Revenue Recognition

Adoption of ASC 606

On January 1, 2018 the Company adopted Accounting Standards Codification 606-Revenue From Contracts With Customers (“ASC 606”). As part of the Company's adoption of ASC 606, it concluded that it has two separate performance obligations, and accordingly, two separate revenue streams: products and services. As a result, the Company is now reporting two separate revenue streams and two separate costs of revenues. The adoption of ASC 606 had a minimal impact on total reported revenues, costs and net income for the first nine months of 2018. However, the adoption required prospective reclassification of certain selling expenses associated with the separately identified vendor managed inventory services performance obligation costs historically classified as selling expenses to cost of sales. As ASC 606 was adopted on a modified retrospective method, prior quarters are not restated. Effective January 1, 2018, the Company recorded a cumulative effect adjustment in opening retained earnings in the amount of $0.3 million based on applying the guidance to the customer contracts that were not completed on that date.

ASC 606 defines a five step process to recognize revenues at the time and in an amount that reflects the consideration expected to be received for the performance obligations that have been provided. ASC 606 defines contracts as written, oral and through customary business practice. Under this definition, the Company considers contracts to be created at the time an order to purchase product is agreed upon regardless of whether or not there is a written contract.

Performance Obligations

Lawson has two operating segments; the Lawson segment and the Bolt Supply segment. Customer contracts have the following performance obligations:

The Lawson segment has two distinct performance obligations offered to its customers: a product performance obligation and a service performance obligation. Although the Company has identified that it offers its customers both a product and a service obligation, the customer only receives one invoice per transaction with no price breakout between these obligations. The Company does not price its offerings based on any breakout between these obligations.

Lawson generates revenue primarily from the sale of MRO products to its customers. Revenue related to product sales is recognized at the time that control of the product has been transferred to the customer; either at the time the product is shipped or the time the product has been received by the customer. The Company does not commit to long-term contracts to sell customers a certain minimum quantity of products.

The Lawson segment offers a VMI service proposition to its customers. A portion of these services, primarily related to stocking of product and maintenance of the MRO inventory, is provided a short period of time after control of the purchased product has been transferred to the customer. Since some components of VMI service have not been provided at the time the control of the product transfers to the customer, that portion of expected consideration is deferred until the time that those services have been provided.

The Bolt Supply segment does not provide VMI services for its customers or provide services in addition to product sales to customers. Revenue is recognized at the time that control of the product has been transferred to the customer which is either upon delivery or shipment depending on the terms of the contract.

Accounting Policy Elections

The Company has elected to treat shipping and handling costs after the control of the product has been transferred to the customer as a fulfillment cost.

Sales taxes that are imposed on our sales and collected from customers are excluded from revenues.

The Company expenses sales commissions when incurred as the amortization period is one year or less.

Significant Judgments

The Company employs certain significant judgments to estimate the dollar amount of revenue, and related expenses, allocated to the sale of product and service. These judgments include, among others, the percentage of customers that take advantage of the VMI services offered, the amount of revenue to be allocated to the VMI service based on the value of the service to its customers, and the amount of time after control of the product passes to the customer that the VMI service obligation is completed. It is assumed that any customer who averages placing orders at a frequency of longer than 30 days does not take advantage of the available VMI services offered. The estimate of the cost of sales is based on expenses directly related to sales representatives that provide direct VMI services to the customer.

Financial Impact of ASC 606 Adoption

As a result of applying ASC 606 the Company recorded a liability of $0.7 million for deferred revenue on January 1, 2018. Expenses related to these revenues of $0.4 million were also deferred resulting in a net reduction to opening retained earnings of $0.3 million as of January 1, 2018. At September 30, 2018, the Company had a deferred revenue liability of $0.7 million and a deferred expense of $0.3 million for related expenses associated with the deferred service performance obligations, respectively. The deferral of revenue and expenses does not affect the amount, timing and any uncertainty of cash flows generated from operations.

The following table presents the impact of ASC 606 on Condensed Consolidated Statements of Operations (Unaudited):



	Three Months Ended September 30, 2018
(Dollars in thousands)	As Reported			Service Revenues and Costs Adjustments			Pro-Forma as if Previous Accounting Guidance Was in Effect

Product revenue	$	78,377		$	10,207		$	88,584
Service revenue	10,153			(10,153		)	—
Total revenue	$	88,530		$	54		$	88,584

Product cost of goods sold	$	36,979		$	—		$	36,979
Service costs	3,443			(3,443		)	—
Total cost of goods sold	$	40,422		$	(3,443	)	$	36,979

Gross profit	48,108			3,497			51,605
Gross profit percentage	54.3		%				58.3		%

Selling expenses	22,175			3,468			25,643
General and administrative expenses	28,199			—			28,199
Operating expenses	50,374			3,468			53,842

Operating loss as reported was $2.27 million whereas pro forma operating loss as if previous accounting guidance was in effect would have been $2.24 million.



	Nine Months Ended September 30, 2018
(Dollars in thousands)	As Reported			Service Revenues and Costs Adjustments			Pro-Forma as if Previous Accounting Guidance Was in Effect

Product revenue	$	233,744		$	29,609		$	263,353
Service revenue	29,627			(29,627		)	—
Total revenue	$	263,371		$	(18	)	$	263,353

Product cost of goods sold	$	109,667		$	—		$	109,667
Service costs	10,247			(10,247		)	—
Total cost of goods sold	$	119,914		$	(10,247	)	$	109,667

Gross profit	143,457			10,229			153,686
Gross profit percentage	54.5		%				58.4		%

Selling expenses	66,119			10,092			76,211
General and administrative expenses	72,213			—			72,213
Operating expenses	138,332			10,092			148,424

Operating income as reported was $5.13 million whereas pro forma operating income as if previous accounting guidance was in effect would have been $5.26 million.

Disaggregated revenue by geographic area follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands)	2018		2017		2018		2017

United States	$	70,652	$	67,575	$	210,596	$	202,176
Canada	17,878		8,076		52,775		23,098
Consolidated total	$	88,530	$	75,651	$	263,371	$	225,274

Disaggregated revenue by product type follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017

Fastening Systems	24.6	%	20.4	%	24.5	%	20.6	%
Fluid Power	14.6	%	16.3	%	14.7	%	15.7	%
Specialty Chemicals	12.6	%	14.5	%	12.3	%	14.3	%
Cutting Tools and Abrasives	13.7	%	14.2	%	13.5	%	14.3	%
Electrical	10.6	%	11.7	%	10.9	%	11.9	%
Aftermarket Automotive Supplies	7.6	%	8.4	%	8.0	%	8.8	%
Safety	4.6	%	4.2	%	4.6	%	4.2	%
Welding and Metal Repair	1.7	%	2.2	%	1.9	%	2.2	%
Other	10.0	%	8.1	%	9.6	%	8.0	%
Consolidated Total	100.0	%	100.0	%	100.0	%	100.0	%