NOTE 2—REVENUE RECOGNITION

ASC 606: Revenue from Contracts with Customers

General Description of the New Guidance

Effective October 1, 2018, the Company applied the modified retrospective approach for its adoption of ASC 606. The primary impact of the new standard resulted in a change in the timing of the Company’s revenue recognition for some customer contracts for our custom manufacturing services to recognizing revenue over time as products are manufactured, as opposed to the prior revenue recognition of point in time. The transitional adjustment resulted in the recognition of unbilled revenue with a corresponding reduction in finished goods and work-in-process inventory (“WIP inventory”). The Company recognized the cumulative effect of initially applying the new revenue standard, totaling $0.4 million, as an adjustment to its opening accumulated deficit balance at October 1, 2018 included in stockholders’ equity. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.

Satisfaction of Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contracts transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Many of the Company's contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. The Company primarily provides contract manufacturing services to its customers. The customer provides a design, the Company procures materials and manufactures to that design and ships the product to the customer. Revenue is derived primarily from the manufacturing of these electronics components that are built to customer specifications.

The Company's performance obligations are satisfied at a point in time or over time as work progresses. Revenue from goods and services transferred to customers at a point in time accounted for 48.7% of the Company's revenue for the three months ended December 28, 2018. Revenue on these contracts is recognized when obligations under the terms of the customer contract are satisfied; generally this occurs with the transfer of control upon shipment. If there is no enforceable right to payment for work completed to date, or the Company does not recapture costs incurred plus an applicable margin, then the Company records revenue upon shipment to the customer.

Revenue from goods and services transferred to customers over time accounted for 51.3% of our revenue for the three months ended December 28, 2018. For revenue recognized over time, the Company uses an input measure to determine progress towards completion. Under this method, sales and gross profit are recognized as work is performed generally based on the relationship between the actual costs incurred and the total estimated costs at completion. If the Company has an enforceable right to payment for work completed to date, with a recapture of costs incurred plus an applicable margin, and the goods do not have an alternative future use once the manufacturing process has commenced, then the Company records an unbilled revenue associated with non-cancellable customer orders.

The Company derives revenue from engineering and design services. Service revenue is generally recognized once the service has been rendered. For material management arrangements, revenue is generally recognized as services are rendered. Under such arrangements, some or all of the following services may be provided: design, bid, procurement, testing, storage or other activities relating to materials the customer expects to incorporate into products that it manufactures. Value-added support services revenue, including material management and repair work revenue, amounted to less than 5% of total revenue in each of the three months ended December 28, 2018 and December 29, 2017.

Returns and Discounts

The Company does not offer its customers a right of return. Rather, the Company warrants that each unit received by the customer will meet the agreed upon technical and quality specifications and requirements. Only when the delivered units do not meet these requirements can the customer return the non-compliant units as a corrective action under the warranty. The remedy offered to the customer is repair of the returned units or replacement if repair is not viable. Accordingly, the Company records a warranty reserve and any warranty activities are not considered to be a separate performance obligation. Historically, warranty reserves have not been material.

Provisions for discounts, allowances, estimated returns and other adjustments are recorded in the period the related sales are recognized.

Shipping and Handling Costs

Amounts billed to customers for shipping and handling activities after the customer obtains control are treated as a promised service performance obligation and recorded in net sales in the accompanying condensed consolidated statements of operations. Shipping and handling costs incurred by the Company for the delivery of goods to customers are considered a cost to fulfill the contract and are included in cost of sales in the accompanying condensed consolidated statements of operations.

Contract Assets

Contract assets consist of unbilled contract amounts resulting from sales under contracts when the revenue recognized exceeds the amount billed to the customer.

Practical Expedients and Exemptions

The Company generally expenses incremental costs of obtaining a contract when incurred because the amortization period would be less than one year. These costs primarily relate to sales commissions and are recorded in selling and administrative expense in the condensed consolidated statements of operations.

The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.

Disaggregated Revenue

The table below shows net sales from contracts with customers by market sector. See additional information regarding market sectors in Note 10—Market Sectors and Major Customers.



	Three Months Ended
	December 28, 2018
	Point in Time		Over Time		Net Sales
(in thousands)
Aerospace & Defense	$	7,565	$	11,147	$	18,712
Medical	3,685		5,474		9,159
Industrial	6,014		1,556		7,570
	$	17,264	$	18,177	$	35,441

Impact of adoption of ASC 606

The following table presents the impacted financial statements line items in the condensed consolidated balance sheet as of December 28, 2018:



	Balances Without Adoption of ASC 606			Effect of Change			As Reported
(in thousands)
Assets:
Unbilled contract revenue	$	—		$	6,103		$	6,103
Inventories	42,281			(5,067		)	37,214
Deferred income taxes	8,647			(228		)	8,419

Stockholders’ Equity:
Accumulated deficit	(19,758		)	808			(18,950		)

The following table presents the impacted financial statement line items under ASC 605 "Revenue Recognition" and ASC 606 in the condensed consolidated statements of operations for the three months ended December 28, 2018:



	Balances Without Adoption of ASC 606		Effect of Change		As Reported
(in thousands)
Net sales	$	33,671	$	1,770	$	35,441

Cost of sales	29,083		1,299		30,382
Gross profit	4,588		471		5,059
Income tax expense	208		104		312
Net income	705		367		1,072

For each of the three months ended December 28, 2018 and December 29, 2017, less than 1% of net sales were shipped to locations outside the United States.