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, net of tax, 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 contract's 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 52.3% and 50.8% of the Company's revenue for the three and nine months ended June 28, 2019, respectively. 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 47.7% and 49.2% of our revenue for the three and nine months ended June 28, 2019, respectively. 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 3% of total revenue in each of the three and nine months ended June 28, 2019 and June 29, 2018.

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						Nine Months Ended
	June 28, 2019						June 28, 2019
	Point in Time		Over Time		Net Sales		Point in Time		Over Time		Net Sales
(in thousands)
Aerospace & Defense	$	11,300	$	13,298	$	24,598	$	30,950	$	35,755	$	66,705
Medical	5,127		3,744		8,871		12,441		12,432		24,873
Industrial	4,657		2,198		6,855		14,063		7,418		21,481
	$	21,084	$	19,240	$	40,324	$	57,454	$	55,605	$	113,059

Impact of adoption of ASC 606

The following table presents the impacted financial statement line items in the condensed consolidated balance sheet as of October 1, 2018:



	Balances Without Adoption of ASC 606			Effect of Change			Adjusted
(in thousands)
Assets:
Unbilled contract revenue	$	—		$	4,333		$	4,333
Inventories	34,126			(3,768		)	30,358
Deferred income taxes	8,855			(124		)	8,731

Stockholders’ Equity:
Accumulated deficit	(20,463		)	441			(20,022		)

The following table presents the impacted financial statement line items in the condensed consolidated balance sheet as of June 28, 2019:



	Balances Without Adoption of ASC 606			Effect of Change			As Reported
(in thousands)
Assets:
Unbilled contract revenue	$	—		$	7,305		$	7,305
Inventories	51,086			(6,197		)	44,889
Deferred income taxes	8,242			(243		)	7,999

Stockholders’ Equity:
Accumulated deficit	(17,934		)	865			(17,069		)

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 and nine months ended June 28, 2019:



	Three Months Ended						Nine Months Ended
	June 28, 2019						June 28, 2019
	Balances Without Adoption of ASC 606		Effect of Change		As Reported		Balances Without Adoption of ASC 606		Effect of Change		As Reported

Net sales	$	39,062	$	1,262	$	40,324	$	110,087	$	2,972	$	113,059
Cost of sales	33,604		1,115		34,719		95,379		2,429		97,808
Gross profit	5,458		147		5,605		14,708		543		15,251
Income tax expense	189		32		221		617		119		736
Net income	1,096		115		1,211		2,529		424		2,953

For each of the three and nine months ended June 28, 2019 and June 29, 2018, less than 1% of net sales were shipped to locations outside the United States.