| Description of Business and Summary of Significant Accounting Policies | 1. Description of Business and Summary of Significant Accounting Policie
Control4 Corporation (‘‘Control4’’ or the ‘‘Company’’) is a leading provider of personalized, smart home and business solutions that are designed to enhance the daily lives of its customers. The Company’s solutions unlock the potential of connected devices throughout a home or business, making entertainment systems easier to use and more accessible, spaces more comfortable and energy efficient, and individuals more secure. The Company was incorporated in the state of Delaware on March 27, 2003.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly‑owned subsidiaries. All intercompany balances and transactions have been eliminated in the consolidated financial statements.
Segment Reporting
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, the Chief Executive Officer, in making decisions regarding resource allocation and assessing performance. To date, the Company has viewed its operations and manages its business as one operating segment.
Concentrations of Risk
The Company’s accounts receivable is derived from revenue earned from its worldwide network of independent dealers and distributors. The Company’s sales to dealers and distributors located outside the United States are generally denominated in U.S. dollars, except for sales to dealers and distributors located in the United Kingdom, Canada, Australia, and the European Union, which are generally denominated in pounds sterling, Canadian dollars, Australian dollars, and the euro, respectively. There were no individual account balances greater than 10% of total accounts receivable as of December 31, 2017 and 2016.
No dealer or distributor accounted for more than 10% of total revenue for the years ended December 31, 2017, 2016 and 2015.
The Company relies on a limited number of suppliers for its contract manufacturing. A significant disruption in the operations of certain of these manufacturers would impact the production of the Company’s products for a substantial period of time, which could have a material adverse effect on the Company’s business, financial condition and results of operations.
Geographic Information
The Company’s revenue includes amounts earned through sales to dealers and distributors located outside of the United States. There was no single foreign country that accounted for more than 10% of total revenue for the three years ended December 31, 2017, 2016 and 2015. The following table sets forth revenue from the United States., Canadian and all other international dealers and distributors combined (in thousands):
Years Ended
December 31,
2017
2016
2015
Revenue-United States
$
169,930
$
148,803
$
109,435
Revenue-Canada
20,812
16,084
14,285
Revenue-all other international sources
53,983
43,915
39,459
Total revenue
$
244,725
$
208,802
$
163,179
International revenue (excluding Canada) as a percent of total revenue
%
%
%
Use of Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, sales returns, provisions for doubtful accounts, product warranty, inventory obsolescence, litigation, determination of fair value of stock options, deferred tax asset valuation allowances and income taxes. Actual results may differ from those estimates.
Limited Product Warranties
The Company provides its customers a limited product warranty of two, three, or ten years depending on product type and brand. The limited product warranties require the Company, at its option, to repair or replace defective products during the warranty period at no cost to the customer or refund the purchase price. The Company estimates the costs that may be incurred to replace, repair or issue a refund for defective products and records a reserve at the time revenue is recognized. Factors that affect the Company’s warranty liability include the cost of the products sold, the Company’s historical experience, and management’s judgment regarding anticipated rates of product warranty returns, net of refurbished products. The Company assesses the adequacy of its recorded warranty liability each period and makes adjustments to the liability as necessary. Warranty costs accrued include amounts accrued for products at the time of shipment, adjustments for changes in estimated costs for warranties on products shipped in the period, and changes in estimated costs for warranties on products shipped in prior periods. It is not practicable for the Company to determine the amounts applicable to each of these components.
The following table presents the changes in the product warranty liability (in thousands):
Years Ended
December 31,
2017
2016
2015
Balance at the beginning of the period
$
1,945
$
1,415
$
1,191
Warranty costs accrued
3,147
2,458
2,068
Warranty claims
(3,060)
(1,928)
(1,844)
Balance at the end of the period
$
2,032
$
1,945
$
1,415
Net Income (Loss) Per Share
Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding and potentially dilutive common shares outstanding during the period that have a dilutive effect on net income per share. Potentially dilutive common shares result from the assumed exercise of outstanding stock options and settlement of restricted stock units.
The following table presents the reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per share (in thousands):
Years Ended
December 31,
2017
2016
2015
Numerator:
Net income (loss)
$
15,979
$
12,954
$
(1,652)
Denominator:
Weighted average common stock outstanding for basic net income per common share
24,803
23,402
24,121
Effect of dilutive securities—stock options and restricted stock units
1,972
958
—
Weighted average common shares and dilutive securities outstanding
26,775
24,360
24,121
In a net loss position, diluted net loss per share is computed using only the weighted-average number of common shares outstanding during the period, as any additional common shares would be anti-dilutive as they would decrease the loss per share. Potentially dilutive securities, including common equivalent shares, in which the assumed proceeds exceed the average market price of common stock for the applicable period, were not included in the calculation of diluted net income per share as their impact would be anti-dilutive. The following weighted-average common stock equivalents were anti-dilutive and therefore were excluded from the calculation of diluted net income (loss) per share (in thousands):
Years Ended
December 31,
2017
2016
2015
Options to purchase common stock
660
2,328
4,756
Restricted stock units
5
17
162
Total
665
2,345
4,918
Revenue Recognition
The Company sells its products through a network of independent dealers, regional and national retailers and distributors. These dealers, retailers and distributors generally sell the Company’s products to the end consumer as part of a bundled sale, which typically includes other third‑party products and related services, project design and installation services and on‑going support.
The Company records estimated reductions to revenue for dealer, retailer and distributor incentives at the time of the initial sale. The estimated reductions to revenue are based on the sales terms and the Company’s historical experience and trend analysis. The most common incentive relates to amounts paid or credited to dealers and distributors for achieving defined volume levels or growth objectives.
The Company’s products include embedded software that is essential to the functionality of the hardware. Accordingly, the hardware and embedded software are accounted for as a single deliverable. When a software license and controller are sold together, a multiple element arrangement exists and revenue is allocated to each deliverable based on relative selling prices. Typically, delivery of both the product and the software license occurs at the same time. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. Product or licensed software is considered delivered once it has been shipped and title and risk of loss have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped.
The Company offers a subscription service that allows consumers to control and monitor their homes remotely and allows the Company’s dealers to perform remote diagnostic services. Subscription revenue is deferred at the time of payment and recognized on a straight‑line basis over the period the service is provided.
Total revenue for subscription services represents less than 10% of total revenue for all periods presented.
The Company recognizes revenue net of cost of revenue for third‑party products sold through the Company’s online ordering system. While the Company assumes credit risk on sales to its dealers and distributors for third‑party products, the Company does not determine the product selling price, does not retain associated inventory risks and is not the primary obligor to the end consumer.
The Company’s agreements with dealers and distributors generally do not include rights of return or acceptance provisions. Even though contractual agreements do not provide return privileges, there are circumstances in which the Company will accept returns. In addition, agreements with certain retail distributors contain price protection and limited rights of return. The Company maintains a reserve for such returns based on the Company’s historical return experience.
Shipping charges billed to dealers and distributors are included in revenue and related shipping costs are included in cost of revenue.
Cost of Revenue
Cost of revenue includes the following: the cost of inventory sold during the period, inventory write‑down costs, payroll, purchasing costs, royalty obligations, shipping expenses to dealers and distributors and warehousing costs, which include inbound freight costs from manufacturers, rent, payroll and benefit costs, acquisition-related costs, amortization of intangible assets and depreciation.
Cash and Cash Equivalents
The Company considers all highly liquid short‑term investments with original maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents consist primarily of money market funds.
Restricted Cash
Restricted cash as of December 31, 2017 and 2016, is composed of a guarantee made by the Company’s subsidiary in the United Kingdom to HM Revenue & Customs related to a customs duty deferment account.
Allowance for Doubtful Accounts
The Company extends credit to the majority of its dealers and distributors, which consist primarily of small, local businesses. Issuance of credit is based on ongoing credit evaluations by the Company of dealers’ and distributors’ financial condition and generally requires no collateral. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company maintains an allowance for doubtful accounts to reserve for potential uncollectible receivables. The allowance is based upon the creditworthiness of the Company’s dealers and distributors, the dealers’ and distributors’ historical payment experience, the age of the receivables and current market and economic conditions. Provisions for potentially uncollectible accounts are recorded in sales and marketing expenses. The Company writes off accounts receivable balances to the allowance for doubtful accounts when it becomes likely that they will not be collected.
The following table presents the changes in the allowance for doubtful accounts (in thousands):
Years Ended
December 31,
2017
2016
2015
Balance at beginning of period
$
981
$
824
$
705
Provision
815
345
345
Deductions
(649)
(188)
(226)
Balance at end of period
$
1,147
$
981
$
824
Inventories
Inventories consist primarily of hardware and related component parts and are stated at the lower of cost or net realizable value using the first‑in, first‑out method. The Company periodically assesses the recoverability of its inventory and reduces the carrying value of the inventory when items are determined to be obsolete, defective or in excess of forecasted sales requirements. Inventory write‑downs for excess, defective and obsolete inventory are recorded as a cost of revenue and totaled $4.1 million, $3.1 million, and $2.3 million, for the years ended December 31, 2017, 2016 and 2015, respectively.
Property and Equipment
Property and equipment are recorded at historical cost, less accumulated depreciation. Depreciation is computed using the straight‑line method over the following estimated useful lives:
Computer equipment and software
-
4
years
Manufacturing tooling and test equipment
-
4
years
Lab and warehouse equipment
-
4
years
Furniture and fixtures
-
5
years
Other
-
4
years
Maintenance and repairs that do not extend the life of or improve the asset are expensed in the year incurred. Leasehold improvements are depreciated over the estimated useful life (usually 3‑8 years) or the life of the associated lease, whichever is less.
Intangible Assets
Intangible assets primarily consist of acquired technology, customer relationships and trademarks/trade names. The Company amortizes, to cost of revenue and operating expenses, definite‑lived intangible assets on a straight‑line basis over the life of the asset.
Impairment of Long‑Lived Assets and Goodwill
The carrying value of long‑lived assets is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded is calculated by the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted cash flow analysis.
The Company tests goodwill for impairment annually as of October 1, or whenever events or changes in circumstances indicate that goodwill may be impaired. The Company initially assesses qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, then the Company compares the reporting unit’s carrying amount to its fair value. If the reporting unit’s carrying amount exceeds its fair value, an impairment charge is recorded based on that difference.
There was no impairment of long-lived assets or goodwill during the years ended December 31, 2017, 2016 and 2015.
Foreign Currency Translation
The functional currency of the Company’s subsidiaries in the United Kingdom, Germany, Australia, China, and India are the pound sterling, the euro, the Australian dollar, the Chinese yuan, and the Indian rupee, respectively. The subsidiary’s assets and liabilities have been translated to U.S. dollars using the exchange rates in effect at the balance sheet dates. Statements of operations amounts have been translated using the monthly average exchange rate for each year. Resulting gains or losses from translating foreign currency financial statements are recorded as other comprehensive income (loss).
Foreign currency transaction gains and losses resulting from exchange rate fluctuations on transactions denominated in a currency other than the local currency are primarily included in other income (expense). The Company enters into forward contracts to help offset the exposure to movements in foreign currency exchange rates in relation to certain U.S. dollar denominated balance sheet accounts of its subsidiaries in the United Kingdom and Australia. The foreign currency derivatives are not designated as accounting hedges. The Company recognized a foreign exchange loss, net of the foreign currency derivatives, of $0.1 million, $0.6 million and $0.8 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Stock‑Based Compensation
The Company recognizes compensation expense for all stock‑based awards issued to employees and directors based on estimated grant date fair values. The Company selected the Black‑Scholes option‑pricing model to determine the estimated fair value at the date of grant for stock options.
The Black‑Scholes option‑pricing model requires management assumptions regarding various factors that require extensive use of accounting judgment and financial estimates. The Company estimates the expected term for options using the simplified method, which utilizes the weighted average expected life of each tranche of the stock option, determined based on the sum of each tranche’s vesting period plus one‑half of the period from the vesting date of each tranche to the stock option’s expiration, because the Company’s options are considered “plain vanilla.” The Company computed the expected volatility using multiple peer companies for a period approximating the expected term. The risk‑free interest rate was determined using the implied yield on U.S. Treasury issues with a remaining term within the expected life of the award.
The fair value of each restricted stock unit award is based on the number of shares granted and the closing price of the Company’s common stock as reported on the NASDAQ Global Select Market. The Company elected to amortize compensation expense using the straight‑line attribution method, under which stock‑based compensation expense is recognized on a straight‑line basis over the period the employee performs the related services, generally the vesting period, net of estimated forfeitures. The Company has elected to recognize forfeitures as they occur.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the fiscal year in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
The Company operates in various tax jurisdictions and is subject to audit by various tax authorities. The Company provides for tax contingencies whenever it is deemed probable that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. Tax contingencies are based upon their technical merits, relative tax law and the specific facts and circumstances as of each reporting period. Changes in facts and circumstances could result in material changes to the amounts recorded for such tax contingencies.
The Company recognizes uncertain income tax positions taken on income tax returns at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.
The Company’s policy for recording interest and penalties associated with uncertain tax positions is to record such items as a component of its income tax provision. During the years ended December 31, 2017, 2016 and 2015, the Company did not record any material interest income, interest expense or penalties related to uncertain tax positions or the settlement of audits for prior periods.
Presentation of Certain Taxes
The Company collects various taxes from dealers and distributors and remits these amounts to the applicable taxing authorities. The Company’s accounting policy is to exclude these taxes from revenue and cost of revenue.
Research and Development
Research and development expenses consist primarily of personnel costs, including incentive compensation, depreciation associated with research and development equipment, contract labor and consulting services, facilities‑related costs, and travel‑related costs. Research and development costs are expensed as incurred.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel costs and related travel expenses for sales and marketing personnel, including non-cash stock compensation expense. Sales and marketing expenses also include expenses associated with trade shows, marketing events, advertising, training and other marketing-related programs. Advertising and other promotional costs are expensed as incurred and were $1.3 million, $1.2 million, and $2.4 million, for the years ended December 31, 2017, 2016, and 2015, respectively.
Recent Accounting Pronouncements
In January 2017, the FASB issued ASU 2017-04, “ Intangibles—Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment”. The amendments in this update simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. This update is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 31, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing after January 1, 2017. The Company early adopted this standard for the October 1, 2017 goodwill impairment test. The adoption of this standard did not impact the consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, “ Business Combinations (Topic 805): Clarifying the Definition of a Business, ” which narrows the definition of a business. This update is effective for annual periods beginning after December 15, 2017, including interim periods within those years. Early adoption is permitted. The guidance will impact the Company’s acquisitions beginning January 1, 2018 and could cause fewer acquired sets of assets to be identified as a business.
In November 2016, the FASB issued ASU 2016-18, “ Statement of Cash Flows (Topic 230): Restricted Cash ,” which provides amendments to current guidance to address the classifications and presentation of changes in restricted cash in the statement of cash flows. The effective date for the standard is for fiscal years beginning after December 15, 2017. Early adoption is permitted. Upon the adoption of this standard, the Company will combine restricted cash with unrestricted cash and cash and cash equivalents in the statement of cash flows.
In October 2016, the FASB issued ASU 2016-16, “ Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory ” requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. The amendments in this ASU are applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the period of adoption. The adoption of this standard on January 1, 2018 will not have a material impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326)” which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. For trade receivables, the Company will be required to use a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The guidance is effective for fiscal years beginning after December 31, 2019, including interim periods within those years. Early application of the guidance is permitted for all entities for fiscal years beginning after December 15, 2018, including the interim periods within those fiscal years. Application of the amendments is through a cumulative-effect adjustment to retained earnings as of the effective date. The Company is currently evaluating the impact of this update on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . ” The amendments in this update simplify 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. The Company adopted the new guidance on January 1, 2017. The primary impact of adoption was the recognition of excess tax benefits in the provision for income taxes rather than paid-in capital. Adoption of the new standard resulted in the recognition of excess tax benefits in the provision for income taxes rather than paid-in capital of $7.3 million for the year ended December 31, 2017. However, as the Company has a full valuation allowance against its domestic net deferred tax asset, a corresponding adjustment was recorded to increase the valuation allowance by $7.3 million.
As of December 31, 2016, the Company had $20.6 million and $17.6 million of gross federal and state net operating losses (“NOLs”), respectively, attributable to excess windfall benefits from share-based compensation. As a result of the adoption of this new standard, on January 1, 2017, the Company increased its net deferred tax asset for NOL carryforwards, with an offsetting cumulative effect of adoption adjustment to accumulated deficit, in the amount of $7.7 million. A corresponding adjustment was recorded to increase the valuation allowance by $7.7 million with an offsetting adjustment to accumulated deficit, resulting in no net impact to the financial statements. In addition, the Company has elected to apply the presentation requirements for cash flows related to excess tax benefits retrospectively which resulted in increase in both net cash provided by operating activities and net cash used in financing activities of $0.1 million for the year ended December 31, 2016. Further, under the provisions of ASU 2016-09, the Company has elected to recognize forfeitures as they occur to determine the amount of compensation cost to be recognized in each period. This resulted in an increase of $0.3 million to accumulated deficit with a corresponding increase to additional paid-in capital on January 1, 2017. The amendment related to the accounting for minimum statutory withholding requirements had no impact on retained earnings as of January 1, 2017.
In February 2016, the FASB issued ASU 2016-02, “ Leases (Topic 842 ) ,” which supersedes the guidance in ASC 840, “Leases .” The purpose of the new standard is to improve transparency and comparability related to the accounting and reporting of leasing arrangements. The guidance will require balance sheet recognition for assets and liabilities associated with rights and obligations created by leases with terms greater than twelve months. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. Modified retrospective application is required. Early adoption is permitted. The Company expects the standard will have a material impact on the Company’s consolidated balance sheets but will not have a material impact on the consolidated statements of operations. The most significant impact will be the recognition of right of use assets and lease liabilities for operating leases. The Company is in the process of calculating the right of use assets and lease liabilities and implementing internal controls to enable the preparation of financial statements upon adoption of this standard.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which amends the guidance in ASC 605, “Revenue Recognition.” 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 to in exchange for those goods or services.
The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). The Company will adopt this standard on January 1, 2018 using the full retrospective method restating each prior reporting period presented in future filings. The Company has substantially completed its analysis of the impact of adoption and has concluded the adoption of ASC 606 will not have a significant impact on the Company’s financial statements. |
