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 in 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 on 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.

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 Costs - Contracts 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, in Note 3 – Balance Sheet Details, and in Note 4 – Revenue Recognition.

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 adopting ASC 606. 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 significant financing components that will be recognized as interest income as payments are received over the contractual terms, and upfront setup fees that will recognized ratably over the expected contractual terms.

The cumulative effect of applying ASC 606 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

The impact of adopting ASC 606 and ASC 340-40 on our Condensed Consolidated Statement of Operations for the three months ended March 31, 2018 was as follows (in thousands):


	Amounts in Accordance with ASC 606			Amounts in Accordance with ASC 605			Effect of change higher (lower)
Revenue	$	239,866		$	238,407		$	1,459
Cost of revenue		120,759			120,817			(58	)
Gross profit		119,107			117,590			1,517
Operating expenses		121,172			121,033			139
Loss from operations		(2,065	)		(3,443	)		1,378
Interest expenses and other, net		(3,665	)		(3,840	)		175
Loss before income taxes		(5,730	)		(7,283	)		1,553
Benefit from income taxes		2,135			2,284			(149	)
Net loss		(3,595	)		(4,999	)		1,404

The impact of adopting ASC 606 and ASC 340-40 on our Condensed Consolidated Balance Sheet at March 31, 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	$	251,227	$	250,188	$	1,039
Other current assets		49,731		51,301		(1,570	)
Deferred tax assets		40,931		42,546		(1,615	)
Other assets		27,246		19,323		7,923
Liabilities
Deferred revenue		68,912		69,705		(793	)
Noncurrent contingent and other liabilities		24,748		24,257		491
Stockholders’ equity:
Retained earnings		403,623		397,544		6,079

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 (“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 might 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 a measurement period when more information becomes available, and report this information in our financial statements in that period.

Restricted Cash. Accounting Standard Updates (“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 the statement of cash flows. We previously included the changes in restricted cash equivalents in operating or investing activities in the Condensed Consolidated Statements of Cash Flows. Upon the adoption of ASU 2016-18, changes in restricted cash equivalents related to the off-balance sheet financing arrangement described in Note 8 – Commitments and Contingencies are no longer presented as an investing cash outflow, but instead are presented as a component of the beginning and ending balance of cash, cash equivalents, and restricted cash equivalents in the Condensed 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)	March 31, 2018		December 31, 2017		March 31, 2017		December 31, 2016
Cash and cash equivalents	$	163,077	$	170,345	$	151,096	$	164,313
Restricted cash equivalents		35,733		32,531		4,509		1,142

Total cash, cash equivalents, and restricted cash equivalents shown in the statement of cash flows	$	198,810	$	202,876	$	155,605	$	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 2017-01 did not impact our condensed consolidated financial statements as of March 31, 2018 because we did not acquire a business during the first quarter of 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 2014-09) and is expected to have a material impact on the accounting for real estate dispositions. ASU 2017-05 became effective in the first quarter of 2018. During the three months ended March 31, 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 for the three months ended March 31, 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 cash settlement. 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 Consolidated Statement of Cash Flows. Convertible debt was not settled as of March 31, 2018. We will apply ASU 2016-15 upon cash settlement.

Recent Accounting Pronouncements

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 2016-02, 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 in excess of 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 judgement will be required in applying the new lease guidance.

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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.

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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 have not 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 consolidated financial position as reflected in our Consolidated Balance Sheets. As stated above, the recognition, measurement, and presentation of expenses and cash flows by a lessee have not significantly changed from previous guidance; accordingly, the impact on our results of operations as reflected in our Condensed Consolidated Statements of Operations is not expected to be material. We also 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.

Hedge Accounting. In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, which amends the hedge accounting recognition and presentation requirements in ASC 815, Derivatives and Hedging.

Under current guidance, changes in the fair value of the effective portion of these contracts are reported as a component of other comprehensive income (“OCI”) and reclassified to operating expense in the periods of payment of the hedged cash flows. The ineffective portion is recognized as a component of interest income and other income, net. Under the new guidance, the entire change in the fair value of hedging instruments designated as cash flow hedges that are included in the assessment of hedge effectiveness will be recorded in OCI. Those amounts are reclassified to earnings in the periods of payment in the same income statement line item as the hedged operating expenses. Upon adoption, a cumulative-effect adjustment will be required for the ineffective portion of derivative contracts designated as cash flow hedges existing at the date of adoption to accumulated OCI with a corresponding adjustment to the retained earnings as of the beginning of the fiscal year of the adoption.

The new guidance continues to require an initial prospective quantitative hedge effectiveness assessment unless the hedging relationship qualifies for the critical-terms-match method or facts and circumstances method, which permit an assumption of perfect hedge effectiveness. After the initial quantitative assessment, the new guidance permits a qualitative ongoing effectiveness assessment for certain hedges if we can reasonably support an expectation of high effectiveness throughout the term of the hedge. The new guidance also requires additional disclosure related to the effect on the income statement of cash flow hedges.

ASU 2017-12 will be effective in the first quarter of 2019. We do not believe this guidance will materially impact our results of operations. We did not have any of these cash flow hedges as of March 31, 2018.

Financial Instruments. ASU 2016-13, Measurement of Credit Losses on Financial Instruments, issued in June 2016, amends current guidance regarding other-than-temporary impairment of available-for-sale debt securities. The new guidance requires an estimate of expected credit loss when fair value is below the amortized cost of the asset without regard for the length of time that the fair value has been below the amortized cost or the historical or implied volatility of the asset. Credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The use of an allowance to record estimated credit losses (and subsequent recoveries) will also be required under the new guidance.

ASU 2016-13 will be effective in the first quarter of 2020. We are evaluating its impact on the carrying value of our available-for-sale securities and results of operations.

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.

A change in our estimate of total cost 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 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 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:

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. Under these arrangements, the software is installed at the customer’s location. 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. 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. For contracts billed on a fixed price basis, revenue is recognized in accordance with the input method based on the proportion of services performed to the total fixed fee.

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 services and/or on-going support services that represent a single promise (i.e. each individual promised service is not distinct) to provide continuous access to the software solution. Any setup fees associated with our SaaS arrangements, assuming they do not create a material right, are recognized ratably over the contract term. If they do create a material right, we recognize the setup fees over the contract term plus expected renewals.

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 services delivered over time. Our SaaS-based arrangements may include fixed, variable, or a combination of fixed and variable consideration. Fixed consideration is recognized over the term of the arrangement. Variable consideration in these arrangements is typically a function of a tier-based pricing structure. Variable consideration is estimated at contract inception and allocated to each distinct service period within the series and revenue is recognized as each distinct service period is performed.

Hardware. Our hardware, such as Industrial Inkjet printers and Fiery digital front ends (“DFEs”), are 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. Considerations 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 will be 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.

Customized Development. We enter into contracts for professional services required to customize our hardware and software products to allow them to be integrated with a customer’s copier or other product. These integration services are designed to meet the customer’s specifications. The contract pricing is typically at a fixed amount which is paid over the contract term, based on the completion of the phases of the project. The services provided under these contracts result in the transfer of control of the applicable deliverable over time. We recognize revenue on the proportion of labor hours expended and/or costs incurred to the total estimated labor hours and/or costs expected as of the completion of the services.

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.

Supplemental Cash Flow Information


	Three months ended March 31,
(in thousands)	2018		2017
Net cash paid for income taxes	$	2,562	$	2,092
Cash paid for interest expense	$	1,716	$	1,661

Non-cash investing and financing activities:
Property, equipment, and intellectual property received, but not paid	$	999	$	1,060