REVENUE RECOGNITION

The Company adopted ASC 606 - Revenue from Contracts with Customers using the modified retrospective method effective July 1, 2018. The Company completed an analysis of revenue streams at each of its business units and evaluated the impact of adopting ASC 606 on revenue recognition. The Company primarily sells purchased products and the majority of its revenue is recognized at a point in time. The cumulative effect of initially applying ASC 606 resulted in a net increase to the opening retained earnings balance of $3,429, net of tax, at July 1, 2018. The transition adjustment is comprised of two components. The first component is recognition of revenue from bill and hold arrangements. The second component is recognition of revenue from contracts that meet the criteria to recognize revenue over time as the underlying products have no alternative use and the Company has a right to payment for performance completed to date. Revenue for periods prior to July 1, 2018 has not been adjusted and continues to be reported under ASC Topic 605 - Revenue Recognition.

Revenue Recognition

The Company primarily sells purchased products distributed through its network of service centers and recognizes revenue at a point in time when control of the product transfers to the customer, typically upon shipment from an Applied facility or directly from a supplier. For products that ship directly from suppliers to customers, Applied acts as the principal in the transaction and recognizes revenue on a gross basis. Revenue recognized over time is not significant. Revenue is measured as the amount of consideration expected to be received in exchange for the products and services provided, net of allowances for product returns, variable consideration, and any taxes collected from customers that will be remitted to governmental authorities. Shipping and handling costs are recognized in net sales when they are billed to the customer. The Company has elected to account for shipping and handling activities as fulfillment costs. There are no significant costs associated with obtaining customer contracts.

Payment terms with customers vary by the type and location of the customer and the products or services offered. The Company does not adjust the promised amount of consideration for the effects of significant financing components based on the expectation that the period between when the Company 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. Arrangements with customers that include payment terms extending beyond one year are not significant.

Accounts Receivable

Accounts receivable are stated at their estimated net realizable value and consist of amounts billed or billable and currently due from customers. The Company maintains an allowance for doubtful accounts, which reflects management’s best estimate of probable losses based on an analysis of customer accounts, known troubled accounts, historical experience with write-offs, and other currently available evidence.

Variable Consideration

The Company’s products are generally sold with a right of return and may include variable consideration in the form of incentives, discounts, credits or rebates. Product returns are estimated based on historical return rates. The Company estimates and recognizes variable consideration based on historical experience to determine the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services to a customer. The Company records variable consideration as an adjustment to the transaction price in the period it is incurred. The realization of variable consideration occurs within a short period of time from product delivery; therefore, the time value of money effect is not significant.

Contract Assets

The Company’s contract assets consist of un-billed amounts resulting from contracts for which revenue is recognized over time using the cost-to-cost method, and for which revenue recognized exceeds the amount billed to the customer. On July 1, 2018, $13,823 of contract assets were recognized as part of the cumulative effect adjustment resulting from the adoption of ASC 606.

Activity related to contract assets, which are included in other current assets on the condensed consolidated balance sheet, is as follows:



	December 31, 2018		July 1, 2018		$ Change			% Change
Contract assets	$	9,324	$	13,823	$	(4,499	)	(32.5	)%

The following tables summarize the impacts of ASC 606 on the Company's condensed consolidated financial statements:



	For the three months ended December 31, 2018
	As Reported		Adjustments		Balances without adoption of ASC 606
Net sales	$	840,038	$	1,005	$	841,043
Cost of sales	597,178		699		597,877
Gross profit	242,860		306		243,166
Selling, distribution and administrative expense, including depreciation	181,895		55		181,950
Operating income	60,965		251		61,216
Interest expense, net	9,578		—		9,578
Other expense, net	946		—		946
Income before income taxes	50,441		251		50,692
Income tax expense	11,724		64		11,788
Net income	$	38,717	$	187	$	38,904



	For the six months ended December 31, 2018
	As Reported		Adjustments		Balances without adoption of ASC 606
Net sales	$	1,704,553	$	4,317	$	1,708,870
Cost of sales	1,209,840		3,103		1,212,943
Gross profit	494,713		1,214		495,927
Selling, distribution and administrative expense, including depreciation	367,409		274		367,683
Operating income	127,304		940		128,244
Interest expense, net	20,054		—		20,054
Other expense, net	707		—		707
Income before income taxes	106,543		940		107,483
Income tax expense	18,888		236		19,124
Net income	$	87,655	$	704	$	88,359



	As of December 31, 2018
	As Reported		Adjustments			Balances without adoption of ASC 606
Assets
Other current assets	$	44,041	$	(9,324	)	$	34,717
Inventories	445,881		11,830			457,711
Other assets	21,901		192			22,093

Liabilities
Other current liabilities	60,164		6,626			66,790
Compensation and related benefits	56,882		(456		)	56,426
Other liabilities	73,675		(747		)	72,928

Equity
Retained Earnings	$	889,915	$	(2,725	)	$	887,190

Disaggregation of Revenues

The following tables present the Company's net sales by reportable segment and by geographic areas based on the location of the facility shipping the product for the three and six months ended December 31, 2018. Other countries consist of Mexico, Australia, New Zealand, and Singapore.



	Three Months Ended December 31,
	2018						2017
	Service Center Based Distribution		Fluid Power & Flow Control		Total		Service Center Based Distribution		Fluid Power & Flow Control		Total
Geographic Areas:
United States	$	479,335	$	247,862	727,197		$	448,819	$	108,212	$	557,031
Canada	68,569		—		68,569		67,479		—		$	67,479
Other countries	41,394		2,878		44,272		39,309		3,368		$	42,677
Total	$	589,298	$	250,740	$	840,038	$	555,607	$	111,580	$	667,187



	Six Months Ended December 31,
	2018						2017
	Service Center Based Distribution		Fluid Power & Flow Control		Total		Service Center Based Distribution		Fluid Power & Flow Control		Total
Geographic Areas:
United States	$	970,109	$	504,511	1,474,620		$	907,815	$	216,761	$	1,124,576
Canada	137,676		—		137,676		134,296		—		$	134,296
Other countries	85,562		6,695		92,257		82,409		6,607		$	89,016
Total	$	1,193,347	$	511,206	$	1,704,553	$	1,124,520	$	223,368	$	1,347,888

The following tables present the Company’s percentage of revenue by reportable segment and major customer industry for the three and six months ended December 31, 2018:



	For the three months ended December 31, 2018
	Service Center Based Distribution		Fluid Power & Flow Control		Total
General Industry	35.9	%	46.1	%	38.9	%
Industrial Machinery	9.7	%	20.3	%	12.9	%
Metals	13.6	%	8.5	%	12.1	%
Food	10.1	%	2.7	%	7.8	%
Oil & Gas	10.2	%	2.1	%	7.8	%
Chem/Petrochem	2.9	%	14.0	%	6.2	%
Forest Products	7.1	%	2.9	%	5.9	%
Cement & Aggregate	6.0	%	0.9	%	4.5	%
Transportation	4.5	%	2.5	%	3.9	%
Total	100.0	%	100.0	%	100.0	%



	For the six months ended December 31, 2018
	Service Center Based Distribution		Fluid Power & Flow Control		Total
General Industry	35.8	%	44.9	%	38.4	%
Industrial Machinery	9.5	%	20.8	%	12.9	%
Metals	12.3	%	8.2	%	11.1	%
Food	10.4	%	2.6	%	8.1	%
Oil & Gas	9.9	%	2.1	%	7.6	%
Chem/Petrochem	3.2	%	14.8	%	6.7	%
Forest Products	8.0	%	2.8	%	6.4	%
Cement & Aggregate	6.4	%	1.0	%	4.8	%
Transportation	4.5	%	2.8	%	4.0	%
Total	100.0	%	100.0	%	100.0	%

The following tables present the Company’s percentage of revenue by reportable segment and product line for the three and six months ended December 31, 2018:



	For the three months ended December 31, 2018
	Service Center Based Distribution		Fluid Power & Flow Control		Total
Power Transmission	34.3	%	1.3	%	24.4	%
Fluid Power	13.7	%	38.1	%	21.0	%
General Maintenance; Hose Products	25.4	%	5.8	%	19.6	%
Bearings, Linear & Seals	26.6	%	0.4	%	18.8	%
Specialty Flow Control	—	%	54.4	%	16.2	%
Total	100.0	%	100.0	%	100.0	%



	For the six months ended December 31, 2018
	Service Center Based Distribution		Fluid Power & Flow Control		Total
Power Transmission	33.5	%	1.4	%	23.9	%
Fluid Power	13.8	%	37.9	%	21.0	%
General Maintenance; Hose Products	26.6	%	5.2	%	20.2	%
Bearings, Linear & Seals	26.1	%	0.2	%	18.3	%
Specialty Flow Control	—	%	55.3	%	16.6	%
Total	100.0	%	100.0	%	100.0	%