(4) REVENUE RECOGNITION

Adoption of ASC Topic 606, “Revenue from Contracts with Customers”

On August 1, 2018, the Company adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of August 1, 2018. Results for reporting periods beginning after August 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic accounting under Topic 605.

The Company recognizes revenue from its contracts with customers primarily from the sale of supply chain management services and marketing solutions offerings. Revenue is recognized when control of the promised goods or services is transferred to a customer, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. For ModusLink’s supply chain management services arrangements and IWCO’s marketing solutions offerings, the services are considered to be transferred over time as they are performed. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue.

ModusLink’s revenue primarily comes from the sale of supply chain management services to its clients. Under the new standard, the majority of these arrangements consist of two distinct performance obligations (i.e. a warehousing and inventory management service and a separate kitting, packaging and assembly service), each of which is recognized over time as services are performed using an input method based on the level of efforts expended. A significant portion of ModusLink’s revenue from these arrangements continues to be recognized over time as the services are performed based on an input method of efforts expended which corresponds with the transfer of value to the customer. For the limited population of contracts where the Company previously recognized revenues upon completion of all services and historically recognized revenue at a point in time (generally upon product shipment), the new standard accelerates the recognition of revenue as the Company’s performance enhances assets that the customer controls and therefore revenue is recognized over time based on an input method of efforts expended which corresponds with the transfer of value to the customer.

Revenue from the sale of perpetual licenses sold in ModusLink’s e-Business operations is now recognized at a point in time upon execution of the relevant license agreement and when delivery has taken place.

Revenue recognized related to the majority of IWCO’s marketing solutions offerings, which typically consist of a single integrated performance obligation, is now recognized over time as the Company performs because the products have no alternative use to the Company and the Company has an enforceable right to payment for performance completed to date.

Revenue Recognition

In accordance with Topic 606, revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services, and excludes any sales incentives or taxes collected from customers which are subsequently remitted to government authorities. To achieve this core principle, the Company applies the following five steps:

Identify the contract(s) with a customer - A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to those goods or services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company’s arrangements with customers are typically documented within a master services agreement (MSA) together with a statement of work (SOW) or business requirements document (BRD). Depending on the nature of the goods and/or services being provided, a contract will be created at the time that the Company and the customer have entered into an MSA and SOW or BRD, and the Company has received some form of authorization or acknowledgment from the customer as to the request for the specified services. For certain goods and/or services, a contract does not exist until the Company receives a firm order to commence the specified activities. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.

Identify the performance obligations in the contract - Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, the Company must apply judgment to determine whether promised goods or services are capable of being distinct and distinct in the context of the contract. If these criteria are not met, the promised goods or services are accounted for as a combined performance obligation.

The Company’s contracts typically do not include options that would result in a material right. If options to purchase additional goods or services are included in customer contracts, the Company evaluates the option in order to determine if the Company’s arrangement include promises that may represent a material right and needs to be accounted for as a performance obligation in the contract with the customer. The Company did not note any significant provisions within its typical contracts that would create a material right.

Determine the transaction price - The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. None of the Company’s contracts as of October 31, 2018 contained a significant financing component. Determining the transaction price requires significant judgment.

Allocate the transaction price to the performance obligations in the contract - If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation on a relative standalone selling price (SSP) basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation. The Company determines SSP based on the price at which the performance obligation is sold separately. If the SSP is not observable through past transactions, the Company estimates the SSP taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.

Recognize revenue when (or as) the Company satisfies a performance obligation - The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer.

Disaggregation of Revenue

The following table presents the Company’s revenues disaggregated by major good or service line, timing of revenue recognition, and sales channel (in thousands). The table also includes a reconciliation of the disaggregated revenue with the reportable segments.


	Three Months Ended October 31, 2018
	Americas		Asia		Europe		Direct Marketing		e-Business		Consolidated Total
	(In thousands)
Major Goods/Service Lines
Supply chain management services	$	17,440	$	44,256	$	19,521	$	—	$	5,409	$	86,626
Perpetual software licenses		—		—		—		—		—		—
Marketing solutions offerings		—		—		—		128,094		—		128,094
Other		—		—		—		—		413		413

		17,440		44,256		19,521		128,094		5,822		215,133
Timing of Revenue Recognition
Goods transferred over time		—		—		—		128,094		—		128,094
Services transferred over time		17,440		44,256		19,521		—		5,822		87,039

		17,440		44,256		19,521		128,094		5,822		215,133
Total Revenue
Revenue from contracts with customers		17,440		44,256		19,521		128,094		5,822		215,133

	$	17,440	$	44,256	$	19,521	$	128,094	$	5,822	$	215,133

Over the three months ended October 31, 2018, the Company had no revenue recognized at a point in time. Prior period amounts have not been adjusted under the modified retrospective method.

Supply chain management services.

ModusLink’s revenue primarily comes from the sale of supply chain management services to its clients. Amounts billed to customers under these arrangements include revenue attributable to the services performed as well as for materials procured on the customer’s behalf as part of its service to them. The majority of these arrangements consist of two distinct performance obligations (i.e. warehousing/inventory management service and a separate kitting/packaging/assembly service), revenue related to each of which is recognized over time as services are performed using an input method based on the level of efforts expended.

Perpetual software licenses.

Revenue from the sale of perpetual software licenses in the Company’s e-Business operations is recognized at a point in time upon execution of the relevant license agreement and when delivery has taken place.

Marketing solutions offerings.

IWCO’s revenue is generated through the provision of data-driven marketing solutions, primarily through providing direct mail products to customers. Revenue related to the majority of IWCO’s marketing solutions contracts, which typically consist of a single integrated performance obligation, is recognized over time as the Company performs because the products have no alternative use to the Company and the Company has an enforceable right to payment for performance completed to date.

Other.

Other revenue consists of cloud-based software subscriptions, software maintenance and support service contracts, and fees for professional services. Revenue related to these arrangements is recognized on a straight-line basis over the term of the agreement or over the term of the agreement in proportion to the costs incurred in satisfying the obligations under the contract.

Significant Judgments

The Company’s contracts with customers may include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. For arrangements with multiple performance obligations, the Company allocates revenue to each performance obligation based on its relative standalone selling price. Judgment is required to determine the standalone selling price for each distinct performance obligation. The Company generally determines standalone selling prices based on the prices charged to customers and uses a range of amounts to estimate standalone selling prices when we sell each of the products and services separately and need to determine whether there is a discount that needs to be allocated based on the relative standalone selling prices of the various products and services. The Company typically has more than one range of standalone selling prices for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, the Company may use information such as the type of customer and geographic region in determining the range of standalone selling prices.

The Company may provide credits or incentives to customers, which are accounted for as variable consideration when estimating the transaction price of the contract and amounts of revenue to recognize. The amount of variable consideration to include in the transaction price is estimated at contract inception using either the estimated value method or the most likely amount method based on the nature of the variable consideration. These estimates are updated at the end of each reporting period as additional information becomes available and revenue is recognized only to the extent that it is probable that a significant reversal of any amounts of variable consideration included in the transaction price will not occur.

Practical Expedients and Exemptions

The Company has elected to make the following accounting policy elections through the adoption of the following practical expedients:

Right to Invoice

Where applicable, the Company will recognize revenue from a contract with a customer in an amount that corresponds directly with the value to the customer of the Company’s performance completed to date and the amount to which the entity has a right to invoice.

Sales and Other Similar Taxes

The Company will exclude sales taxes and similar taxes from the measurement of transaction price and will ensure that it complies with the disclosure requirements of ASC 235-10-50-1 through 50-6.

Significant Financing Component

The Company will not adjust the promised amount of consideration for the effects of a significant financing component if the Company expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.

Cost to Obtain a Contract

The Company will recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the Company otherwise would have recognized is one year or less and there are no renewal periods on which the Company does not pay commissions that are not commensurate with those originally paid.

Promised Goods or Services that are Immaterial in the Context of a Contract

The Company has elected to assess promised goods or services as performance obligations that are deemed to be immaterial in the context of a contract. As such, the Company will not aggregate and assess immaterial items at the entity level. That is, when determining whether a good or service is immaterial in the context of a contract, the assessment will be made based on the application of ASC 606 at the contract level.

Contract Balances

Timing of revenue recognition may differ from timing of invoicing to customers. The Company records contract assets and liabilities related to its contracts with customers as follows:

•

Accounts receivable when revenue is recognized prior to receipt of cash payments and if the right to such amounts is unconditional and solely based on the passage of time

•

Contract asset when the Company recognizes revenue based on efforts expended but the right to such amount is conditional upon satisfaction of another performance obligations. Contract assets are primarily comprised of fees related to marketing solutions offerings and supply chain management services. The Company notes that its contract assets are all short-term in nature and are included in prepaid expenses and other current assets in the Company’s condensed consolidated balance sheets

•

Deferred revenue when cash payments are received or due in advance of performance. Deferred revenue is primarily comprised of fees related to supply chain management services, cloud-based software subscriptions and software maintenance and support service contracts, which are generally billed in advance. Deferred revenue also includes other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. The deferred revenue balance is classified as a component of other current liabilities and other long-term liabilities on the balance sheet.

The opening balance of contract assets was $24.0 million as of August 1, 2018. During the three months ended October 31, 2018, substantially all of this entire balance was classified as accounts receivable, trade, upon billing to the customer where such amounts became unconditional. As of October 31, 2018, the contract asset balance was $22.7 million.

The opening balance of current deferred revenue and long-term deferred revenue was $3.7 million and $184 thousand, respectively, as of August 1, 2018. As of October 31, 2018, current deferred revenue and long-term deferred revenue was $3.4 million and $212 thousand, respectively.

Changes in deferred revenue during the three months ended October 31, 2018, were as follows (in thousands):


Balance at beginning of period	$	3,858
Deferral of revenue		503
Recognition of deferred amounts upon satisfaction of performance obligation		(720	)

Balance at end of period	$	3,641

We expect to recognize approximately $3.4 million of the unearned amount in fiscal year 2019 and $212 thousand in fiscal year 2020.

Assets Recognized from the Costs to Obtain a Contract with a Customer

Prior to the adoption of Topic 606, the Company expensed incremental costs to obtain a contract, which represented commissions, as the liability was incurred. In accordance with Topic 606, the Company recognizes an asset for the incremental costs of obtaining a contract with a customer if the period over which such costs would be amortized is greater than one year. The Company has determined that certain commissions programs meet the requirements to be capitalized. However, as of August 1, 2018, the total commission expense that had been incurred under the commissions programs identified was not material and therefore, the Company determined that no amounts were required to be capitalized at the date of adoption. For the three months ended October 31, 2018, the total commission expense that had been incurred under the commissions programs identified was not material and the Company determined that no amounts were required to be capitalized at October 31, 2018.

The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

The cumulative effect of the changes made to the Company’s consolidated August 1, 2018 balance sheet for the adoption of Topic 606 were as follows (in thousands):


	July 31,			Adjustments Due			August 1,
	2018			to ASU 2014-09			2018
Assets
Inventories, net	$	47,786		$	(21,233	)	$	26,553
Prepaid expenses and other current assets		13,415			24,041			37,456
Total current assets		264,281			2,808			267,089
Total assets	$	827,050		$	2,808		$	829,858

Liabilities
Other Current Liabilities	$	42,125		$	(3,330	)	$	38,795
Total current liabilities		276,356			(3,330	)		273,026
Total liabilities		684,230			(3,330	)		680,900
Stockholders’ equity
Accumulated deficit		(7,363,569	)		6,138			(7,357,431	)
Total stockholders’ equity		107,628			6,138			113,766
Total liabilities, contingently redeemable preferred stock and stockholders’ equity	$	827,050		$	2,808		$	829,858

The Company reduced opening accumulated deficit by $6.1 million as of August 1, 2018 due to the cumulative impact of adopting Topic 606, with the impact attributable to the acceleration of revenue related to ModusLink’s supply chain management services arrangements and IWCO’s marketing solutions offerings where the Company previously recognized revenues upon completion of all services and historically recognized revenue at a point in time (generally upon product shipment or when the products were complete). The adoption of ASC 606 primarily resulted in an acceleration of revenue as of August 1, 2018, which in turn generated additional deferred tax liabilities that ultimately reduced the Company’s net deferred tax asset position. As the Company fully reserves its net deferred tax assets in the jurisdictions impacted by the adoption of Topic 606, this impact was offset by a corresponding reduction to the valuation allowance.

In accordance with the requirements of the new standard, the disclosure of the impact of the adoption on the Company’s consolidated balance sheet and statement of operations was as follows (in thousands, except per share amounts):

Balance Sheet:


	October 31, 2018
				Balances without			Effect of Change
	As Reported			Adoption of ASC 606			Higher/(Lower)
Assets
Inventories, net	$	29,969		$	51,392		$	(21,423	)
Prepaid expenses and other current assets		34,187			11,524			22,663
Total current assets		276,054			274,814			1,240
Total assets	$	827,727		$	826,487		$	1,240

Liabilities
Other Current Liabilities	$	38,408		$	44,041		$	(5,633	)
Total current liabilities		280,197			285,830			(5,633	)
Total liabilities		687,098			692,731			(5,633	)
Stockholders’ equity
Accumulated deficit		(7,365,332	)		(7,372,205	)		6,873
Total stockholders’ equity		105,431			98,558			6,873
Total liabilities, contingently redeemable preferred stock and stockholders’ equity	$	827,727		$	826,487		$	1,240

Statement of Operations:


	Three Months Ended October 31, 2018
				Balances without			Effect of Change
	As Reported			Adoption of ASC 606			Higher/(Lower)
Net revenue	$	215,133		$	214,208		$	925
Cost of revenue		176,933			176,743			190
Gross profit		38,200			37,465			735
Loss before income taxes		(6,254	)		(6,989	)		735
Net loss		(7,365	)		(8,100	)		735
Net loss attributable to common stockholders	$	(7,901	)	$	(8,636	)	$	735
Basic and diluted net loss per share attributable to common stockholders:	$	(0.13	)	$	(0.14	)	$	0.01

The impact to revenues for the quarter ended October 31, 2018 was an increase of $0.9 million as a result of applying Topic 606 primarily related to the acceleration of revenue related to IWCO’s marketing solutions arrangements for certain contracts with customers that under Topic 606 are being recognized over time based on an input method of efforts expended which depicts the transfer of value to the customer.