted the cash flow presentation that requires presentation of excess tax benefits within operating activities on a prospective basis. Additionally, under ASU 2016-09, we have elected to continue to estimate equity award forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact on our results of operations. The presentation requirements for cash flows related to employee taxes paid for withheld shares also had no impact to any of the periods presented in our consolidated statements of cash flows since such cash flows have historically been presented as a financing activity.
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 and will be adopted using a modified retrospective transition approach on January 1, 2019. The Company has reviewed the requirements of the new standard and expects that it will have a material impact on our consolidated financial statements, as all long-term leases will be capitalized on the consolidated balance sheet. The Company has identified the population of leases and lease assets, has selected a software repository to track all of its lease agreements and to assist in the reporting and disclosures required by the new standard, and is still in the process of testing the data and calculations performed by the software. The Company is also in the process of implementing changes to our procedures and controls in conjunction with both the review of existing lease agreements and any future agreements that will be accounted for under this new standard. The future lease payments that will be subject to the new accounting standard are disclosed in Note 12 to the 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 us 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. |
