| Description of Business and Summary of Significant Accounting Policies | 1. Description of Business and Summary of Significant Accounting Policies
Control4 Corporation (‘‘Control4’’ or the ‘‘Company’’) is a leading provider of smart home and business solutions that are designed to personalize and enhance how consumers engage with an ever-changing connected world. Our entertainment, smart lighting, comfort and convenience, safety and security, and networking solutions unlock the potential of connected devices, making entertainment systems easier to use and more accessible, homes and businesses more comfortable and energy efficient, and individuals more secure . The Company was incorporated in the state of Delaware on March 27, 2003.
Unaudited Interim Financial Statements
The accompanying condensed consolidated balance sheets, condensed consolidated statements of operations, condensed consolidated statements of comprehensive income, and condensed consolidated statements of cash flows are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (‘‘GAAP’’) on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, considered necessary to present fairly the Company’s financial position, results of operations and cash flows. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018, or any other future interim or annual period.
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 15, 2018. The December 31, 2017 condensed consolidated balance sheet included herein was derived from the audited financial statements as of that date.
Basis of Presentation
The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in the unaudited condensed 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 are 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 euros, respectively. There were no individual account balances greater than 10% of total accounts receivable as of March 31, 2018 and December 31, 2017.
No dealer or distributor accounted for more than 10% of total revenue for the three months ended March 31, 2018 and 2017.
While the Company partners with many manufacturers, in many cases one manufacturer is our sole source for a particular product or product family. A significant disruption in the operations of one 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.
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 for the three months ended March 31, 2018 (in thousands):
Warranty Liability
Balance at December 31, 2017
$
2,032
Warranty costs accrued
1,189
Warranty claims
(854)
Balance at March 31, 2018
$
2,367
Net Income Per Share
Basic net income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income 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 per share (in thousands):
Three Months Ended
March 31,
2018
2017
Numerator:
Net income
$
966
$
821
Denominator:
Weighted average common stock outstanding for basic net income per common share
25,904
24,005
Effect of dilutive securities—stock options and restricted stock units
1,622
1,652
Weighted average common shares and dilutive securities outstanding
27,526
25,657
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 per share (in thousands):
Three Months Ended
March 31,
2018
2017
Options to purchase common stock
—
1,523
Restricted stock units
166
3
Total
166
1,526
Revenue Recognition
On January 1, 2018, the Company adopted “Revenue from Contracts with Customers (Topic 606),” (“ASC 606”) utilizing the full retrospective method of transition, which required a retrospective adjustment of each prior reporting period presented. The Company applied the new standard using a practical expedient where the consideration allocated to the remaining performance obligations or an explanation of when the Company expects to recognize that amount as revenue for all reporting periods presented before the date of the initial application is not disclosed. Upon adoption of ASC 606, t he Company implemented internal controls to enable the preparation of financial information.
Adoption of ASC 606 did not have a significant impact on the Company’s financial statements, however, while preparing for the adoption of ASC 606, the Company evaluated the accounting for technical support and unspecified upgrade rights, which the Company considered inconsequential under ASC 605. While the Company determined that these services are immaterial in the context of the contract under ASC 606, the Company believes that as product offerings continue to mature these services will become more material over time. Accordingly, under ASC 606, the Company will account for technical support and unspecified upgrade rights as a performance obligation, distinct from the hardware product and embedded software, with the associated revenue satisfied over time.
The adoption of ASC 606 impacted the Company’s previously reported results as follows (in thousands, except share data):
Three Months Ended
March 31,
2017
As previously reported
ASC 606 adjustment
As
Revenue
$
50,235
$
(27)
$
50,208
Income tax benefit
(2,781)
(5)
(2,786)
Net income
843
(22)
821
Basic earnings per share
$
0.04
$
(0.01)
$
0.03
Diluted earnings per share
$
0.03
$
—
$
0.03
December 31,
2017
As previously reported
ASC 606 adjustment
As
Other assets
$
1,576
$
42
$
1,618
Current portion of deferred revenue
2,311
2,227
4,538
Other long-term liabilities
882
3,060
3,942
Stockholders’ equity
174,773
(5,245)
169,528
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration expected to be received in exchange for those products or services. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.
Shipping charges billed to dealers and distributors are included in product revenue and related shipping costs are included in cost of revenue. The Company has elected to account for shipping and handling activities performed after control has been transferred to the customer as a fulfillment cost and accrues for these costs if revenue is recognized before contractually agreed-upon shipping and handling occurs.
Solution Products Revenue
The Company sells its solution products through a network of independent dealers, distributors and retailers. These dealers, distributors and retailers generally sell the Company’s products as part of a bundled sale, which typically includes other third‑party products and related services, project design, installation services and on‑going support.
The Company’s products are generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to dealers, distributors, and retailers, which is typically at the time the product is shipped. In cases where revenue is allocated to software updates and technical support, primarily because the updates and technical support are provided at no additional charge, revenue is recognized as the updates and technical support are provided, which is ratably over the estimated life of the related device.
Certain customers may receive cash-based incentives or credits; which are accounted for as variable consideration. The Company records estimated reductions to revenue for dealer 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 for achieving defined volume levels or growth objectives.
Subscription Service Revenue
The Company offers a subscription service that allows consumers to control and monitor their homes remotely and allows the consumer’s respective Control4 dealer to perform remote diagnostic services. Subscription revenue is deferred at the time of payment and recognized ratably over the contract period which is typically one year.
Third-Party Product Revenue
The Company recognizes revenue net of cost of revenue for non-inventoried, third‑party products sold through the Company’s online ordering system. The Company’s primary role is to arrange for another entity to provide the goods or services and the Company does not control the promised good or service before it is transferred to the customer.
Significant Judgments
The Company’s contracts with dealers, distributors, and retailers can include promises to transfer multiple products and services. Determining whether multiple products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
Judgment is required to determine the stand-alone selling price (“SSP”) for each distinct performance obligation. The Company uses a single amount to estimate SSP for items that are not sold separately, including software updates and technical support provided at no additional charge. In instances where SSP is not directly observable, such as when the Company does not sell the product or service separately, the SSP is determined using information that may include market conditions and other observable inputs.
The Company’s products are generally sold with a limited right of return and the Company may provide other credits or incentives, which are accounted for as variable consideration when estimating the amount of revenue to recognize.
Disaggregated Revenue
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 months ended March 31, 2018 and 2017. The following table sets forth revenue from U.S., Canadian and all other international dealers and distributors combined (in thousands):
Three Months Ended
March 31,
2018
2017
Revenue-United States
$
40,964
$
35,172
Revenue-Canada
5,264
4,247
Revenue-all other international sources
12,921
10,789
Total revenue
$
59,149
$
50,208
International revenue (excluding Canada) as a percent of total revenue
%
%
Contract Balances
As of March 31, 2018 and December 31, 2017, accounts receivable, net of allowance for doubtful accounts, were $26.8 million and $29.9 million, respectively.
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 generally 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 receivables 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):
Allowance
Balance at December 31, 2017
$
1,147
Provision
71
Write-offs
(21)
Balance at March 31, 2018
$
1,197
Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined the contracts generally do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing products and services, not to receive financing from customers, such as invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period.
Deferred revenue is comprised mainly of unearned revenue related to subscription services as well as revenue deferred on the sale of solution products for software updates and technical support. The following table presents the changes in deferred revenue for the three months ended March 31, 2018 (in thousands):
Deferred Revenue
Balance at December 31, 2017
$
7,682
Deferred revenue
2,260
Recognition of deferred revenue
(2,067)
Balance at March 31, 2018
$
7,875
Revenue allocated to remaining performance obligations represent contracted revenue that has not yet been recognized (“contracted not recognized”), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $8.8 million as of March 31, 2018, of which the Company expects to recognize approximately 41% of the revenue over the next 12 months and the remainder over a period of three to four years.
Assets Recognized from the Costs to Obtain a Contract with a Customer
The Company has elected to immediately expense contract acquisition costs that would be amortized in one year or less. The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if the benefit of those costs is expected to be longer than one year; these incremental costs were immaterial during both periods presented.
Restricted Cash
Restricted cash as of March 31, 2018 and December 31, 2017 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.
Recent Accounting Pronouncements
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. The Company adopted the standard effective January 1, 2018; the adoption of this standard did not have a material impact on the consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, “ Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory .” The amendments in this update will require recognition of current and deferred income taxes resulting from an intra-entity transfer of an asset other than inventory when the transfer occurs. This update is effective for annual and interim periods beginning after December 15, 2017. The Company adopted the standard effective January 1, 2018; the adoption of this standard did not have a material impact on the 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 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. |
