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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
_____________________________________________________________ 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 000-18805
______________________________________________________________ 
ELECTRONICS FOR IMAGING, INC.
(Exact name of registrant as specified in its charter)
______________________________________________________________ 
Delaware
94-3086355
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
6750 Dumbarton Circle, Fremont, CA 94555
(Address of principal executive offices) (Zip code)
(650) 357-3500
(Registrant’s telephone number, including area code)
______________________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act) (Check one):
Large accelerated filer
 
x
 
Accelerated filer
 
 
 
 
 
 
 
 
Non-accelerated filer
 
 
Smaller reporting company
 
 
 
 
 
 
 
 
Emerging growth company
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    Yes  ☐    No  ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  x
The number of shares of Common Stock outstanding as of July 30, 2018 was 44,375,342.
 



Table of Contents

Electronics For Imaging, Inc.
INDEX
 
 
Page No.
PART I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
Exhibit 3.1
 
Exhibit 3.2
 
Exhibit 12.1
 
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
Exhibit 101
 


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PART I         FINANCIAL INFORMATION
Item 1:        Condensed Consolidated Financial Statements (Unaudited)
Electronics For Imaging, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(in thousands)
June 30, 2018
 
December 31, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
179,507

 
$
170,345

Short-term investments
134,006

 
148,697

Accounts receivable, net of allowances of $30.4 million and $32.2 million, respectively
243,400

 
244,416

Inventories
118,115

 
125,813

Income taxes receivable
8,952

 
4,565

Assets held for sale
4,200

 
4,200

Other current assets
57,814

 
41,799

Total current assets
745,994

 
739,835

Property and equipment, net
95,981

 
98,762

Restricted cash equivalents
39,809

 
32,531

Goodwill
395,421

 
403,278

Intangible assets, net
97,536

 
123,008

Deferred tax assets
44,384

 
45,083

Other assets
29,885

 
15,504

Total assets
$
1,449,010

 
$
1,458,001

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
128,039

 
$
123,935

Accrued and other liabilities
91,026

 
98,090

Deferred revenue
66,581

 
55,833

Income taxes payable
6,501

 
5,309

Total current liabilities
292,147

 
283,167

Convertible senior notes, net
326,512

 
318,957

Imputed financing obligation related to build-to-suit lease
13,880

 
13,944

Noncurrent contingent and other liabilities
20,185

 
28,801

Deferred tax liabilities
8,220

 
11,652

Noncurrent income taxes payable
20,710

 
20,169

Total liabilities
681,654

 
676,690

Commitments and contingencies (Note 10)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 5,000 shares authorized; none issued and outstanding

 

Common stock, $0.01 par value; 150,000 shares authorized; 54,577 and 54,249 shares issued, respectively
546

 
542

Additional paid-in capital
769,223

 
745,661

Treasury stock, at cost; 10,056 and 9,070 shares, respectively
(404,603
)
 
(375,574
)
Accumulated other comprehensive income (loss)
(5,202
)
 
8,138

Retained earnings
407,392

 
402,544

Total stockholders’ equity
767,356

 
781,311

Total liabilities and stockholders’ equity
$
1,449,010

 
$
1,458,001

See accompanying notes to condensed consolidated financial statements.

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Electronics For Imaging, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in thousands, except per share amounts)
2018
 
2017
 
2018
 
2017
Revenue
$
261,072

 
$
247,047

 
$
500,938

 
$
475,738

Cost of revenue (1) 
132,484

 
119,795

 
253,243

 
224,956

Gross profit
128,588

 
127,252

 
247,695

 
250,782

Operating expenses:
 
 
 
 
 
 
 
Research and development (1) 
41,081

 
38,989

 
79,360

 
78,616

Sales and marketing (1) 
46,107

 
43,714

 
92,787

 
86,749

General and administrative (1) 
13,206

 
21,135

 
32,627

 
42,164

Amortization of identified intangibles
11,526

 
11,752

 
23,664

 
22,530

Restructuring and other
3,024

 
3,671

 
7,678

 
4,589

Total operating expenses
114,944

 
119,261

 
236,116

 
234,648

Income from operations
13,644

 
7,991

 
11,579

 
16,134

Interest expense
(4,989
)
 
(4,966
)
 
(9,943
)
 
(9,626
)
Interest income and other income (expense), net
(355
)
 
755

 
934

 
1,042

Income before income taxes
8,300

 
3,780

 
2,570

 
7,550

Provision for income taxes
(4,532
)
 
(1,021
)
 
(2,397
)
 
(4
)
Net income
$
3,768

 
$
2,759

 
$
173

 
$
7,546

 
 
 
 
 
 
 
 
Net income per basic common share
$
0.08

 
$
0.06

 
$

 
$
0.16

Net income per diluted common share
$
0.08

 
$
0.06

 
$

 
$
0.16

Shares used in basic per-share calculation
44,691

 
46,429

 
44,860

 
46,490

Shares used in diluted per-share calculation
45,439

 
47,150

 
45,461

 
47,199

____________________

(1) 
Includes stock-based compensation expense as follows:

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenue
$
1,043

 
$
665

 
$
1,811

 
$
1,499

Research and development
3,513

 
2,346

 
5,868

 
5,916

Sales and marketing
2,591

 
1,773

 
4,390

 
4,068

General and administrative
4,638

 
2,829

 
6,486

 
6,410

See accompanying notes to condensed consolidated financial statements.


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Table of Contents

Electronics For Imaging, Inc.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(unaudited)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Net income
$
3,768

 
$
2,759

 
$
173

 
$
7,546

Net unrealized investment gains (losses):
 
 
 
 
 
 
 
Unrealized holding gains (losses), net of tax (1) 
112

 
99

 
(436
)
 
235

Reclassification adjustments included in
 net income (loss), net of tax (1) 
9

 
(17
)
 
11

 
(22
)
Net unrealized investment gains (losses)
121

 
82

 
(425
)
 
213

Currency translation adjustments
(18,535
)
 
12,136

 
(12,875
)
 
18,310

Net unrealized gains (losses) on cash flow hedges

 
(51
)
 
41

 
4

Comprehensive income (loss)
$
(14,646
)
 
$
14,926

 
$
(13,086
)
 
$
26,073

____________________

(1) 
Tax effects were less than $0.1 million for the periods presented above.    

See accompanying notes to condensed consolidated financial statements.


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Electronics For Imaging, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
 
Six Months Ended
June 30,
(in thousands)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
173

 
$
7,546

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
33,830

 
30,911

Deferred taxes
(3,209
)
 
(1,571
)
Provisions and releases for bad debt and sales-related allowances
703

 
6,401

Provision for inventory obsolescence
2,928

 
1,465

Stock-based compensation expense
18,555

 
17,893

Non-cash accretion of interest expense on convertible notes and imputed financing obligation
7,677

 
7,459

Change in fair value of contingent consideration
(12,775
)
 
899

Net change in derivative assets and liabilities
(7,100
)
 
1,012

Other non-cash charges and gains
256

 
979

Changes in operating assets and liabilities, net of effect of acquired businesses
(3,807
)
 
(33,984
)
Net cash provided by operating activities
37,231

 
39,010

Cash flows from investing activities:
 
 
 
Purchases of short-term investments

 
(62,431
)
Proceeds from sales and maturities of short-term investments
14,042

 
85,306

Purchases of restricted investments (1) 

 
(10,011
)
Purchases, net of proceeds from sales, of property and equipment
(6,435
)
 
(5,711
)
Businesses purchased, net of cash acquired
(252
)
 
(13,512
)
Net cash provided by (used for) investing activities (1) 
7,355

 
(6,359
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
5,010

 
6,643

Purchases of treasury stock and net share settlements
(29,028
)
 
(41,326
)
Repayment of debt assumed through business acquisitions
(1,618
)
 
(1,489
)
Contingent consideration payments related to businesses acquired
(698
)
 
(1,294
)
Net cash used for financing activities
(26,334
)
 
(37,466
)
Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash equivalents
(1,812
)
 
3,259

Increase (decrease) in cash, cash equivalents, and restricted cash equivalents
16,440

 
(1,556
)
Cash, cash equivalents, and restricted cash equivalents at beginning of period (1) 
202,876

 
165,455

Cash, cash equivalents, and restricted cash equivalents at end of period (1)
$
219,316

 
$
163,899

____________________

(1) 
Certain prior period amounts have been revised due to the implementation of ASU 2016-18. See Note 1 for details.
See accompanying notes to condensed consolidated financial statements.


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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
Note 1.     Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements (“condensed consolidated financial statements”) include the accounts of Electronics For Imaging, Inc. and its subsidiaries (“EFI” or “Company”). All intercompany accounts and transactions have been eliminated in consolidation.
These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim financial information, rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements, and accounting policies consistent in all material respects with those applied in preparing our audited annual consolidated financial statements included in our Annual Report on Form 10-K, as amended by Amendment No. 1, for the year ended December 31, 2017 (the “2017 Form 10-K”). These condensed consolidated financial statements and accompanying notes should be read in conjunction with our annual consolidated financial statements and the notes included in the 2017 Form 10-K. In the opinion of management, these condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments, management considers necessary for the fair presentation of our financial position, operating results, comprehensive income, and cash flows for the interim periods presented. Our results for the interim periods are not necessarily indicative of results for the entire year.
Out-of-Period Adjustments
In the three and six months ended June 30, 2017, we recorded out-of-period adjustments related to certain bill and hold transactions, which decreased revenue by $4.9 and $3.4 million, respectively, decreased gross profit by $0.9 and $0.5 million, respectively, and decreased net income by $0.6 and $0.3 million, respectively (or $0.01 per diluted share in both periods). We evaluated these adjustments considering both qualitative and quantitative factors, their impact in relation to each period, as well as the periods in which they originated. The impact of recognizing these adjustments in prior years was not significant to any individual period. Management believes these adjustments are immaterial to the condensed consolidated financial statements for the three and six months ended June 30, 2017 and all previously issued financial statements.
Recently Adopted Accounting Pronouncements
Revenue Recognition. Effective January 1, 2018, we adopted Accounting Standards Codification (“ASC”) 606 Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective method applied to all incomplete contracts as of the date of initial application. ASC 606 supersedes the revenue recognition requirements in ASC 605, Revenue Recognition (“ASC 605”), and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the considerations to which the entity expects to be entitled to in exchange for those goods or services. In addition, ASC 606 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Effective January 1, 2018, we also adopted ASC 340-40, Other Assets and Deferred CostsContracts with Customers (“ASC 340-40”), using the modified retrospective method to all incomplete contracts as of the date of initial application. ASC 340-40 requires the deferral of incremental costs of obtaining a contract with a customer.
Results for reporting periods beginning after January 1, 2018 are presented under ASC 606 and ASC 340-40, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 605. Additional discussion of these recently adopted pronouncements is included below under Significant Accounting Policies, in Note 4Revenue, and in Note 5Supplemental Financial Statement Information.
Income Taxes. Staff Accounting Bulletin (“SAB”) 118 provides guidance for the application of ASC 740 for a measurement period to complete the accounting for certain elements of the Tax Cut & Jobs Act of 2017 (the “2017 Tax Act”). The measurement period is defined as up to one year from the enactment date, which will expire on December 22, 2018. SAB 118 requires that we recognize those income tax effects in our financial statements for which the accounting can be completed, as may be the case for the effect of rate changes on deferred tax assets and deferred tax liabilities. For matters that have not been completed, we are required to recognize provisional amounts to the extent that they are reasonably estimable, adjust them during the measurement period when more information becomes available, and report this information in our financial statements in that period. See additional information in Note 14 Income Taxes.

Restricted Cash. Accounting Standard Update (“ASU”) 2016-18, Statement of Cash Flows: Restricted Cash, became effective in the first quarter of 2018 requiring the statement of cash flows to explain the change in cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents are included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts in

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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


the statement of cash flows. We previously included the changes in restricted cash equivalents in operating or investing activities in the Consolidated Statements of Cash Flows. Prior period amounts have been revised to conform to the current year presentation.
Reconciliation of cash, cash equivalents, and restricted cash equivalents
(in thousands)
June 30, 2018
 
December 31, 2017
 
June 30, 2017
 
December 31, 2016
Cash and cash equivalents
$
179,507

 
$
170,345

 
$
158,577

 
$
164,313

Restricted cash equivalents
39,809

 
32,531

 
5,322

 
1,142

Total cash, cash equivalents, and restricted cash
 equivalents shown in the statement of cash flows
$
219,316

 
$
202,876

 
$
163,899

 
$
165,455

Definition of a Business. In January 2017, the Financial Accounting Standard Board (“FASB’) issued ASU 2017-01, Business Combinations: Clarifying the Definition of a Business, which significantly narrows how businesses are defined and became effective in the first quarter of 2018. Under ASU 2017-01, when substantially all of the fair value of the gross assets acquired is concentrated in a single asset or group of similar identifiable assets, then the assets acquired do not constitute a business. If substantially all of the fair value of the gross assets acquired is not concentrated in a single asset or group of similar assets, then the assets acquired may constitute a business if certain criteria are met. We must determine whether the acquired gross assets and activities include an input and a “substantive” process that together “significantly” contribute to the ability to create an output. A framework and specific criteria are provided to assist with the evaluation of whether a process is “substantive” and “significantly contributes” to the ability to create an output. “Output” is narrowly defined to be consistent with the description of a performance obligation in the new revenue guidance or this ASU. Missing inputs and processes may not be replaced by integration with our own inputs and processes under the new guidance. The adoption of ASU 2017-1 did not impact our condensed consolidated financial statements as of June 30, 2018 because we did not acquire a business during the six months ended June 30, 2018.
Nonfinancial Asset Derecognition. In February 2017, the FASB issued ASU 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets: Clarifying the Scope of Asset Derecognition and Accounting for Partial Sales of Nonfinancial Assets, which clarifies the scope of recent guidance as it relates to nonfinancial asset derecognition and the accounting for partial sales of nonfinancial assets. The ASU conforms the derecognition guidance as it relates to nonfinancial assets with the derecognition guidance in the new revenue standard (ASU 2014-9) and is not expected to have a material impact on the accounting for real estate dispositions. ASU 2017-5 became effective in the first quarter of 2018. During the six months ended June 30, 2018, we did not have any non-financial asset derecognition transactions.
Stock Compensation Modification. In May 2017, the FASB issued ASU 2017-09, Stock Compensation – Scope of Modification Accounting, which clarifies the scope of modification accounting for share-based payment arrangements, which became effective in the first quarter of 2018. Specifically, we do not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. We elected to adopt this guidance prospectively to awards modified on or after the adoption date. The adoption of ASU 2017-09 did not have a material impact on our condensed consolidated financial statements during the three and six months ended June 30, 2018.
Settlement of Convertible Debt. ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, issued in August 2016, requires that cash settlements of principal amounts of debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the debt must classify the portion of the principal payment attributable to the accreted interest related to the debt discount as cash outflows from operating activities. This is consistent with the classification of the coupon interest payments.

ASU 2016-15 became effective in the first quarter of 2018. Accordingly, $63.6 million of the debt discount attributable to the difference between the 0.75% coupon interest rate on our 0.75% Convertible Senior Notes due 2019 (“Notes”) and the 4.98% (5.46% inclusive of debt issuance costs) effective interest rate will be classified as an operating cash outflow in the Condensed Consolidated Statement of Cash Flows upon any cash settlement of the Notes. If we settle the conversion of the Notes in cash on or prior to the maturity date of September 1, 2019, the cash outflow of $63.6 million will be recorded in operating activities in the Condensed Consolidated Statement of Cash Flows. The Notes were not settled as of June 30, 2018. We will apply ASU 2016-15 upon any cash settlement of the Notes.

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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Recent Accounting Pronouncements Not Yet Adopted
Lease Arrangements. Under current guidance, the classification of a lease by a lessee as either an operating or capital lease determines whether an asset and liability is recognized on the balance sheet. ASU 2016-2, Leases, which was issued in February 2016 and will be effective in the first quarter of 2019, requires that a lessee recognize an asset and liability on its balance sheet related to all leases with terms more than one year. For all leases, a lessee will be required to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position. The right-to-use asset represents the right to use the underlying asset during the lease term.
The recognition, measurement, and presentation of expenses and cash flows by a lessee have not significantly changed from previous guidance. There continues to be a differentiation between finance leases and operating leases. The criteria for determining whether a lease is a finance or operating lease are substantially the same as existing guidance except that the “bright line” percentages have been removed. Also, an additional criterion has been added in the new guidance to consider whether the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. Additional judgment will be required in applying the new lease guidance.
For finance leases, interest is recognized on the lease liability separately from depreciation of the right-of-use asset in the statement of operations. Principal repayments are classified within financing activities and interest payments are classified as operating activities in the statement of cash flows.
For operating leases, a lessee is required to recognize lease expense generally on a straight-line basis. All operating lease payments are classified as operating activities in the statement of cash flows.
The current build-to-suit lease accounting guidance will be rescinded by the new guidance, although simplified guidance will remain regarding lessee control during the construction period. Consequently, the accounting for build-to-suit leases will be the same as operating leases unless the lessee control provisions are applicable.
We expect to apply the additional transition method provided in ASU 2018-11, which allows us to initially apply the new leases standard at our January 1, 2019 adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. We have not yet quantified the impact, but the requirement to recognize a right-of-use asset and a lease liability related to operating leases will have a material impact on our financial position as reflected on our Consolidated Balance Sheets. The adoption of this standard to our lease transactions as lessee is not expected to have a material impact on our results of operations as reflected in our Consolidated Statements of Operations. We do not expect a material impact on our results of operations or financial position from adoption of this standard to our lease transactions as lessor.
Significant Accounting Policies
There have been no material changes in our significant accounting policies, as compared to the significant accounting policies described in our 2017 Form 10-K, with the exception of the following:
Revenue Recognition
On January 1, 2018, we adopted ASC 606 using the modified retrospective method applied to those contracts that were not completed as of January 1, 2018. On January 1, 2018, we also adopted ASC 340-40 using the modified retrospective method applied to all contracts as of the date of initial application.
We apply judgment in determining the customer’s ability and intention to pay. Judgments are made after considering a variety of factors including the customer’s historical payment experience, current creditworthiness, current economic impacts on the customer, past due balances, and significant one-time events or, in the case of a new customer, published credit and financial information.
For customer arrangements that include multiple products or services, judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. Where an observable price is not available, we gather all reasonable available data points, consider adjustments based on market conditions, entity-specific factors, and the need to stratify selling prices into meaningful groups (e.g., geographic region) in determining SSP. We allocate the total contract consideration to each distinct performance obligation on a relative SSP basis. Revenue is then recognized in accordance with the timing of the transfer of control to the customer.
Accounting for long-term contracts where we provide information technology system development and implementation services requires significant judgment to estimate total contract revenue and costs. For long-term contracts, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete the services. We then recognize that revenue and profit over the life of the contract. Contract estimates are based on various assumptions to project the outcome of future events that could span several years.

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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


A change in our estimate of total costs to complete could affect the profitability of our contracts. We review and update our contract-related estimates regularly, and the effects of changes, if any, are reflected in the Condensed Consolidated Statements of Operations in the period that they are determined. Changes in estimates related to certain types of contracts accounted for using an input method measure of progress, such as cost-to-cost, can occur over the life of a contract for a variety of reasons, including the availability of labor and labor productivity, the nature and complexity of the work to be performed, cost estimates, level of effort and/or other assumptions impacting revenue or cost to perform a contract. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If, at any time, the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter it is identified.
Management exercises judgment to determine the period of benefit to amortize contract acquisition costs by considering factors such as expected renewals of customer contracts, duration of customer relationships and our technology development life cycle. Although we believe that the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Amortization of deferred contract acquisition costs is included in sales and marketing expense in the Condensed Consolidated Statements of Operations. We periodically review these deferred costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred contract acquisition costs.
The nature of our products and services are as follows:
Hardware. Our hardware, such as Industrial Inkjet printers and Fiery digital front ends (“DFEs”), is generally sold with software that is integral to the functionality of the product. In these cases, the hardware and software license are accounted for as a single performance obligation. The contract consideration is generally in the form of a fixed fee at contract inception and revenue is recognized at the point in time when control is transferred to the customer. Consideration received from customers may include trade-in printers, which are valued at the lower of cost or net realizable value.
We offer shipping and handling services to customers related to the sale of hardware. We have elected the practical expedient to account for shipping and handling activities performed after transferring control of goods to our customer as a cost to fulfill the contract. The cost of shipping and handling is accrued at the point in which control transfers to the customer and revenue is recognized.
Ink. We typically enter into contracts with our existing customer base of installed printers to purchase ink that is not bundled with other deliverables within the contract. The ink is accounted for as a single performance obligation and revenue is recognized at the point in time when control of ink is transferred to the customer.
License. Our software license arrangements provide the customer with the right to install and use functional intellectual property (as it exists at the point in time at which the license is granted) for the duration of the contract term. Revenue from distinct software licenses is recognized at the point in time when the software is made available to the customer for download.

Our software license arrangements are generally comprised of fixed license fees (“license fees”) that are payable upfront, annually, quarterly, or monthly based on negotiated customer payment terms. For software license arrangements in which a significant portion of the license fees are due more than 12 months after the software is delivered to the customer, a significant financing component may exist. The significant financing component is calculated as the difference between the stated value and present value of the software license fees and is recognized as interest income under the effective interest method over the contract term. The total software license fee net of the significant financing component is recognized as revenue at the point in time when the software is made available to the customer for download or when the software is shipped to the customer. In instances where the timing of revenue recognition and the timing of invoicing is one year or less, we follow the practical expedient and do not impute interest for these contracts.
Maintenance. Our software license arrangements typically include an initial (bundled) post contract customer support (maintenance or “PCS”) term. Our promise to those customers who elect to purchase PCS represents a distinct, stand-ready performance obligation. Contract consideration is allocated to the PCS based on its relative SSP and revenue is recognized over the PCS term.
Professional Services. We provide various professional services to customers, primarily project management, software implementation, and training. Revenues from arrangements to provide professional services are generally distinct from the other promises in the contract(s). The majority of our professional services contracts are billed on a time and materials basis and revenue is recognized over time as the services are performed.

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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Software as a Service (“SaaS”). Our SaaS-based arrangements provide customers with continuous access to the software solutions in the form of a service hosted in the cloud. These arrangements may include initial implementation and setup and/or on-going support that represent a single promise (i.e. each individual promised component is not distinct) to provide continuous access to the software solution. Any setup fees associated with our SaaS arrangements are recognized ratably over the contract term plus expected renewal periods. As the customer simultaneously receives and consumes the benefits as access is provided, our performance obligation under our SaaS-based arrangements is comprised of a series of distinct components delivered over time. Our SaaS-based arrangements consideration is typically fixed.
Extended Service Plans (“ESP”). For our hardware arrangements, we enter into contracts with customers to provide services to maintain and repair the hardware for an extended period. ESPs are classified as service-type warranties under ASC 606 as they are sold separately and provide services which are incremental to the assurance that the product will perform to the agreed upon standards. The ESPs are accounted for as a separate performance obligation. Revenue from ESPs are recognized ratably over the contract period as the service is provided.
Note 2.     Earnings Per Share
Net income per basic common share is computed using the weighted average number of common shares outstanding during the period. Net income per diluted common share is computed using the weighted average number of common and dilutive potential common shares outstanding during the period. Potential common shares result from the assumed exercise of outstanding common stock options having a dilutive effect using the treasury stock method, non-vested shares of time-based restricted stock units ("RSUs") having a dilutive effect, non-vested performance-based restricted stock units ("PSUs") for which the performance criteria have been met, shares to be purchased under our Employee Stock Purchase Plan (“ESPP”) having a dilutive effect, the assumed release of shares from escrow for the expected satisfaction of contingent consideration based on achievement of specified performance criteria related to the acquisition of Corrugated Technologies, Inc. (“CTI”), the assumed conversion of our Notes having a dilutive effect using the treasury stock method when the stock price exceeds the conversion price of the Notes, as well as the dilutive effect of our warrants when the stock price exceeds the warrant strike price. Our stock price has not exceeded the conversion price of the Notes or the strike price of the warrants during any periods presented. Any potential shares that are anti-dilutive are excluded from the effect of dilutive securities.
PSUs and market-based restricted stock units that would be issuable if the end of the reporting period were the end of the vesting period, if the result would be dilutive, are assumed to be outstanding for purposes of determining net income per diluted common share as of the later of the beginning of the period or the grant date. Accordingly, PSUs, which vested on various dates during the three and six months ended June 30, 2018and 2017, based on achievement of specified performance criteria related to revenue, cash flows from operating activities, and non-GAAP operating income targets, are included in the determination of net income per diluted common share as of the beginning of each period.
Basic and diluted earnings per share are reconciled as follows (in thousands, except per share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Basic net income per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
3,768

 
$
2,759

 
$
173

 
$
7,546

Weighted average common shares outstanding
44,691

 
46,429

 
44,860

 
46,490

Basic net income per share
$
0.08

 
$
0.06

 
$

 
$
0.16

Diluted net income per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
3,768

 
$
2,759

 
$
173

 
$
7,546

Weighted average common shares outstanding
44,691

 
46,429

 
44,860

 
46,490

Dilutive stock options and non-vested RSUs and PSUs
748

 
721

 
601

 
709

Weighted average common shares outstanding for purposes of computing diluted net income per share
45,439

 
47,150

 
45,461

 
47,199

Diluted net income per share
$
0.08

 
$
0.06

 
$

 
$
0.16


11


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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Potential shares of common stock that were not included in the determination of diluted net income per share because the impact of including them would have been anti-dilutive or performance conditions have not been met, consisted of the following (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
RSUs & PSUs
592

 
437

 
446

 
399

ESPP purchase rights
799

 

 
1,113

 
476

Total potential shares of common stock excluded from the computation of diluted earnings per share
1,391

 
437

 
1,559

 
875


The weighted-average number of common shares outstanding does not include the effect of the potential common shares from conversion of our Notes and exercise of our warrants. The effects of these potentially outstanding shares were not included in the calculation of diluted net income per share because the effect would have been anti-dilutive since the conversion price of the Notes and the strike price of the warrants exceeded the average market price of our common stock. We have the option to pay cash, issue shares of common stock, or any combination thereof for the aggregate amount due upon conversion of the Notes. Our intent is to settle the principal amount of the Notes in cash upon conversion. As a result, only amounts payable in excess of the principal amount of the Notes are considered in diluted net income per share under the treasury stock method. The Note Hedges are not included in the calculation of diluted net income per share because the effect of any exercise of the Note Hedges would be anti-dilutive. Please refer to Note 9Convertible Senior Notes for additional information and definitions.
Note 3.     Segment and Geographic Information
Operating segment information is presented based on the internal reporting used by the chief operating decision making group (“CODM”) to allocate resources and evaluate operating segment performance. Our segments consist of Industrial Inkjet, Productivity Software, and Fiery.

Industrial Inkjet consists of our VUTEk super-wide and wide format display graphics, Nozomi corrugated packaging and display, Reggiani textile, and Cretaprint ceramic tile decoration and building material industrial digital inkjet printers; digital ultra-violet (“UV”) curable, light-emitting diode (“LED”) curable, ceramic, water-based, and thermoforming and specialty inks, as well as a variety of textile inks including dye sublimation, pigmented, reactive dye, acid dye, pure disperse dye, water-based dispersed printing ink, supplies, and coatings; digital inkjet printer parts; and professional services. Printing surfaces include paper, vinyl, corrugated, textile, glass, plastic, aluminum composite, ceramic tile, wood, and many other flexible and rigid substrates.
Productivity Software consists of a complete software suite that enables efficient and automated end-to-end business and production workflows for the print and packaging industry. This Productivity Suite also provides tools to enable revenue growth, efficient scheduling, and optimization of processes, equipment, and personnel. Customers are provided the financial and technical flexibility to deploy locally within their business or to be hosted in the cloud. The Productivity Suite addresses all segments of the print industry and consists of the: (i) Packaging Suite, with Radius at its core, for tag & label, cartons, and flexible packaging businesses; (ii) Corrugated Packaging Suite, with CTI at its core, for corrugated packaging businesses, including corrugated control capability using EFI Escada; (iii) Enterprise Commercial Print Suite, with Monarch at its core, for enterprise print businesses; (iv) Publication Print Suite, with Monarch or Technique at its core, for publication print businesses; (v) Midmarket Print Suite, with Pace at its core, for medium size print businesses; (vi) Quick Print Suite, with PrintSmith Vision and essential capabilities of Digital StoreFront at its core, for small printers and in-plant sites; and (vii) Value Added Products, available with the suite and standalone, such as web-to-print, e-commerce, cross media marketing, warehousing, fulfillment, shop floor data collection, and shipping to reduce costs, increase profits, and offer new products and services to their existing and future customers. We also market Optitex computer-aided fashion design (“fashion CAD”) software, which facilitates fast fashion and increased efficiency in the textile and fashion industries.
Fiery consists of Fiery and FreeFlow Print Server (“FFPS”), which was acquired from Xerox Corporation (“Xerox”), that transform digital copiers and printers into high performance networked printing devices for the office, commercial and industrial printing markets. This operating segment is comprised of (i) stand-alone DFEs connected to digital printers, copiers, and other peripheral devices, (ii) embedded DFEs and design-licensed solutions used in digital copiers and multi-functional devices, (iii) optional software integrated into our DFE solutions such as Fiery Central, and Graphics Arts Package, (iv) Fiery Self Serve, our self-service and payment solution, and (v) stand-alone software-based solutions such as our proofing, textile, and scanning solutions.
Operating income is not reported by operating segment because operating expenses include significant shared expenses and other costs that are managed outside of the operating segments. Such operating expenses include various corporate expenses such as stock-

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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


based compensation, corporate sales and marketing, research and development, amortization of identified intangibles, various non-recurring charges, and other separately managed general and administrative expenses.
Our revenue and gross profit (i.e., gross profit excluding stock-based compensation expense and amortization of the fair value adjustment on acquired FFPS inventory) by operating segment are summarized as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Industrial Inkjet
 
 
 
 
 
 
 
Revenue
$
156,434

 
$
141,693

 
$
298,643

 
$
264,956

Gross profit
54,983

 
52,510

 
104,690

 
101,580

Gross profit percentages
35.1
%
 
37.1
%
 
35.1
%
 
38.3
%
Productivity Software
 
 
 
 
 
 
 
Revenue
$
41,612

 
$
39,063

 
$
85,387

 
$
74,121

Gross profit
29,181

 
29,168

 
60,594

 
54,764

Gross profit percentages
70.1
%
 
74.7
%
 
71.0
%
 
73.9
%
Fiery
 
 
 
 
 
 
 
Revenue
$
63,026

 
$
66,291

 
$
116,908

 
$
136,661

Gross profit
45,467

 
46,239

 
84,222

 
95,937

Gross profit percentages
72.1
%
 
69.8
%
 
72.0
%
 
70.2
%
Operating segment profit is reconciled to our Condensed Consolidated Statements of Operations as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Segment gross profit
$
129,631

 
$
127,917

 
$
249,506

 
$
252,281

Stock-based compensation expense
(1,043
)
 
(665
)
 
(1,811
)
 
(1,499
)
Gross profit
$
128,588

 
$
127,252

 
$
247,695

 
$
250,782


Tangible and intangible assets, net of liabilities, are summarized by operating segment as follows (in thousands):
June 30, 2018
Industrial
Inkjet
 
Productivity
Software
 
Fiery
 
Corporate and
Unallocated Net
Assets
 
Total
Goodwill
$
150,682

 
$
170,632

 
$
74,107

 
$

 
$
395,421

Identified intangible assets, net
52,216

 
28,272

 
17,048

 

 
97,536

Tangible assets, net of liabilities
240,548

 
(22,908
)
 
11,030

 
45,729

 
274,399

Net tangible and intangible assets
$
443,446

 
$
175,996

 
$
102,185

 
$
45,729

 
$
767,356

December 31, 2017
 
 
 
 
 
 
 
 
 
Goodwill
$
154,373

 
$
174,644

 
$
74,261

 
$

 
$
403,278

Identified intangible assets, net
66,547

 
36,379

 
20,082

 

 
123,008

Tangible assets, net of liabilities
221,933

 
(27,755
)
 
11,286

 
49,561

 
255,025

Net tangible and intangible assets
$
442,853

 
$
183,268

 
$
105,629

 
$
49,561

 
$
781,311


Corporate and unallocated assets and liabilities consist of cash and cash equivalents, short-term investments, restricted cash equivalents, corporate headquarters facility, convertible senior notes, imputed financing obligation related to build-to-suit lease, income taxes receivable, and income taxes payable.

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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Geographic Regions
We report revenue by geographic region based on ship-to destination, summarized as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Americas
$
122,294

 
$
114,014

 
$
239,679

 
$
223,909

Europe, Middle East, and Africa (“EMEA”)
94,010

 
101,513

 
182,185

 
189,546

Asia Pacific (“APAC”)
44,768

 
31,520

 
79,074

 
62,283

Total revenue
$
261,072

 
$
247,047

 
$
500,938

 
$
475,738

Note 4.     Revenue
We derive our revenue primarily from product revenue, which includes industrial digital inkjet printers, ink, and parts; print production software; and Fiery DFEs. We receive service revenue from printer maintenance agreements, customer support, training, software development, and consulting.
In accordance with ASC 606, revenue is recognized when control of the promised products and/or services is transferred to our customers in an amount reflecting the consideration we are entitled to in exchange for those products or services. In accordance with ASC 340-40, incremental costs of obtaining a contract with a customer are deferred and recognized over the contract term.
Upon the adoption of ASC 606 and ASC 340-40, we recorded a net increase to our opening balance of retained earnings of $4.7 million as of January 1, 2018, after considering the income tax impact, due to the cumulative effect of adoption. The adoption impact primarily related to capitalizing customer contract acquisition costs consisting of sales commissions, partially offset by an increase in deferred revenue to reflect the inclusion of a significant financing component that will be recognized as interest income as payments are received over the contractual terms, and deferral of upfront setup fees that will recognized ratably over the expected contractual terms.

The cumulative effect of applying ASC 606 and ASC 340-40 to active contracts as of the adoption date resulted in the following adjustments to the Condensed Consolidated Balance Sheet as of January 1, 2018 (in thousands):
 
As previously Reported at
December 31, 2017
 
ASC 606
Adjustments
 
As Adjusted
January 1, 2018
Assets
 
 
 
 
 
Accounts receivable, net
$
244,416

 
$
102

 
$
244,518

Other current assets
41,799

 
(1,628
)
 
40,171

Deferred tax assets
45,083

 
(1,466
)
 
43,617

Other assets
15,504

 
8,062

 
23,566

Liabilities
 
 
 
 
 
Deferred revenue
55,833

 
(95
)
 
55,738

Noncurrent contingent and other liabilities
28,801

 
491

 
29,292

Stockholders’ equity:
 
 
 
 
 
Retained earnings
402,544

 
4,674

 
407,218


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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


The impact of adopting ASC 606 and ASC 340-40 on our Condensed Consolidated Statement of Operations is summarized as follows (in thousands):
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
Amounts in
Accordance with
ASC 606
 
Amounts in
Accordance with
ASC 605
 
Effect of change
higher (lower)
 
Amounts in
Accordance with
ASC 606
 
Amounts in
Accordance with
ASC 605
 
Effect of change
higher (lower)
Revenue
$
261,072

 
$
260,195

 
$
877

 
$
500,938

 
$
498,602

 
$
2,336

Cost of revenue
132,484

 
132,625

 
(141
)
 
253,243

 
253,442

 
(199
)
Gross profit
128,588

 
127,570

 
1,018

 
247,695

 
245,160

 
2,535

Operating expenses
114,944

 
115,069

 
(125
)
 
236,116

 
236,102

 
14

Income from operations
13,644

 
12,501

 
1,143

 
11,579

 
9,058

 
2,521

Interest income and other income (expense), net
(355
)
 
(490
)
 
135

 
934

 
624

 
310

Income before income taxes
8,300

 
7,022

 
1,278

 
2,570

 
(261
)
 
2,831

Provision for income taxes
(4,532
)
 
(4,386
)
 
(146
)
 
(2,397
)
 
(2,102
)
 
(295
)
Net income
3,768

 
2,636

 
1,132

 
173

 
(2,363
)
 
2,536

The impact of adopting ASC 606 and ASC 340-40 on our Condensed Consolidated Balance Sheet as of June 30, 2018 was as follows (in thousands):
 
Amounts in
Accordance with
ASC 606
 
Amounts in
Accordance with
ASC 605
 
Effect of change
higher (lower)
Assets
 
 
 
 
 
Accounts receivable, net
$
243,400

 
$
240,814

 
$
2,586

Other current assets
57,814

 
59,243

 
(1,429
)
Deferred tax assets
44,384

 
46,145

 
(1,761
)
Other assets
29,885

 
21,837

 
8,048

Liabilities
 
 
 
 
 
Deferred revenue
66,581

 
66,735

 
(154
)
Noncurrent contingent and other liabilities
20,185

 
19,798

 
387

Stockholders’ equity
 
 
 
 
 
Retained earnings
407,392

 
400,181

 
7,211



15


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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


The following table presents our disaggregated revenue by source (in thousands). Sales and usage-based taxes are excluded from revenue:
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
Industrial
Inkjet
 
Productivity
Software
 
Fiery
 
Total
 
Industrial
Inkjet
 
Productivity
Software
 
Fiery
 
Total
Major Products and Service Lines:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Industrial Inkjet
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Printers and parts
$
97,599

 
$

 
$

 
$
97,599

 
$
185,973

 
$

 
$

 
$
185,973

Ink, supplies, and maintenance
58,835

 

 

 
58,835

 
112,670

 

 

 
112,670

Productivity Software
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Licenses

 
10,656

 

 
10,656

 

 
23,312

 

 
23,312

Professional services

 
8,025

 

 
8,025

 

 
15,570

 

 
15,570

Maintenance and subscriptions

 
22,931

 

 
22,931

 

 
46,505

 

 
46,505

Fiery
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Digital front ends and related
 products

 

 
59,360

 
59,360

 

 

 
109,456

 
109,456

Maintenance and subscriptions

 

 
3,666

 
3,666

 

 

 
7,452

 
7,452

Total
$
156,434

 
$
41,612

 
$
63,026

 
$
261,072

 
$
298,643

 
$
85,387

 
$
116,908

 
$
500,938

Timing of Revenue Recognition:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Transferred at a Point in Time
$
151,149

 
$
10,656

 
$
59,360

 
$
221,165

 
$
288,259

 
$
23,312

 
$
109,456

 
$
421,027

Transferred Over Time
5,285

 
30,956

 
3,666

 
39,907

 
10,384

 
62,075

 
7,452

 
79,911

Total
$
156,434

 
$
41,612

 
$
63,026

 
$
261,072

 
$
298,643

 
$
85,387

 
$
116,908

 
$
500,938

Recurring/Non-Recurring:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-Recurring
$
97,599

 
$
18,681

 
$
59,360

 
$
175,640

 
$
185,973

 
$
38,882

 
$
109,456

 
$
334,311

Recurring
58,835

 
22,931

 
3,666

 
85,432

 
112,670

 
46,505

 
7,452

 
166,627

Total
$
156,434

 
$
41,612

 
$
63,026

 
$
261,072

 
$
298,643

 
$
85,387

 
$
116,908

 
$
500,938

Remaining Performance Obligations
Revenue allocated to remaining performance obligations includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods (“backlog”). Remaining performance obligations were $128.2 million as of June 30, 2018, of which we expect to recognize substantially all of the revenue over the next 12 months.
Contract Balances
Timing of revenue recognition may differ from timing of invoicing to customers. Payment terms and conditions vary by contract. Deferred revenue (contract liability) represents amounts received in advance, or invoiced in advance, for product support contracts, software customer support contracts, consulting and integration projects, SaaS arrangements, or product sales. We defer these amounts when we collect or invoice the customer and then generally recognize revenue either ratably over the support contract term, upon performing the related services, under the cost-to-cost method, or in accordance with our revenue recognition policy. Revenue recognized during the three and six months ended June 30, 2018, which was included in deferred revenue as of December 31, 2017, was $11.8 and $37.7 million, respectively.
Unbilled accounts receivable represents contract assets for revenue that have been recognized in advance of billing the customer, which is common for long-term contracts. Billing requirements vary by contract but are generally structured around the completion of certain development milestones. Unbilled accounts receivable as of December 31, 2017, that were transferred to accounts receivable during the three and six months ended June 30, 2018, were $10.3 and $21.9 million, respectively.

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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


The following table reflects the balances in unbilled accounts receivable and deferred revenue (in thousands):
 
June 30, 2018
 
January 1, 2018
Unbilled accounts receivable – current
$
30,557

 
$
23,296

Unbilled accounts receivable – noncurrent
4,055

 
4,122

Deferred revenue – current
66,581

 
55,738

Deferred revenue – noncurrent
434

 
565

Note 5.     Supplemental Financial Statement Information
Supplemental Cash Flow Information
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
Net cash paid for income taxes
$
8,799

 
$
7,115

Cash paid for interest expense
1,560

 
2,011

Property, equipment, and intellectual property received, but not paid
1,472

 
843

Inventories
Inventories are summarized as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Raw materials
$
50,416

 
$
57,061

Work-in-process
12,831

 
9,792

Finished goods
54,868

 
58,960

Total
$
118,115

 
$
125,813

Deferred Contract Acquisition Costs
Certain of our sales incentive programs that meet the definition of an incremental cost of obtaining a customer contract are required to be capitalized under ASC 340-40. We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year.
Sales commissions for renewal of a contract may not be commensurate with the commissions paid for the acquisition of the initial contract because commissions are generally not paid on the renewal of the specifically anticipated contract. Sales commissions for initial contracts are deferred and then amortized generally on a straight-line basis over a period of benefit that we have determined to be three to four years. We determined the period of benefit by taking into consideration our customer contracts, our technology, and other factors.
Upon adoption of ASC 340-40 on January 1, 2018, we capitalized $8.1 million in contract acquisition costs related to contracts that were not completed. For contracts that have durations of less than one year, we follow the practical expedient and expense these costs when incurred.
During the three and six months ended June 30, 2018, we amortized $1.0 and $2.1 million of deferred contract acquisition costs, respectively, and we recognized no impairment losses in relation to costs capitalized. During the three and six months ended June 30, 2018, an additional $1.1 and $2.1 million of contract acquisition costs were capitalized, respectively. Deferred contract acquisition costs are included within other noncurrent assets in our Condensed Consolidated Balance Sheets.
Deferred Cost of Revenue
Deferred cost of revenue related to unrecognized revenue on shipments to customers was $0.4 and $3.5 million as of June 30, 2018 and December 31, 2017, respectively, and is included in other current assets in our Condensed Consolidated Balance Sheets.


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Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Product Warranty Reserves
Product warranty reserves are included in accrued and other liabilities on our Condensed Consolidated Balance Sheets. The changes in product warranty reserves are as follows (in thousands):
 
June 30,
 
2018
 
2017
Beginning balance
$
16,335

 
$
10,319

Liability assumed upon acquiring FFPS

 
9,368

Provisions, net of releases
4,265

 
4,790

Settlements
(6,795
)
 
(6,254
)
Ending balance
$
13,805

 
$
18,223

Equipment Subject to Operating Leases, Net
Equipment subject to operating leases was as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Equipment subject to operating leases
$
8,025

 
$
5,432

Accumulated depreciation
(2,788
)
 
(1,927
)
Equipment subject to operating leases, net
$
5,237

 
$
3,505

Scheduled minimum future rental revenue on operating leases as of June 30, 2018 was as follows (in thousands):
Remainder of 2018
$
1,120

2019
2,244

2020
2,826

2021
384

2022
432

 
$
7,006

Accumulated Other Comprehensive Income (Loss) (“AOCI”)
AOCI classified within stockholders’ equity in our Condensed Consolidated Balance Sheets was as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Net unrealized investment losses
$
(1,122
)
 
$
(697
)
Currency translation gains (losses)
(4,080
)
 
8,794

Net unrealized gains on cash flow hedges

 
41

Total
$
(5,202
)
 
$
8,138

Amounts reclassified out of AOCI, net of tax, were immaterial for all periods presented, and consisted of unrealized gains and losses from investments in debt securities that are reported within interest income and other income (expense), net, in our Condensed Consolidated Statements of Operations.

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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Note 6.     Accounts Receivable
Financing Receivables
Our financing receivables consist of sales-type lease and trade receivables that have an original contractual maturity in excess of one year. Sales-type lease receivables are included within other current assets and other assets, while trade receivables are included in accounts receivable (net of allowances) and other assets. Our financing receivables are summarized as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
Sales-type lease receivables
$
22,147

 
$
16,558

Trade receivables
12,121

 
12,125

Total financing receivables
$
34,268

 
$
28,683

 
 
 
 
Scheduled to be received in excess of one year
$
18,352

 
$
15,191

The credit quality of financing receivables is evaluated on the same basis as trade receivables. We do not have material past due financing receivables.
Accounts Receivable Sales Arrangements
Trade receivables are derecognized from our Condensed Consolidated Balance Sheet when sold to third parties upon determining that such receivables are presumptively beyond the reach of creditors in a bankruptcy proceeding. Any recourse obligation is measured using market data from similar transactions and the servicing liability is determined based on the fair value that a third party would charge to service these receivables. These liabilities were determined to not be material as of June 30, 2018 and December 31, 2017.
We have facilities in the U.S. and Europe that enable us to sell to third parties, on an ongoing basis, certain trade receivables with recourse. Trade receivables sold with recourse are generally short-term receivables with payment due dates of less than 10 days from the date of sale. Trade receivables sold under these facilities were $6.8 and $10.0 million during the three and six months ended June 30, 2018, respectively, and $21.4 million during the year ended December 31, 2017, which approximates the cash received.
We have facilities in Europe that enable us to sell to third parties, on an ongoing basis, certain trade receivables without recourse. Trade receivables sold without recourse are generally short-term receivables secured by letters of credit with payment due dates of less than one year. Trade receivables sold under these facilities were $4.3 and $5.7 million during the three and six months ended June 30, 2018, respectively, and $5.9 million during the year ended December 31, 2017, which approximates the cash received.

We report collections from the sale of trade receivables to third parties as operating cash flows in the Condensed Consolidated Statements of Cash Flows.
Note 7.     Fair Value Measurements
We invest our excess cash on deposit with major banks in money market, United States (“U.S.”) Treasury and government-sponsored entity, corporate, municipal government, asset-backed, and mortgage-backed residential debt securities. By policy, we invest primarily in high-grade marketable securities. We are exposed to credit risk in the event of default by the financial institutions or issuers of these investments to the extent of the amounts recorded in our Condensed Consolidated Balance Sheets.
We consider all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. Typically, the cost of these investments approximates fair value. Marketable investments with a maturity greater than three months are classified as available-for-sale short-term investments. Available-for-sale securities are stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. The credit portion of any other-than-temporary impairment is included in net income. Realized gains and losses on sales of financial instruments are recognized upon sale of the investments using the specific identification method.

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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Our available-for-sale short-term investments are summarized as follows (in thousands):
 
Amortized cost
 
Gross unrealized
gains
 
Gross unrealized
losses
 
Fair value
June 30, 2018
 
 
 
 
 
 
 
U.S. Government and sponsored entities
$
59,822

 
$

 
$
(773
)
 
$
59,049

Corporate debt securities
66,529

 

 
(662
)
 
65,867

Municipal securities
382

 

 
(3
)
 
379

Asset-backed securities
8,545

 
35

 
(77
)
 
8,503

Mortgage-backed securities – residential
210

 

 
(2
)
 
208

Total short-term investments
$
135,488

 
$
35

 
$
(1,517
)
 
$
134,006

December 31, 2017
 
 
 
 
 
 
 
U.S. Government and sponsored entities
$
59,824

 
$

 
$
(660
)
 
$
59,164

Corporate debt securities
79,356

 

 
(450
)
 
78,906

Municipal securities
382

 

 
(2
)
 
380

Asset-backed securities
9,808

 
44

 
(47
)
 
9,805

Mortgage-backed securities – residential
445

 

 
(3
)
 
442

Total short-term investments
$
149,815

 
$
44

 
$
(1,162
)
 
$
148,697

The fair value and duration that investments, including cash equivalents, have been in a gross unrealized loss position below are as follows (in thousands):
 
Less than 12 Months
 
More than 12 Months
 
Total
  
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and sponsored entities
$
22,889

 
$
(346
)
 
$
36,008

 
$
(427
)
 
$
58,897

 
$
(773
)
Corporate debt securities
32,229

 
(349
)
 
33,293

 
(313
)
 
65,522

 
(662
)
Municipal securities
377

 
(3
)
 

 

 
377

 
(3
)
Asset-backed securities
4,302

 
(56
)
 
4,134

 
(21
)
 
8,436

 
(77
)
Mortgage-backed securities – residential
11

 

 
160

 
(2
)
 
171

 
(2
)
Total
$
59,808

 
$
(754
)
 
$
73,595

 
$
(763
)
 
$
133,403

 
$
(1,517
)
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and sponsored entities
$
23,023

 
$
(206
)
 
$
35,989

 
$
(454
)
 
$
59,012

 
$
(660
)
Corporate debt securities
45,857

 
(207
)
 
32,634

 
(243
)
 
78,491

 
(450
)
Municipal securities
378

 
(2
)
 

 

 
378

 
(2
)
Asset-backed securities
6,779

 
(31
)
 
2,947

 
(16
)
 
9,726

 
(47
)
Mortgage-backed securities – residential
162

 
(2
)
 
142

 
(1
)
 
304

 
(3
)
Total
$
76,199

 
$
(448
)
 
$
71,712

 
$
(714
)
 
$
147,911

 
$
(1,162
)
For fixed income securities that have unrealized losses as of June 30, 2018, we do not have the intent to sell any of these investments and it is not more likely than not that we will be required to sell any of these investments before recovery of the entire amortized cost basis. We have evaluated these fixed income securities and determined that no credit losses exist. Accordingly, management has determined that the unrealized losses on our fixed income securities as of June 30, 2018 were temporary in nature.


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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Amortized cost and estimated fair value of investments as of June 30, 2018, are summarized as follows (in thousands):
 
Amortized cost
 
Fair value
Mature in less than one year
$
78,377

 
$
77,843

Mature in one to three years
57,111

 
56,163

Total short-term investments
$
135,488

 
$
134,006

Net realized gains from sales of investments are recognized in interest income and other income (expense), net, and were immaterial during the three and six months ended June 30, 2018, and June 30, 2017, respectively. Net unrealized losses of $1.5 and $1.1 million were included in AOCI in the accompanying Condensed Consolidated Balance Sheets as of June 30, 2018, and December 31, 2017, respectively.
Fair Value Measurements
Our fair value hierarchy is defined as follows:
Level 1: Inputs that are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;
Level 2: Inputs that are other than quoted prices included within Level 1, that are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date for the duration of the instrument’s anticipated life or by comparison to similar instruments; and
Level 3: Inputs that are unobservable or reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. These include management’s own judgments about market participant assumptions developed based on the best information available in the circumstances.
We utilize the market approach to measure the fair value of our fixed income securities. The market approach is a valuation technique that uses the prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of our fixed income securities is obtained using readily-available market prices from a variety of industry standard data providers, large financial institutions, and other third-party sources for the identical underlying securities. The fair value of our investments in certain money market funds is expected to maintain a net asset value of $1 per share and, as such, is priced at the expected market price.
We obtain the fair value of our Level 2 financial instruments from several third-party asset managers, custodian banks, and accounting service providers. Independently, these service providers use professional pricing services to gather pricing data, which may include quoted market prices for identical or comparable instruments or inputs other than quoted prices that are observable either directly or indirectly. As part of this process, we engaged a pricing service to assist management in its pricing analysis and assessment of other-than-temporary impairment. All estimates, key assumptions, and forecasts were either provided by or reviewed by us. While we utilize a third-party pricing service, the impairment analysis and related valuations represent conclusions of management and not conclusions or statements of any third party.


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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Our assets and liabilities measured at fair value by levels within the fair value hierarchy are summarized as follows (in thousands):
 
June 30, 2018
 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
1,017

 
$

 
$

 
$
1,017

 
$
9,897

 
$

 
$

 
$
9,897

U.S. Government and sponsored
 entities
33,207

 
25,842

 

 
59,049

 
33,261

 
25,903

 

 
59,164

Corporate debt securities

 
65,867

 

 
65,867

 

 
78,906

 

 
78,906

Municipal securities

 
378

 

 
378

 

 
380

 

 
380

Asset-backed securities

 
8,462

 
43

 
8,505

 

 
9,754

 
51

 
9,805

Mortgage-backed securities
 – residential

 
208

 

 
208

 

 
442

 

 
442

 
$
34,224

 
$
100,757

 
$
43

 
$
135,024

 
$
43,158

 
$
115,385

 
$
51

 
$
158,594

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration,
 current and noncurrent
$

 
$

 
$
22,129

 
$
22,129

 
$

 
$

 
$
35,702

 
$
35,702

Self-insurance

 

 
969

 
969

 

 

 
902

 
902

 
$

 
$

 
$
23,098

 
$
23,098

 
$

 
$

 
$
36,604

 
$
36,604

Money market funds have been classified as cash equivalents as of June 30, 2018, and December 31, 2017, respectively.
Investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices or alternative pricing sources with reasonable levels of price transparency. Investments in U.S. Treasury obligations and overnight money market mutual funds have been classified as Level 1 because these securities are valued based on quoted prices in active markets or are actively traded at $1.00 net asset value. There have been no transfers between Level 1 and 2 during the six months ended June 30, 2018 and 2017.
Government agency investments and corporate debt instruments, including investments in asset-backed and mortgage-backed securities, have generally been classified as Level 2 because markets for these securities are less active or valuations for such securities utilize significant inputs, which are directly or indirectly observable. We hold asset-backed securities with income payments derived from and collateralized by a specified pool of underlying assets. Asset-backed securities in the portfolio are predominantly collateralized by credit cards and auto loans. We also hold two asset-backed securities collateralized by mortgage loans, which have been fully reserved.
Liabilities for Contingent Consideration
Acquisition-related liabilities for contingent consideration (i.e., earnouts) as of June 30, 2018 are related to the acquisitions of Escada Innovations Limited and Escada Systems, Inc. (collectively, “Escada”) and Generation Digital Solutions, Inc. (“Generation Digital”), in 2017; Optitex Ltd. (“Optitex”) and Rialco Limited (“Rialco”) in 2016; Shuttleworth Business Systems Limited and CDM Solutions Limited (collectively, “Shuttleworth”), and CTI in 2015; and PrintLeader Software (“PrintLeader”) in 2013.

The fair value of these earnouts is estimated to be $22.1 and $35.7 million as of June 30, 2018, and December 31, 2017, respectively, by applying the income approach in accordance with ASC 805-30-25-5. Key assumptions include risk-free discount rates between 0.6% and 4.98%, as well as probability-adjusted revenue, gross profit, and direct operating income using the Monte Carlo valuation method. Probability-adjusted revenue, gross profit, and direct operating income are significant inputs that are not observable in the market, and are therefore classified as Level 3 inputs. These contingent liabilities have been reflected in the Condensed Consolidated Balance Sheet as of June 30, 2018, as current and noncurrent liabilities of $8.0 and $14.1 million, respectively.

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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Changes in the fair value of contingent consideration are summarized as follows (in thousands):
Fair value of contingent consideration as of January 1, 2017
$
56,463

Fair value of Generation Digital contingent consideration at August 14, 2017
3,600

Fair value of Escada contingent consideration at October 1, 2017
2,049

Escrow adjustment for Reggiani acquisition
(4,711
)
Changes in valuation
4,761

Earnout accretion
1,711

Payments and settlements
(30,924
)
Foreign currency adjustment
2,753

Fair value of contingent consideration at December 31, 2017
$
35,702

Changes in valuation
(12,775
)
Earnout accretion
104

Payments
(751
)
Foreign currency adjustment
(151
)
Fair value of contingent consideration as of June 30, 2018
$
22,129

The Optitex and Shuttleworth earnout liability valuations decreased, on a combined basis, during the three and six months ended June 30, 2018 by $11.3 and $12.8 million, respectively, based on recent actual and updated forecasted financial performance data. The Optitex, CTI and Rialco earnout performance probabilities increased, while the Shuttleworth earnout performance probability decreased, during 2017. The earnout liability valuations increased during the three and six months ended June 30, 2017 by less than $0.1 and $0.9 million, respectively. Changes in the fair value of contingent consideration subsequent to the acquisition date are reported in general and administrative expenses.
Earnout payments and settlements during the three and six months ended June 30, 2018 of $0.1 and $0.8 million were primarily related to the Shuttleworth contingent consideration liability. Earnout payments and settlements during the year ended December 31, 2017 of $21.5, $6.8, $1.3, and $1.2 million were related to the previously accrued Reggiani, Optitex, Rialco, and Shuttleworth contingent consideration liabilities, respectively.
The primary inputs to the fair value measurement of contingent consideration liability are the discount rate and probability-adjusted revenue or earnings targets specified in the acquisition agreements. Accordingly, we reviewed the sensitivity of the fair value measurement to changes in these inputs. We assessed the probability of achieving the revenue and profitability performance targets for contingent consideration associated with each acquisition at percentage levels between 50% and 100% as of each respective acquisition date based on an assessment of the historical performance of each acquired entity, our current expectations of future performance, and other relevant factors. A change in probability-adjusted revenue of five percentage points from the level assumed in the current valuations would result in an increase in the fair value of contingent consideration of $2.0 million or a decrease of $1.7 million. A change in the discount rate of one percentage point would result in an increase in the fair value of contingent consideration of $0.2 million or a decrease of $0.2 million. The potential undiscounted amount of contingent consideration that we could be required to make related to our business acquisitions, beyond amounts currently accrued, was $11.3 million as of June 30, 2018.
Fair Value of Derivative Instruments
We utilize the income approach to measure the fair value of our derivative assets and liabilities. The income approach uses pricing models that rely on market observable inputs such as yield curves, currency exchange rates, and forward prices, and are therefore classified as Level 2 measurements. The notional amount of our derivative assets and liabilities was $250.7 and $239.4 million as of June 30, 2018 and December 31, 2017, respectively. We did not have any cash flow hedges as of June 30, 2018. The fair value of our derivative assets and liabilities that were designated for cash flow hedge accounting treatment having notional amounts of $3.9 million as of December 31, 2017 was not material.


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Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


Fair Value of Convertible Senior Notes
In September 2014, we issued $345 million aggregate principal amount of our Notes. The Notes are carried at their original issuance value, net of unamortized debt discount, and are not marked to market each period. The fair value of the Notes as of June 30, 2018 was approximately $342.8 million and was classified as a Level 2 fair value measurement. Fair value was estimated based upon actual quotations obtained at the end of the reporting period or the most recent date available. A substantial portion of the market value of our Notes in excess of the outstanding principal amount relates to the conversion premium.
Note 8.     Derivatives and Hedging
We are exposed to market risk and foreign currency exchange risk from changes in foreign currency exchange rates, which could affect operating results, financial position, and cash flows. We manage our exposure to these risks through our regular operating and financing activities and, when appropriate, through use of derivative financial instruments. These derivative financial instruments are used to hedge monetary assets and liabilities, intercompany balances, trade receivables, anticipated cash flows, and to reduce earnings and cash flow volatility resulting from shifts in foreign currency exchange rates. Our objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, thereby reducing volatility of earnings or protecting fair values of assets and liabilities. We do not have any leveraged derivatives, nor do we use derivative contracts for speculative purposes. We present the fair value of all open derivative instruments, including those embedded in other contracts, as assets or liabilities on our Condensed Consolidated Balance Sheets. The related cash flow impacts of our derivative contracts are reflected as cash flows from operating activities.
Our exposures are primarily related to non-U.S. dollar-denominated revenue in Europe, the U.K., Latin America, China, Israel, and Australia, and to non-U.S. dollar-denominated operating expenses in Europe, India, the U.K., China, Israel, Brazil, and Australia. From time to time we have hedged our operating expense cash flow exposure in Indian rupees. We hedge balance sheet remeasurement exposure associated with British pound sterling, Canadian dollar, Chinese renminbi, Brazilian real, Israeli shekel, Japanese yen, Chinese renminbi, and Euro-denominated intercompany balances; Brazilian real, British pound sterling, Australian dollar, Chinese renminbi, Israeli shekel, and Euro-denominated trade receivables; and British pound sterling, Israeli shekel, Canadian dollar, and other Euro-denominated net monetary assets.

By their nature, derivative instruments involve, to varying degrees, elements of market and credit risk. The market risk associated with these instruments resulting from currency exchange movement is expected to offset the market risk of the underlying transactions, assets, and liabilities being hedged. Under our master netting agreements with our foreign currency derivative counterparties, we are allowed to net transactions of the same currency with a single net amount payable by one party to the other. The derivatives held by us are not subject to any credit contingent features negotiated with these counterparties. We are not required to pledge cash collateral related to these foreign currency derivative contracts. We do not believe there is significant risk of loss from non-performance by the counterparty associated with these instruments because, by policy, we only deal with counterparties having a minimum investment grade or better credit rating. Credit risk is managed through the continuous monitoring of exposures to such counterparties.
Cash Flow Hedges
We did not have any foreign currency derivative contracts designated as cash flow hedges as of June 30, 2018 nor during the three months ended June 30, 2018. Our foreign currency derivative contracts designated as cash flow hedges for our Indian rupee operating expenses were in the notional amount of $3.9 million as of December 31, 2017. The fair value of the net assets (liabilities) related to these cash flow hedges were not material. The changes in fair value of these contracts are reported as a component of AOCI and reclassified to operating expense in the periods of payment of the hedged operating expenses. The amount of ineffectiveness that was recorded in the Condensed Consolidated Statements of Operations for these designated cash flow hedges was immaterial. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness. 
Balance Sheet Hedges
Our forward contracts are not designated for hedge accounting treatment since there is a natural offset for the remeasurement of the underlying foreign currency denominated asset or liability. We recognize changes in the fair value of non-designated derivative instruments in earnings in the period of change. Gains and losses on foreign currency forward contracts used to hedge balance sheet exposures are recognized in interest income and other income (expense), net, in the same period as the remeasurement gain or loss of the related foreign currency denominated assets and liabilities. Our forward contracts not designated for hedge accounting treatment consisted of hedges of Australian dollar, British pound sterling, Brazilian real, Canadian dollar, Chinese renminbi, Euro, Israeli shekel and Japanese yen.

24


Table of Contents
Electronics For Imaging, Inc.
Notes to Condensed Consolidated Financial Statements
(Continued)


These balance sheet hedges cover currency exposures in the following line items in the notional amounts indicated (in thousands):
Balance sheet categories
June 30, 2018
 
December 31, 2017
Accounts Receivable
$
50,010

 
$
44,427

Other assets and liabilities, net
39,367

 
46,550

Intercompany balances
161,351

 
144,477

Total
$
250,728

 
$
235,454

Note 9.     Convertible Senior Notes
0.75% Convertible Senior Notes Due 2019
In September 2014, we completed a private placement of $345 million principal amount of 0.75% Convertible Senior Notes due September 1, 2019. The net proceeds from this offering were approximately $336.3 million, after deducting the initial purchasers’ commissions and the offering expenses paid by us. We used approximately $29.4 million of the net proceeds to purchase the Note Hedges described below, net of the proceeds from the Warrant transactions also described below.
The Notes are senior unsecured obligations of EFI with interest payable semiannually in arrears on March 1 and September 1 of each year. The Notes are not callable and will mature on September 1, 2019, unless previously purchased or converted in accordance with their terms prior to such date. Holders of the Notes who convert in connection with a “fundamental change,” as defined in the indenture governing the Notes (“Indenture”), may require us to purchase for cash all or any portion of their Notes at a purchase price equal to 100 percent of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any.
The initial conversion rate is 18.9667 shares of common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $52.72 per share of common stock. Upon conversion of the Notes, holders will receive cash, shares of common stock or a combination thereof, at our election. Our intent is to settle the principal amount of the Notes in cash upon conversion. If the conversion value exceeds the principal amount, we would deliver shares of our common stock for our conversion obligation in excess of the aggregate principal amount. As of June 30, 2018, none of the conditions allowing holders of the Notes to convert had been met.
We separated the Notes into liability and equity components. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the Notes using the effective interest method with an effective interest rate of 4.98% per annum (5.46% inclusive of debt issuance costs). The equity component is not remeasured if it continues to meet the conditions for equity classification.
We allocated the total transaction costs incurred by the Notes issuance to the liability and equity components based on their relative values. Issuance costs of $7.0 million attributable to the $281.4 million liability component are being amortized to expense over the term of the Notes, and issuance costs of $1.6 million attributable to the $63.6 million equity component were offset against the equity component in stockholders’ equity. Additionally, we recorded a deferred tax liability of $23.7 million on the debt discount, which is not deductible for tax purposes.

The Notes consisted of the following (in thousands):
 
June 30, 2018
 
December 31, 2017
Liability component
$
345,000

 
$
345,000

Debt discount, net of amortization
(16,423
)
 
(23,178
)
Debt issuance costs, net of amortization
(2,065
)
 
(2,865
)
Net carrying amount
$
326,512

 
$
318,957