Quarterly Report


Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

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  ☐    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  ☒    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      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.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The number of shares of Common Stock outstanding as of November 17, 2017 was 45,690,919.

 

 

 


Table of Contents

Electronics For Imaging, Inc.

INDEX

 

         Page No.  
PART I – Financial Information   

Item 1.

 

Financial Statements

  
 

Condensed Consolidated Financial Statements (unaudited)

  
 

Condensed Consolidated Balance Sheets at September 30, 2017 and December 31, 2016

     3  
 

Condensed Consolidated Statements of Operations for the three and nine months ended September  30, 2017 and 2016

     4  
 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016

     5  
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016

     6  
 

Notes to Condensed Consolidated Financial Statements

     7  

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     34  

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     58  

Item 4.

 

Controls and Procedures

     59  
PART II – Other Information   

Item 1.

 

Legal Proceedings

     61  

Item 1A.

 

Risk Factors

     62  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     64  

Item 3.

 

Defaults Upon Senior Securities

     65  

Item 4.

 

Mine Safety Disclosure

     65  

Item 5.

 

Other Information

     65  

Item 6.

 

Exhibits

     65  
Signatures      67  

Exhibit 3.1

    

Exhibit 3.2

    

Exhibit 10.1

    

Exhibit 12.1

    

Exhibit 31.1

    

Exhibit 31.2

    

Exhibit 32.1

    

Exhibit 101

    


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1: Condensed Consolidated Financial Statements

Electronics For Imaging, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

 

(in thousands)

   September 30, 2017     December 31, 2016  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 175,830     $ 164,313  

Short-term investments, available for sale

     217,923       295,428  

Accounts receivable, net of allowances of $32.5 and $23.3 million, respectively

     236,709       220,813  

Inventories

     131,926       96,338  

Income taxes receivable

     4,995       975  

Assets held for sale

     —         3,781  

Other current assets

     44,865       31,881  
  

 

 

   

 

 

 

Total current assets

     812,248       813,529  

Property and equipment, net

     103,541       103,474  

Restricted investments and cash equivalents

     27,753       6,252  

Goodwill

     387,001       359,841  

Intangible assets, net

     126,567       122,997  

Deferred tax assets

     61,899       58,477  

Other assets

     14,827       14,359  
  

 

 

   

 

 

 

Total assets

   $ 1,533,836     $ 1,478,929  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 133,322     $ 114,287  

Accrued and other liabilities

     109,206       85,505  

Deferred revenue

     58,390       53,813  

Income taxes payable

     7,635       10,256  
  

 

 

   

 

 

 

Total current liabilities

     308,553       263,861  

Convertible senior notes, net

     315,255       304,484  

Imputed financing obligation related to build-to-suit lease

     14,087       14,152  

Noncurrent contingent and other liabilities

     31,067       42,786  

Deferred tax liabilities

     13,763       15,601  

Noncurrent income taxes payable

     12,439       12,030  
  

 

 

   

 

 

 

Total liabilities

     695,164       652,914  
  

 

 

   

 

 

 

Commitments and contingencies (Note 8)

    

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; 54,156 and 53,038 shares issued, respectively

     542       530  

Additional paid-in capital

     741,153       705,901  

Treasury stock, at cost; 7,709 and 6,457 shares, respectively

     (330,668     (273,730

Accumulated other comprehensive loss

     (1,243     (24,575

Retained earnings

     428,888       417,889  
  

 

 

   

 

 

 

Total stockholders’ equity

     838,672       826,015  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,533,836     $ 1,478,929  
  

 

 

   

 

 

 

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
September 30,
    Nine months ended
September 30,
 

(in thousands, except per share amounts)

   2017     2016     2017     2016  

Revenue

   $ 248,359     $ 245,575     $ 724,097     $ 725,358  

Cost of revenue (1)

     120,901       120,381       345,858       356,720  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     127,458       125,194       378,239       368,638  

Operating expenses:

        

Research and development (1)

     39,585       36,933       118,201       111,731  

Sales and marketing (1)

     42,269       43,060       129,018       127,360  

General and administrative (1)

     25,075       24,088       67,239       66,366  

Restructuring and other (Note 11)

     833       1,308       5,421       5,733  

Amortization of identified intangibles

     12,299       10,395       34,829       29,360  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     120,061       115,784       354,708       340,550  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     7,397       9,410       23,531       28,088  

Interest expense

     (4,912     (4,510     (14,538     (13,243

Interest income and other income, net

     1,760       915       2,802       1,114  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     4,245       5,815       11,795       15,959  

Benefit from (provision for) income taxes

     (791     11,847       (795     9,041  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 3,454     $ 17,662     $ 11,000     $ 25,000  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per basic common share

   $ 0.07     $ 0.38     $ 0.24     $ 0.53  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per diluted common share

   $ 0.07     $ 0.37     $ 0.23     $ 0.52  
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in basic per-share calculation

     46,348       46,794       46,442       46,983  
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in diluted per-share calculation

     46,937       47,621       47,102       47,791  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

                                                           
     2017      2016      2017      2016  

Cost of revenue

   $ 486      $ 642      $ 1,985      $ 1,873  

Research and development

     1,640        2,061        7,556        6,987  

Sales and marketing

     1,108        2,260        5,176        6,159  

General and administrative

     1,414        3,590        7,824        11,923  

See accompanying notes to condensed consolidated financial statements.

 

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Electronics For Imaging, Inc.

Condensed Consolidated Statements of Comprehensive Income

(unaudited)

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(in thousands)

   2017     2016     2017     2016  

Net income

   $ 3,454     $ 17,662     $ 11,000     $ 25,000  

Net unrealized investment gains (losses):

        

Unrealized holding gains (losses), net of tax provisions of less than $0.1 and $0.2 million for the three and nine months ended September 30, 2017, respectively, and tax benefit of $0.2 million and tax provision of $0.5 million for the three and nine months ended September 30, 2016, respectively

     48       (316     283       785  

Reclassification adjustments included in net income, net of tax benefit and tax provision of less than $0.1 million for the three and nine months ended September 30, 2017, and tax benefit and tax provision of less than $0.1 million for the three and nine months ended September 30, 2016, respectively

     (27     (98     (49     16  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized investment gains (losses)

     21       (414     234       801  

Currency translation adjustments, net of no tax benefit for the three and nine months ended September 30, 2017, and tax provisions of $0.4 and $0.7 million for the three and nine months ended September 30, 2016, respectively

     4,931       1,509       23,121       3,293  

Net unrealized gains (losses) on cash flow hedges

     (28     27       (24     11  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 8,378     $ 18,784     $ 34,331     $ 29,105  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Electronics For Imaging, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

     Nine months ended
September 30,
 

(in thousands)

   2017     2016  

Cash flows from operating activities:

    

Net income

   $ 11,000     $ 25,000  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     48,029       40,734  

Deferred taxes

     (9,149     (22,127

Provisions for bad debt and sales-related allowances

     10,868       7,558  

Provision for inventory obsolescence

     3,642       4,492  

Stock-based compensation, net of cash settlements

     22,541       26,743  

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

     11,211       9,991  

Other non-cash charges and credits

     3,254       5,920  

Changes in operating assets and liabilities, net of effect of acquired businesses

     (58,955     (42,487
  

 

 

   

 

 

 

Net cash provided by operating activities

     42,441       55,824  
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of short-term investments

     (87,623     (195,904

Proceeds from sales and maturities of short-term investments

     164,979       223,206  

Purchases of restricted investments and cash equivalents

     (21,459     (3,745

Purchases, net of proceeds from sales, of property and equipment

     (8,745     (17,611

Businesses purchased, net of cash acquired

     (16,739     (19,614
  

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     30,413       (13,668
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from issuance of common stock

     11,730       10,359  

Purchases of treasury stock and net share settlements

     (56,937     (65,354

Repayment of debt assumed through business acquisitions and debt issuance costs

     (10,786     (8,539

Contingent consideration payments related to businesses acquired

     (9,512     (1,868
  

 

 

   

 

 

 

Net cash used for financing activities

     (65,505     (65,402
  

 

 

   

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

     4,168       2,158  
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     11,517       (21,088

Cash and cash equivalents at beginning of period

     164,313       164,091  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 175,830     $ 143,003  
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Electronics For Imaging, Inc.

Notes to Condensed Consolidated Financial Statements

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 (“U.S. GAAP” or “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. 2, for the year ended December 31, 2016. These condensed consolidated financial statements and accompanying notes should be read in conjunction with our annual consolidated financial statements and the notes thereto for the year ended December 31, 2016, included in our Annual Report on Form 10-K, as amended in Amendment No. 2. 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.

Correction of Prior Period Financial Information

During the preparation of the consolidated financial statements for three and nine months ended September 30, 2017, we identified certain errors at our Italian manufacturing subsidiary attributable to the valuation and classification of certain finished goods inventory. The errors related to finished goods that should have been impaired and expensed in 2015, inventory utilized in research and development projects that expired and should have been expensed in 2016, and certain assets included in inventory that should have been capitalized and depreciated over their estimated useful lives. The preceding resulted in an understatement of cost of revenue in 2015 and operating expenses in 2016 due to failure to properly impair and expense certain items and properly classify certain amounts included in inventories on the balance sheet and appropriately depreciate those amounts.

As a result, we have corrected the accompanying condensed consolidated balance sheet as of December 31, 2016 as follows:

 

     December 31, 2016  
     As
Previously
Reported
     Adjustments      As Adjusted  

(in thousands)

        

Inventories

   $ 99,075      $ (2,737    $ 96,338  

Property and equipment, net

     103,304        170        103,474  

Total assets

     1,481,496        (2,567      1,478,929  

Deferred tax liabilities

     16,351        (750      15,601  

Total liabilities

     653,664        (750      652,914  

Accumulated other comprehensive loss

     (24,694      119        (24,575

Retained earnings

     419,825        (1,936      417,889  

Total shareholders’ equity

     827,832        (1,817      826,015  

We consider this correction to previously issued financial statements to be immaterial.

The impact to net income for the years ended December 31, 2016 and 2015 for this correction is a decrease of $0.6 and $1.3 million, respectively, from amounts previously reported of $45.5 and $33.5 million, respectively.

Significant Accounting Policies

There have been no material changes in our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K, as amended in Amendment No. 2, for the year ended December 31, 2016, with the exception of the following:

 

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Bill and Hold Transactions. We hold certain products manufactured by us on a “bill-and-hold” basis for our customers’ convenience. Revenue is recognized for these “bill-and-hold” arrangements in accordance with SEC Staff Accounting Bulletin (“SAB”) 104, which requires consideration of, among other things, whether the customer has made a fixed commitment to purchase the product; the existence of a substantial business purpose for the arrangement; the “bill-and-hold” arrangement is at the request of the customer; the scheduled delivery date must be reasonable and consistent with the buyer’s business purpose; title and risk of ownership must pass to the customer, including any decline in the market value of the product; the product is complete and ready for shipment; the product has been segregated from our inventory; payment terms for such arrangements have not been modified from our normal billing and credit terms; our custodial risks must be insurable and insured; and no further performance obligations by us exist. Extended procedures are not necessary to assure that there are no exceptions to the customer’s commitment to accept and pay for the product.

Out-of-Period Adjustments

In the nine months ended September 30, 2017, we recorded out-of-period adjustments related to certain bill and hold transactions, which decreased revenue by $3.4 million, decreased gross profit by $0.5 million, and decreased net income by $0.3 million (or $0.01 per diluted share). There were no such out-of-period adjustments in the three months ended September 30, 2017. We evaluated these adjustments considering both qualitative and quantitative factors and the impact of these adjustments 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 material to any individual period. Management believes these adjustments are immaterial to these condensed consolidated financial statements and all previously issued financial statements. Such out-of-period adjustments are not part of the Correction of Prior Period Financial Information described above.

Recent Accounting Pronouncements

Inventory Valuation. In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-11, Simplifying the Measurement of Inventory, which became effective in the first quarter of 2017. ASU 2015-11 requires that inventory be valued at the lower of cost or net realizable value, which is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. We previously valued inventory at the lower of cost or net realizable value less a reasonable profit margin as allowed by previous inventory valuation guidance. The adoption of ASU 2015-11 increased our inventory valuation by $1.7 million as of September 30, 2017.

Revenue Recognition. ASU 2014-09, Revenue from Contracts with Customers, issued in May 2014, ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, and subsequent amendments, enhance the comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The principles-based guidance provides a framework for addressing revenue recognition issues comprehensively. The standards require that revenue be recognized that reflects the consideration the entity expects to be entitled in exchange for goods or services, which are referred to as performance obligations.

 

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ASU 2014-09 will be effective in the first quarter of 2018. Two adoption methods are allowed under ASU 2014-09: the full retrospective method and modified retrospective method. We have elected to use the modified retrospective method by applying the revised guidance to contracts that have not been completed as of January 1, 2018. Retained earnings will be adjusted for the cumulative effect of the change on January 1, 2018. The new standard requires comprehensive annual and interim disclosures regarding the nature, amount, timing, and uncertainty of recognized revenue, which will be provided in the year of adoption along with the impact on recognized revenue compared with revenue that would have been recognized under prior guidance. Qualitative and quantitative disclosures will be required regarding:

 

   

disaggregation of our current disclosures of revenue by segment and geographic area into categories that depict how revenue and cash flows are impacted by economic factors,

 

   

timing of recognition, contract duration, and sales channel,

 

   

billed and unbilled contracts with customers, including revenue and impairments recognized, disaggregation, and information about contract balances and performance obligations,

 

   

significant judgments and changes in judgments required to determine the transaction price, amounts allocated to performance obligations, and the timing for recognizing revenue resulting from the satisfaction of performance obligations,

 

   

assets recognized from the costs to obtain or fulfill a contract (e.g., commissions), and

 

   

bad debt provisions related to billed and unbilled receivables.

Upon evaluation, we believe the key changes in the guidance that impact our revenue recognition relate to the timing of revenue recognition and allocation of contract revenue between services and software licenses. The requirement to defer incremental contract acquisition costs (e.g., commissions) and recognize them over the contract period or expected customer life will result in the recognition of a deferred charge on our balance sheet. We are assessing the impact on our consolidated financial statements, systems, and controls upon adoption.

Principal vs Agent. ASU 2016-08, Principal vs. Agent Considerations (Reporting Revenue Gross vs Net), issued in March 2016, streamlines and clarifies the criteria for identifying whether an entity is satisfying a performance obligation as the principal or agent in the transaction. The entity that is responsible for fulfilling the contractual obligations related to the good or service is acting as the principal and recognizes the gross amount of consideration. The entity that is responsible only for arranging delivery to the customer is acting as the agent and recognizes revenue in the amount of the fee or commission related to arranging for the delivery of the good or service.

Several indicators of the nature of the relationship that are considered under current guidance have been streamlined and clarified in the new guidance by focusing more specifically on the performance obligations that must be fulfilled in the transaction, which entity carries the inventory risk in the transaction, and which entity controls the pricing of the good or service. Credit risk will no longer be a criterion. This guidance will be effective in the first quarter of 2018. We are evaluating its impact on our revenue and results of operations related to third party ink revenue and certain printer components.

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.

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.

 

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ASU 2016-15 will be effective in the first quarter of 2018. Accordingly, $63.6 million 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.

Restricted Cash. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash, requiring that the statement of cash flows 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 will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Under current guidance, changes in restricted cash and restricted cash equivalents are included in operating or investing activities in the Condensed Consolidated Statements of Cash Flows.

ASU 2016-18 will be effective in the first quarter of 2018. Changes in restricted cash related to the off-balance sheet financing arrangement described in Note 8 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements will no longer be presented as an investing cash outflow, but will instead be presented as a component of the beginning and ending balance of cash, cash equivalents, and restricted cash in the Condensed Consolidated Statements of Cash Flows.

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, issued in February 2016 and 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 financing or operating lease are substantially the same as existing guidance except that the “bright line” percentages have been removed.

 

   

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 finance 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 Consolidated Statements of Operations is not expected to be material.

Definition of a Business. ASU 2017-01, Business Combinations: Clarifying the Definition of a Business, was issued in January 2017, and significantly narrows how businesses are defined. Under current guidance, a business is defined as an integrated set of assets and activities that usually consists of business processes and their related inputs and outputs. However, business process outputs are not required to be present and only some business process inputs and business processes must be present if the acquiring entity can produce outputs by integrating the acquired set of assets and activities with its own inputs and processes. Essentially, existing guidance only requires that business processes and inputs be present in order to constitute a business.

 

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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. Missing inputs and processes may not be replaced by integration with our own inputs and processes under the new guidance.

Our condensed consolidated financial statements may be impacted if an acquisition does not qualify as a business combination after ASU 2017-01 is effective in the first quarter of 2018. Such acquisitions would be accounted for as asset purchases.

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 will be effective in the first quarter of 2018. We have elected to adopt the modified retrospective method of implementation.

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. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification.

ASU 2017-09 will be effective in the first quarter of 2018. We will adopt this guidance prospectively to awards modified on or after the adoption date. We do not believe this guidance will materially impact our results of operations.

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 Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging.

Our foreign currency derivative contracts include notional amounts of $3.8 million that have been designated as cash flow hedges of our Indian rupee operating expense exposure at September 30, 2017. 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 to charge 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.

 

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Supplemental Cash Flow Information

 

     Nine months ended
September 30,
 

(in thousands)

   2017      2016  

Net cash paid for income taxes

   $ 15,724      $ 5,787  
  

 

 

    

 

 

 

Cash paid for interest expense

   $ 3,667      $ 3,285  
  

 

 

    

 

 

 

Acquisition of businesses

     

Cash paid for businesses purchased, excluding contingent consideration

   $ 16,836      $ 21,242  

Cash acquired in business acquisitions

     (97      (1,628
  

 

 

    

 

 

 

Net cash paid for businesses purchased, net of cash acquired

   $ 16,739      $ 19,614  
  

 

 

    

 

 

 

Common stock issued in connection with Reggiani Macchine SpA (“Reggiani”) acquisition

   $ —        $ 73  
  

 

 

    

 

 

 

Non-cash investing and financing activities:

     

Non-cash settlement of vacation liabilities by issuing restricted stock units (“RSUs”)

   $ —        $ 2,758  

Property and equipment received, but not paid

     703        1,004  
  

 

 

    

 

 

 
   $ 703      $ 3,762  
  

 

 

    

 

 

 

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 restricted stock having a dilutive effect, non-vested restricted stock 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 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, and the assumed exercise of our warrants having a dilutive effect using the treasury stock method when the stock price exceeds the warrant strike price. Any potential shares that are anti-dilutive as defined in ASC 260, Earnings Per Share, are excluded from the effect of dilutive securities.

Performance-based and market-based restricted stock and stock options 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 in accordance with ASC 260-10-45-48. Accordingly, performance-based RSUs, which vested on various dates during the three and nine months ended September 30, 2017 and 2016, based on achievement of specified performance criteria related to revenue, cash flows from operating activities, and non-GAAP operating income targets, and performance-based stock options, which vested during the nine months ended September 30, 2016 based on achievement of specified targets related to non-GAAP return on equity, 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 during the three and nine months ended September 30, 2017 and 2016 are reconciled as follows (in thousands, except per share amounts):

 

     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

Basic net income per share:

           

Net income available to common shareholders

   $ 3,454      $ 17,662      $ 11,000      $ 25,000  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding

     46,348        46,794        46,442        46,983  

Basic net income per share

   $ 0.07      $ 0.38      $ 0.24      $ 0.53  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

Dilutive net income per share:

           

Net income available to common shareholders

   $ 3,454      $ 17,662      $ 11,000      $ 25,000  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding

     46,348        46,794        46,442        46,983  

Dilutive stock options and non-vested restricted stock

     589        827        660        808  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

     46,937        47,621        47,102        47,791  
  

 

 

    

 

 

    

 

 

    

 

 

 

Dilutive net income per share

   $ 0.07      $ 0.37      $ 0.23      $ 0.52  
  

 

 

    

 

 

    

 

 

    

 

 

 

Potential shares of common stock that were not included in the determination of diluted net income per share for the periods presented 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 September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

RSUs

     327        669        304        601  

ESPP purchase rights

     410        14        342        29  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

     737        683        646        630  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 6 – Convertible Senior Notes, Note Hedges, and Warrants of the Notes to Condensed Consolidated Financial Statements for additional information.

3. Balance Sheet Details

Inventories

Inventories, net of allowances, as of September 30, 2017, and December 31, 2016, are as follows (in thousands):

 

     September 30,      December 31,  
     2017      2016  

Raw materials

   $ 57,059      $ 45,798  

Work in process

     14,676        7,362  

Finished goods

     60,191        43,178  
  

 

 

    

 

 

 
   $ 131,926      $ 96,338  
  

 

 

    

 

 

 

Deferred Cost of Revenue

Deferred cost of revenue related to unrecognized revenue on shipments to customers was $7.2 and $3.4 million as of September 30, 2017, and December 31, 2016, respectively, and is included in other current assets in our Condensed Consolidated Balance Sheets.

 

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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 during the nine months ended September 30, 2017 and 2016 are as follows (in thousands):

 

     2017      2016  

Balance at January 1,

   $ 10,319      $ 9,635  

Liability assumed upon acquiring FreeFlow print server (“FFPS”)

     9,368        —    

Provisions, net of releases

     9,284        9,678  

Settlements

     (12,588      (9,156
  

 

 

    

 

 

 

Balance at September 30,

   $ 16,383      $ 10,157  
  

 

 

    

 

 

 

Accumulated Other Comprehensive Loss (“OCI”)

OCI classified within stockholders’ equity in our Condensed Consolidated Balance Sheets as of September 30, 2017, and December 31, 2016 is as follows (in thousands):

 

     September 30,      December 31,  
     2017      2016  

Net unrealized investment losses

   $ (239    $ (473

Currency translation losses

     (989      (24,111

Net unrealized gain (loss) on cash flow hedges

     (15      9  
  

 

 

    

 

 

 

Accumulated other comprehensive loss

   $ (1,243    $ (24,575
  

 

 

    

 

 

 

Amounts reclassified out of OCI were less than $0.1 million, net of tax, for the three and nine months ended September 30, 2017, $0.1 million, net of tax, for the three months ended September 30, 2016, and less than $0.1 million, net of tax, for the nine months ended September 30, 2016, and consisted of unrealized gains and losses from investments in debt securities that are reported within interest income and other income, net, in our Condensed Consolidated Statements of Operations.

4. Acquisitions

We acquired privately held Generation Digital Solutions, Inc. (“GD”), CRC Information Systems, Inc. (“CRC”) from Reynolds and Reynolds Company (“Reynolds”), and certain assets comprising the FFPS business from Xerox Corporation (“Xerox”), during 2017, which have been included in our Fiery or Productivity Software operating segments. Acquisition-related transaction costs were $0.6 and $1.8 million during the three and nine months ended September 30, 2017, respectively, and $0.4 and $1.7 million during the three and nine months ended September 30, 2016, respectively, related to all acquisitions.

These acquisitions were accounted for as purchase business combinations. We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair value on their acquisition dates. Excess purchase consideration was recorded as goodwill. Factors contributing to a purchase price that results in goodwill include, but are not limited to, the retention of research and development personnel with skills to develop future technology, support personnel to provide maintenance services related to the products, a trained sales force capable of selling current and future products, the opportunity to cross-sell products of the acquired businesses to existing customers, the opportunity to integrate acquired technology into our products, the positive reputation of GD, CRC, and FFPS in the market, integration of the GD digital textile design workflow with our Fiery textile digital front ends (“DFEs”) and Reggiani digital textile printers linking textile design and production, the opportunity to sell Fiery DFEs to FFPS customers, and the opportunity to expand our presence in the DFE market through the synergy of FFPS technology with existing Fiery products.

We engaged a third party valuation firm to aid management in its analyses of the fair value of these acquired businesses. All estimates, key assumptions, and forecasts were either provided by or reviewed by us. While we chose to utilize a third party valuation firm, the fair value analyses and related valuations represent the conclusions of management and not the conclusions or statements of any third party.

The purchase price allocations are preliminary and subject to change within the measurement period as the valuations are finalized. We expect to continue to obtain information to assist us in finalizing the fair value of the net assets acquired during the measurement period, which end at various dates in 2018. Measurement period adjustments will be recognized in the reporting period in which the adjustment amounts are determined, if any.

 

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Fiery Operating Segment

We acquired privately held GD, which is a New York corporation headquartered in New York City on August 14, 2017 for cash consideration of $3.2 million, net of cash acquired, plus an additional potential future cash earnout, which is contingent on achieving certain revenue and operating profit performance targets during a six-month period followed sequentially by a 12-month period. GD provides software to textile and fashion designers for the creation and design of prints and patterns, color matching, and color palette creation and management. GD will be integrated into the Fiery operating segment.

The fair value of the earnout related to the GD acquisition is currently estimated to be $3.6 million at September 30, 2017, by applying the income approach in accordance with ASC 805-30-25-5, Business Combinations. Key assumptions include risk-free discount rate of 2.83% and probability-adjusted revenue and operating profit levels. Probability-adjusted revenue and operating profit are significant inputs that are not observable in the market, which ASC 820-10-35 refers to as a Level 3 inputs. This contingent liability is reflected in our Consolidated Balance Sheet as of September 30, 2017, as a current and noncurrent liability of $1.0 and $2.6 million, respectively, with the first payment due in the third quarter of 2018, if earned. In accordance with ASC 805-30-35-1, changes in the fair value of contingent consideration subsequent to the acquisition date are recognized in general and administrative expenses.

We acquired certain assets comprising the FFPS business from Xerox, a New York corporation headquartered in Norwalk, Connecticut, on January 31, 2017. The FFPS business manufactures and markets the FFPS DFE, which is a DFE that previously competed with our Fiery DFEs and is included in our Fiery operating segment.

We purchased FFPS for cash consideration of $23.9 million consisting of $5.9 million paid at closing, $9.0 million paid in July 2017, and $9.0 million payable in July 2018, which have been discounted at our incremental borrowing rate of 4.98%, resulting in a purchase price of $23.1 million.

Productivity Software Operating Segment

We acquired privately held CRC, which is a Michigan corporation headquartered in Scottsdale, Arizona, from Reynolds, which is an Ohio corporation headquartered in Dayton, Ohio, on May 8, 2017, for cash consideration of $7.6 million. CRC provides business process automation software for label and packaging printers for commercial businesses and is included in the Midmarket Print Suite within our Productivity Software operating segment.

Valuation Methodologies

Intangible assets acquired consist of customer relationships, the Master Purchasing Agreement (the “Purchasing Agreement”) with Xerox, “take-or-pay” contractual penalty, trade names, existing technologies, and in-process research & development (“IPR&D”). The intangible asset valuation methodologies for each acquisition assume a risk-free discount rate of 4.98% or probability-adjusted discount rates between 13% and 23%.

Customer Relationships and Backlog were valued using the excess earnings method, which is an income approach. The value of customer relationships lies in the generation of a consistent and predictable revenue source and the avoidance of costs associated with developing the relationships. Customer relationships were valued by estimating the revenue attributable to existing customer relationships and probability-weighting each forecast year to reflect the uncertainty of maintaining existing relationships based on historical attrition rates.

Trade Names were valued using the relief from royalty method, which is an income approach, with royalty rates based on various factors including an analysis of market data, comparable trade name agreements, and historical advertising dollars spent supporting the trade name.

Existing Technologies were valued using the relief from royalty method based on royalty rates for similar technologies. The values of existing technologies are derived from consistent and predictable revenue, including the opportunity to cross-sell to existing customers, and the avoidance of the costs associated with developing the technologies. Revenue related to existing technologies was adjusted in each forecast year to reflect the evolution of the technology and the cost of sustaining research and development required to maintain the technology.

 

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Purchasing Agreement was valued using the excess earnings method, which is an income approach. The Purchasing Agreement entered into with Xerox states that we will be Xerox’s preferred supplier of DFEs provided that we meet quality, cost, delivery, and services requirements. The value of the Purchasing Agreement lies in the generation of a consistent and predictable revenue source without incurring the costs normally required to acquire the Purchasing Agreement. The Purchasing Agreement was valued by estimating the revenue attributable to the Purchasing Agreement and probability-weighting each forecast year to reflect the uncertainty of maintaining the existing relationship with Xerox beyond the initial five-year term of the agreement.

Take-or-pay Contract was valued using the Monte Carlo method, which is an income approach. If Xerox’s purchases of Fiery and FFPS DFEs during each of four consecutive 12-month periods is less than the minimum level defined for each purchase period, then Xerox shall make a one-time payment in an amount equal to a percentage of such shortfall compared to the minimum level, subject to the maximum payment amount agreed between the parties for each purchase period. Key assumptions include a risk-free discount rate of 4.98%, asset volatility of 27%, and probability-adjusted DFE revenue. If Xerox’s purchases of Fiery and FFPS DFEs exceed the minimum purchase levels defined for each purchase period, then we will pay a percentage of such excess to Xerox.

IPR&D was valued using the relief from royalty method by estimating the cost to develop purchased IPR&D into commercially viable products, estimating the net cash flows resulting from the sale of those products, and discounting the net cash flows back to their present value. FFPS project schedules were 63% complete as of the acquisition date and have been completed as of September 30, 2017, based on management’s estimate that technical and commercial feasibility has been achieved. IPR&D is subject to amortization after product completion over the product life or otherwise assessed for impairment in accordance with acquisition accounting guidance. Additional costs incurred to complete IPR&D after the acquisition were expensed.

The preliminary allocation of the purchase price to the assets acquired and liabilities assumed (in thousands) with respect to these acquisitions at their respective acquisition dates is summarized as follows:

 

     Fiery     Productivity Software  
     FFPS     GD     CRC  
     Weighted average
useful life
     Purchase
Price
Allocation
    Weighted average
useful life
     Purchase
Price
Allocation
    Weighted average
useful life
     Purchase
Price
Allocation
 

Purchasing agreement

     10 years      $ 9,330       —        $ —         —        $ —    

Take-or-pay contract

     4 years        9,000       —          —         —          —    

Customer relationships

     —          —         8 years        3,030       9 years        3,580  

Existing technology

     2 years        2,570       5 years        890       4 years        540  

Trade names

     5 years        1,020       5 years        290       4 years        180  

IPR&D

     less than one year        70       —          —         —          —    

Backlog

     —          —         —          —         less than one year        4  

Goodwill

     —          6,236       —          3,012       —          4,595  
     

 

 

      

 

 

      

 

 

 
        28,226        $ 7,222        $ 8,899  

Net tangible assets (liabilities)

        (5,092        (298        (1,299
     

 

 

      

 

 

      

 

 

 

Total purchase price

      $ 23,134        $ 6,924        $ 7,600  
     

 

 

      

 

 

      

 

 

 

Pro forma results of operations have not been presented because they are not material to our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016. Goodwill, which represents the excess of the purchase price over the net tangible and intangible assets acquired, that was generated by our acquisition of CRC is not deductible for tax purposes. Goodwill that was generated by our acquisitions of GD and FFPS is deductible for tax purposes.

5. Investments and Fair Value Measurements

We invest our excess cash on deposit with major banks in money market, 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 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 has approximated 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 OCI, adjusted for deferred income taxes. 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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Our available-for-sale short-term investments as of September 30, 2017, and December 31, 2016, are as follows (in thousands):

 

     Amortized cost      Gross unrealized
gains
     Gross  unrealized
losses
    Fair value  

September 30, 2017

          

U.S. Government and sponsored entities

   $ 65,345      $ 2      $ (358   $ 64,989  

Corporate debt securities

     138,399        152        (200     138,351  

Municipal government

     1,047        —          (1     1,046  

Asset-backed securities

     12,823        47        (21     12,849  

Mortgage-backed securities – residential

     689        1        (2     688  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total short-term investments

   $ 218,303      $ 202      $ (582   $ 217,923  
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2016

          

U.S. Government and sponsored entities

   $ 70,893      $ 49      $ (348   $ 70,594  

Corporate debt securities

     198,166        102        (621     197,647  

Municipal government

     1,278        —          (1     1,277  

Asset-backed securities

     24,233        79        (17     24,295  

Mortgage-backed securities – residential

     1,615        3        (3     1,615  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total short-term investments

   $ 296,185      $ 233      $ (990   $ 295,428  
  

 

 

    

 

 

    

 

 

   

 

 

 

The fair value and duration that investments, including cash equivalents, have been in a gross unrealized loss position as of September 30, 2017, and December 31, 2016 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
 

September 30, 2017

               

U.S. Government and sponsored entities

   $ 45,777      $ (158   $ 18,040      $ (199   $ 63,817      $ (357

Corporate debt securities

     57,158        (138     21,315        (63     78,473        (201

Municipal government

     379        (1     —          —         379        (1

Asset-backed securities

     11,959        (20     805        (1     12,764        (21

Mortgage-backed securities – residential

     351        (2     11        —         362        (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 115,624      $ (319   $ 40,171      $ (263   $ 155,795      $ (582
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2016

               

U.S. Government and sponsored entities

   $ 39,810      $ (348   $ —        $ —       $ 39,810      $ (348

Corporate debt securities

     133,382        (581     13,158        (40     146,540        (621

Municipal government

     1,268        (1     —          —         1,268        (1

Asset-backed securities

     4,540        (7     4,611        (10     9,151        (17

Mortgage-backed securities – residential

     428        (1     153        (2     581        (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 179,428      $ (938   $ 17,922      $ (52   $ 197,350      $ (990
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

For fixed income securities that have unrealized losses as of September 30, 2017, we have determined that 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 September 30, 2017, were temporary in nature.

Amortized cost and estimated fair value of investments as of September 30, 2017, are summarized by maturity date as follows (in thousands):

 

     Amortized cost      Fair value  

Mature in less than one year

   $ 56,677      $ 56,646  

Mature in one to three years

     161,626        161,277  
  

 

 

    

 

 

 

Total short-term investments

   $ 218,303      $ 217,923  
  

 

 

    

 

 

 

 

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Net realized gains of less than $0.1 and $0.2 million from sales of investments were recognized in interest income and other income, net, during the three and nine months ended September 30, 2017, respectively. Net realized gains of $0.1 and $0.3 million from sales of investments were recognized in interest income and other income, net, during the three and nine months ended September 30, 2016, respectively. Net unrealized losses of $0.4 and $0.8 million were included in OCI in the accompanying Condensed Consolidated Balance Sheets as of September 30, 2017, and December 31, 2016, respectively.

Fair Value Measurements

ASC 820, Fair Value Measurements, identifies fair value as the exchange price, or exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a three-tier fair value hierarchy 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 the 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 chose to 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.

Our investments and liabilities measured at fair value have been presented in accordance with the fair value hierarchy specified in ASC 820 as of September 30, 2017, and December 31, 2016 in order of liquidity as follows (in thousands):

 

     Total      Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
other
Observable
Inputs
(Level 2)
     Unobservable
Inputs

(Level 3)
 

September 30, 2017

           

Assets:

           

Money market funds

   $ 24,426      $ 24,426      $ —        $ —    

U.S. Government and sponsored entities

     64,989        38,966        26,023        —    

Corporate debt securities

     138,351        —          138,351        —    

Municipal government

     1,046        —          1,046        —    

Asset-backed securities

     12,849        —          12,795        54  

Mortgage-backed securities – residential

     687        —          687        —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 242,348      $ 63,392      $ 178,902      $ 54  
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Contingent consideration, current and noncurrent

   $ 53,520      $ —        $ —        $ 53,520  

Self-insurance

     935        —          —          935  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 54,455      $ —        $ —        $ 54,455  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Total      Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
other
Observable
Inputs
(Level 2)
     Unobservable
Inputs

(Level 3)
 

December 31, 2016

           

Assets:

           

Money market funds

   $ 23,575      $ 23,575      $ —        $ —    

U.S. Government and sponsored entities

     70,594        51,870        18,724        —    

Corporate debt securities

     197,647        —          197,647        —    

Municipal government

     1,277        —          1,277        —    

Asset-backed securities

     24,295        —          24,228        67  

Mortgage-backed securities – residential

     1,615        —          1,615        —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 319,003      $ 75,445      $ 243,491      $ 67  
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Contingent consideration, current and noncurrent

   $ 56,463      $ —        $ —        $ 56,463  

Self-insurance

     1,542        —          —          1,542  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 58,005      $ —        $ —        $ 58,005  
  

 

 

    

 

 

    

 

 

    

 

 

 

Money market funds consist of $24.4 and $23.6 million, which have been classified as cash equivalents as of September 30, 2017, and December 31, 2016, 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 nine months ended September 30, 2017 and 2016.

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) are related to the purchase business combinations of GD in 2017; Optitex Ltd. (“Optitex”) and Rialco Limited (“Rialco”) in 2016; Shuttleworth Business Systems Limited and CDM Solutions Limited (collectively, “Shuttleworth”), CTI, and Reggiani in 2015; DiMS! organizing print BV (“DIMS”), DirectSmile GmbH (“DirectSmile”), and SmartLinc, Inc. (“SmartLinc”) in 2014; Outback Software Pty. Ltd. doing business as Metrix Software (“Metrix”) and PrintLeader Software (“PrintLeader”) in 2013.

The fair value of these earnouts is estimated to be $53.5 and $56.5 million as of September 30, 2017, and December 31, 2016, 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% (Monte Carlo valuation method) and discount rates between 4.7% and 6.0% (probability-adjusted method), as well as probability-adjusted revenue and earnings before interest and taxes (“EBIT”) levels. Probability-adjusted revenue, gross profit, operating profit, and EBIT are significant inputs that are not observable in the market, which ASC 820-10-35 refers to as Level 3 inputs. These contingent liabilities have been reflected in the Condensed Consolidated Balance Sheet as of September 30, 2017, as current and noncurrent liabilities of $29.6 and $23.9 million, respectively.

 

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Table of Contents

The fair value of contingent consideration increased by $2.2 million, including $1.2 million of earnout interest accretion related to all acquisitions during the nine months ended September 30, 2017. The Optitex and CTI earnout performance probabilities increased while the Shuttleworth earnout performance probability decreased in 2017. The fair value of contingent consideration increased by $6.8 million, including $2.7 million of earnout interest accretion related to all acquisitions during the year ended December 31, 2016. The Rialco, Optitex, Reggiani, DirectSmile, and CTI earnout performance probabilities increased while the DIMS and Shuttleworth earnout performance probabilities decreased or were not achieved in 2016. In accordance with ASC 805-30-35-1, changes in the fair value of contingent consideration subsequent to the acquisition date have been recognized in general and administrative expense.

Earnout payments and settlements during the nine months ended September 30, 2017 of $8.9, $1.3, and $1.2 million are primarily related to the previously accrued Reggiani, Rialco, and Shuttleworth contingent consideration liabilities, respectively. Earnout payments during the year ended December 31, 2016 of $23.8, $3.6, $0.4, and $0.2 million are primarily related to the previously accrued Reggiani, DirectSmile, SmartLinc, and Metrix contingent consideration liabilities, respectively.

Changes in the fair value of contingent consideration are summarized as follows (in thousands):

 

Fair value of contingent consideration at January 1, 2016

   $ 54,796  

Fair value of Rialco contingent consideration at March 1, 2016

     2,109  

Fair value of Optitex contingent consideration at June 16, 2016

     22,300  

Changes in valuation

     6,813  

Payments

     (28,111

Foreign currency adjustment

     (1,444
  

 

 

 

Fair value of contingent consideration at December 31, 2016

   $ 56,463  

Fair value of GD contingent consideration at August 14, 2017

   $ 3,600  

Changes in valuation

   $ 2,187  

Payments and settlements

     (11,559

Foreign currency adjustment

     2,829  
  

 

 

 

Fair value of contingent consideration at September 30, 2017

   $ 53,520  
  

 

 

 

Since the primary inputs to the fair value measurement of contingent consideration liability are the discount rate and probability-adjusted revenue, we reviewed the sensitivity of the fair value measurement to changes in these inputs. We assessed the probability of achieving the revenue performance targets for contingent consideration associated with each acquisition at percentage levels between 60% 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 $1.7 million or a decrease in the fair value of contingent consideration of $2.8 million, resulting in a corresponding adjustment to general and administrative expense. A change in the discount rate of one percentage point would result in an increase in the fair value of contingent consideration of $0.4 million or a decrease of $0.5 million. The potential undiscounted amount of future contingent consideration cash payments that we could be required to make related to our business acquisitions, beyond amounts currently accrued, is $13.5 million as of September 30, 2017.

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 $191.8 and $161.8 million as of September 30, 2017 and December 31, 2016, respectively. The fair value of our derivative assets and liabilities that were designated for cash flow hedge accounting treatment having notional amounts of $3.8 and $3.2 million as of September 30, 2017 and December 31, 2016, respectively, was not material.

 

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Table of Contents

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 September 30, 2017 was approximately $360.9 million and was considered 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.

6. Convertible Senior Notes (“Notes”), Note Hedges, and Warrants

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 2019 (“Notes”). The Notes were sold to the initial purchasers for resale to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. 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, commencing March 1, 2015. 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 September 30, 2017, none of the conditions listed below allowing holders of the Notes to convert had been met.

Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Holders may convert their Notes only under the following circumstances:

 

   

if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;

 

   

during the five business day period after any five consecutive trading day period (“Notes Measurement Period”) in which the “trading price” (as the term is defined in the Indenture) per $1,000 principal amount of Notes for each trading day of such Notes Measurement Period was less than 98% of the product of the last reported stock price on such trading day and the conversion rate on each such trading day;

 

   

upon the occurrence of specified corporate events; or

 

   

at any time on or after March 1, 2019 until the close of business on the second scheduled trading day immediately preceding the maturity date.

We separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the estimated fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the face value of the Notes as a whole. 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.

 

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Table of Contents

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 consist of the following as of September 30, 2017, and December 31, 2016 (in thousands):

 

     September 30,
2017
     December 31,
2016
 

Liability component

   $ 345,000      $ 345,000  

Debt discount, net of amortization

     (26,488      (36,115

Debt issuance costs, net of amortization

     (3,258      (4,401
  

 

 

    

 

 

 

Net carrying amount

   $ 315,255      $ 304,484  
  

 

 

    

 

 

 

Equity component

   $ 63,643      $ 63,643  

Less: debt issuance costs allocated to equity

     (1,582      (1,582
  

 

 

    

 

 

 

Net carrying amount

   $ 62,061      $ 62,061  
  

 

 

    

 

 

 

Interest expense recognized related to the Notes during the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

0.75% coupon

   $ 647      $ 654      $ 1,933      $ 1,941  

Amortization of debt issuance costs

     388        373        1,144        1,092  

Amortization of debt discount

     3,265        3,126        9,627        9,152  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 4,300      $ 4,153      $ 12,704      $ 12,185  
  

 

 

    

 

 

    

 

 

    

 

 

 

Note Hedges

We paid an aggregate of $63.9 million in convertible note hedge transactions with respect to our common stock (“Note Hedges”) in September 2014. The Note Hedges will expire upon maturity of the Notes. The Note Hedges are intended to offset the potential dilution upon conversion and/or offset any cash payments we are required to make in excess of the principal amount upon conversion of the Notes in the event that the market value per share of our common stock, as measured under the terms of the Note Hedges, is greater than the strike price of the Note Hedges. The strike price of the Note Hedges initially corresponds to the conversion price of the Notes and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion price of the Notes. The Note Hedges are separate transactions and are not part of the Notes. Holders of the Notes will not have any rights with respect to the Note Hedges.

Warrants

Concurrently with entering into the Note Hedges, we separately entered into warrant transactions (“Warrants”), whereby we sold Warrants to acquire shares of our common stock at a strike price of $68.86 per share. We received aggregate proceeds of $34.5 million from the sale of the Warrants. If the average market value per share of our common stock for the reporting period, as measured under the Warrants, exceeds the strike price of the Warrants, the Warrants will have a dilutive effect on our earnings per share. The Warrants are separate transactions and are not part of the Notes or the Note Hedges and are accounted for as a component of additional paid-in capital. Holders of the Notes and Note Hedges will not have any rights with respect to the Warrants.

 

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Table of Contents

7. Income taxes

We recognized tax provisions of $0.8 million on pretax net income of $4.2 and $11.8 million during the three and nine months ended September 30, 2017, respectively. We recognized tax benefits of $11.8 and $9.0 million on pretax net income of $5.8 and $16.0 million during the three and nine months ended September 30, 2016, respectively. The provisions for income taxes before discrete items reflected in the table below were $1.9 and $4.5 million during the three and nine months ended September 30, 2017, respectively, and $3.3 and $6.1 million during the three and nine months ended September 30, 2016, respectively. The decrease in the provisions for income taxes before discrete items for the three and nine months ended September 30, 2017, compared with the same periods in the prior year, is primarily due to decreased profitability before income taxes.

Primary differences between our provision for income taxes before discrete items and the income tax provision at the U.S. statutory rate of 35% include lower taxes on permanently reinvested foreign earnings, the tax effects of stock-based compensation expense pursuant to ASC 718-740, Stock Compensation – Income Taxes, which are non-deductible for tax purposes, and tax benefits from significantly lower reversal of uncertain tax positions in 2017 as compared to those recorded in 2016.

Our tax provisions before discrete items are reconciled to our recorded benefits for income taxes during the three and nine months ended September 30, 2017 and 2016 as follows (in millions):

 

     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

Provision for income taxes before discrete items

   $ 1.9      $ 3.3      $ 4.5      $ 6.1  

Interest related to unrecognized tax benefits

     —          —          0.1        0.3  

Reassessment of taxes upon filing tax returns

     0.3        (0.2      0.4        (0.2

Provision (benefit) related to stock based compensation, including ESPP dispositions

     0.4        (1.4      (1.9      (1.7

Benefit from reassessment of taxes upon foreign statutory tax rate change

     —          —          (0.5      —    

Benefit from reversals of uncertain tax positions due to statute of limitation expirations

     (1.8      (13.5      (1.8      (13.5
  

 

 

    

 

 

    

 

 

    

 

 

 

Benefit from income taxes

   $ 0.8      $ (11.8    $ 0.8      $ (9.0
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2017, and December 31, 2016, gross unrecognized benefits that would affect the effective tax rate if recognized were $32.3 and $32.0 million, respectively. Over the next twelve months, our existing tax positions will continue to generate increased liabilities for unrecognized tax benefits. It is reasonably possible that our gross unrecognized tax benefits will decrease up to $5.0 million in the next twelve months primarily due to the lapse of the statute of limitations for federal and state tax purposes. These adjustments, if recognized, would positively impact our effective tax rate, and would be recognized as additional tax benefits in our Condensed Consolidated Statements of Operations.

In accordance with ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, Similar Tax Loss, or Tax Credit Carryforward Exists, $19.9 million of gross unrecognized tax benefits were offset against deferred tax assets as of September 30, 2017, and the remaining $12.4 million has been recorded as noncurrent income taxes payable.

We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. As of September 30, 2017 and December 31, 2016, we have accrued $0.6 and $0.5 million, respectively, for potential payments of interest and penalties.

We are subject to examination by the Internal Revenue Service (“IRS”) for the 2014-2015 tax years, state tax jurisdictions for the 2012-2015 tax years, the Netherlands tax authority for the 2012-2015 tax years, the Spanish tax authority for the 2013-2016 tax years, the Israel tax authority for the 2011-2015 tax years, and the Italian tax authority for the 2012-2015 tax years.

8. Commitments and Contingencies

Contingent Consideration

We are required to make payments to the former stockholders of acquired companies based on the achievement of specified performance targets as more fully explained in Note 5 – Investments and Fair Value Measurements.

 

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Table of Contents

Lease Commitments and Contractual Obligations

As of September 30, 2017, we have leased certain of our current facilities under noncancellable operating lease agreements. We are required to pay property taxes, insurance, and nominal maintenance costs for certain of these facilities and any increases over the base year of these expenses on the remainder of our facilities.

Assets Held for Sale

In 2016, management approved a plan to sell approximately 5.6 acres and the office building located at 1340 Corporate Center Curve, Eagan, Minnesota, consisting of 43,682 square feet, and the related fixed assets were classified as held for sale. On April 13, 2017, we entered into an agreement under which we agreed to sell the office building and related land, subject to completion of a 150-day due diligence period, which expired without the transaction closing on September 7, 2017. Accordingly, assets previously recorded as held for sale of $3.8 million, which consisted of $2.9 million net book value of the facility and $0.9 million of related land as of December 31, 2016, have been classified as assets held for use within property and equipment, net, in our Condensed Consolidated Balance Sheet as of September 30, 2017.

Off-Balance Sheet Financing – Lease Arrangements

On August 26, 2016, we entered into a lease agreement and have accounted for a lease term of 48.5 years, inclusive of two renewal options of 5.0 and 3.5 years, with the City of Manchester to lease 16.9 acres adjacent to the Manchester Regional Airport. The land is subleased to Bank of Tokyo – Mitsubishi UFJ Leasing & Finance LLC (“BTMU”) during the term of the lease related to the manufacturing facility that is being constructed on the site, which is described below. Minimum lease payments are $13.1 million during the 48.5 year term of the land lease, excluding four months of the land lease that are financed into the manufacturing facility lease.

On August 26, 2016, we entered into a six-year lease with BTMU whereby a 225,000 square foot manufacturing and warehouse facility is under construction related to our super-wide format industrial digital inkjet printer business in the Industrial Inkjet operating segment at a projected cost of $40 million and a construction period of 18 months. Minimum lease payments during the initial six-year term are $1.8 million. Upon completion of the initial six-year term, we have the option to renew the lease, purchase the facility, or return the facility to BTMU subject to an 89% residual value guarantee under which we would recognize additional rent expense in the form of a variable rent payment. We have assessed our exposure in relation to the residual value guarantee and believe that there is no deficiency to the guaranteed value with respect to funds expended by BTMU as of September 30, 2017. We are treated as the owner of the facility for federal income tax purposes.

The funds pledged under the lease represent 115% of the total expenditures made by BTMU through September 30, 2017. The funds are invested in $20.9 and $6.8 million of U.S. government securities and cash equivalents, respectively, with a third party trustee and will be restricted during the construction period. Upon completion of construction, the funds will be released as cash and cash equivalents. The portion of released funds that represents 100% of the total expenditures made by BTMU will be deposited with BTMU and restricted as collateral until the end of the underlying lease period.

The funds pledged as collateral are invested in U.S. government securities and cash equivalents as of September 30, 2017, and are classified as Level 1 in the fair value hierarchy as more fully defined in Note 5 – Investments and Fair Value Measurements. Net unrealized gains of less than $0.1 million were included in OCI in the accompanying Condensed Consolidated Balance Sheet as of September 30, 2017.

We have determined that the lease agreement does not qualify as a variable interest entity under ASC 810-10, Consolidation, and as such, we are not required to consolidate the VIE in our condensed consolidated financial statements.

Legal Proceedings

We may be involved, from time to time, in a variety of claims, lawsuits, investigations, or proceedings relating to contractual disputes, securities laws, intellectual property rights, employment, or other matters that may arise in the normal course of business. We assess our potential liability in each of these matters by using the information available to us. We develop our views on estimated losses in consultation with inside and outside counsel, which involves a subjective analysis of potential results and various combinations of appropriate litigation and settlement strategies. We accrue estimated losses from contingencies if a loss is deemed probable and can be reasonably estimated.

 

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As of September 30, 2017, we are subject to the matters discussed below:

Matan Digital Printing (“MDG”) Matter

EFI acquired Matan Digital Printers (“Matan”) in 2015 from sellers (the “2015 Sellers”) that acquired Matan Digital Printing Ltd. from other sellers in 2001 (the “2001 Sellers”). The 2001 Sellers have asserted a claim against the 2015 Sellers and Matan asserting that they are entitled to a portion of the 2015 Sellers’ proceeds from EFI’s acquisition. The 2015 Sellers dispute this claim and have agreed to indemnify EFI against the 2001 Sellers’ claim.

Although we are fully indemnified and we do not believe that it is probable that we will incur a loss, it is reasonably possible that our financial statements could be materially affected by an unfavorable resolution of this matter. Accordingly, it is reasonably possible that we could incur a material loss in this matter. We estimate the range of loss to be between one dollar and $10.1 million. If we incur a loss in this matter, it will be offset by a receivable of an equal amount representing a claim for indemnification against the escrow account established in connection with the Matan acquisition.

Purported Class Action Lawsuit

On August 10, 2017, a putative class action was filed against the Company and its two named executive officers in the United States District Court for the District of New Jersey, captioned Pipitone v. Electronics For Imaging, Inc ., No. 2:17-cv-05992 (D.N.J.). The complaint alleges, among other things, that statements by the Company and its officers about the Company’s financial reporting, revenue recognition, internal controls, and disclosure controls and procedures were false or misleading. The complaint seeks an unspecified amount of damages, interest, attorneys’ fees, and other costs, on behalf of a putative class of individuals and entities that purchased or otherwise acquired EFI securities from February 22, 2017 through August 3, 2017.

At this time, we do not believe it is probable that we will incur a material loss in this matter. However, it is reasonably possible that our financial statements could be materially affected by an unfavorable resolution of this matter. Because this matter is in the preliminary stages, we are not yet in a position to estimate the amount or range of reasonably possible loss that may be incurred.

Purported Derivative Shareholder Lawsuits

On August 22, 2017, a purported derivative shareholder complaint was filed in the Superior Court of the State of California for the County of Alameda captioned Schiffmiller v. Gecht , No. RG17873197. The complaint makes claims derivatively and on behalf of the Company as nominal defendant against the Company’s named executive officers and directors for alleged breaches of fiduciary duties and unjust enrichment, and alleges, among other things, that statements by the Company and its officers about the Company’s financial reporting, revenue recognition, internal controls, and disclosure controls and procedures were false or misleading. The complaint alleges the Company has suffered damage as a result of the individual defendants’ alleged actions, and seeks an unspecified amount of damages, restitution, and declaratory and other relief. The derivative action has been stayed pending the resolution of the Pipitone class action described above.

At this time, we do not believe it is probable that we will incur a material loss in this matter. However, it is reasonably possible that our financial statements could be materially affected by an unfavorable resolution of this matter. Because this matter has been stayed pending resolution of the Pipitone class action described above, we are not yet in a position to estimate the amount or range of reasonably possible loss that may be incurred.

Other Matters

As of September 30, 2017, we were subject to various other claims, lawsuits, investigations, and proceedings in addition to the matter discussed above. There is at least a reasonable possibility that additional losses may be incurred in excess of the amounts that we have accrued. However, we believe that these claims are not material to our financial statements or the range of reasonably possible losses is not reasonably estimable. Litigation is inherently unpredictable, and while we believe that we have valid defenses with respect to legal matters pending against us, our financial statements could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management’s attention and the incurrence of significant expenses.

 

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9. Segment Information and Geographic Data

Operating segment information is required to be presented based on the internal reporting used by the chief operating decision making group (“CODM”) to allocate resources and evaluate operating segment performance. Our CODM is comprised of our Chief Executive Officer and Chief Financial Officer. The CODM group is focused on assessment and resource allocation among the Industrial Inkjet, Productivity Software, and Fiery operating segments.

Our operating segments are integrated through their reporting and operating structures, shared technology and practices, shared sales and marketing, and combined production facilities. Our enterprise management processes use financial information that is closely aligned with our three operating segments at the gross profit level. Relevant discrete financial information is prepared at the gross profit level for each of our three operating segments, which is used by the CODM to allocate resources and assess the performance of each operating segment.

We classify our revenue, operating segment profit (i.e., gross profit), assets, and liabilities in accordance with our operating segments as follows:

Industrial Inkjet, which consists of our VUTEk and Matan super-wide and wide format display graphics, Reggiani textile, Jetrion label and packaging, Nozomi corrugated packaging, and Cretaprint ceramic tile decoration and construction material industrial digital inkjet printers; digital ultra-violet (“UV”) curable, light-emitting diode (“LED”) curable, ceramic, water-based, and thermoforming ink, as well as a variety of textile ink including dye sublimation, pigmented, reactive dye, acid dye, pure disperse dye, and water-based dispersed printing ink; 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, which 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; (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 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, which consists of DFEs, including the recently acquired FFPS DFE from Xerox, that transform digital copiers and printers into high performance networked printing devices for the office, industrial, and commercial 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, Generation Digital, 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 solutions.

Our CODM evaluates the performance of our operating segments based on net sales and gross profit. Gross profit for each operating segment includes revenue from sales to third parties and related cost of revenue attributable to the operating segment. Cost of revenue for each operating segment excludes certain expenses managed outside the operating segments consisting primarily of stock-based compensation expense.

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-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.

 

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Operating segment profit (i.e., gross profit), excluding stock-based compensation expense, during the three and nine months ended September 30, 2017 and 2016 is summarized as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

Industrial Inkjet

        

Revenue

   $ 142,930     $ 143,004     $ 407,886     $ 408,926  

Gross profit

     53,392       50,433       154,972       141,927  

Gross profit percentages

     37.4     35.3     38.0     34.7

Productivity Software

        

Revenue

   $ 37,171     $ 39,663     $ 111,292     $ 108,554  

Gross profit

     26,667       30,041       81,431       80,961  

Gross profit percentages

     71.7     75.7     73.2     74.6

Fiery

        

Revenue

   $ 68,258     $ 62,908     $ 204,919     $ 207,878  

Gross profit

       47,885       45,362       143,821       147,938  

Gross profit percentages

     70.2     72.1     70.2     71.2

Operating segment profit (i.e., gross profit) is reconciled to our Condensed Consolidated Statements of Operations during the three and nine months ended September 30, 2017 and 2016 as follows (in thousands):

 

     Three Months Ended
September 30,
     Six Months Ended
September 30,
 
     2017      2016      2017      2016  

Segment gross profit

   $ 127,944      $ 125,836      $ 380,224      $ 370,826  

Stock-based compensation expense

     (486      (642      (1,985      (1,873

Other items excluded from segment profit

     —          —          —          (315
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

   $ 127,458      $ 125,194      $ 378,239      $ 368,638  
  

 

 

    

 

 

    

 

 

    

 

 

 

The Fiery gross profit percentage is impacted by less than $0.1 and $1.3 million during the three and nine months ended September 30, 2017, respectively, charged to cost of revenue, which reflects the cost of manufacturing plus a portion of the expected profit margin related to the acquired FFPS inventories. Inventory acquired in the acquisition of FFPS is required to be recorded at fair value rather than historical cost in accordance with ASC 805. This amount is not included in the financial information regularly reviewed by the CODM as this acquisition-related charge is not indicative of the gross margin trends in the FFPS business. Excluding this charge, the Fiery gross profit percentage would be 70.3% and 70.8% for the three and nine months ended September 30, 2017, respectively.

Tangible and intangible assets, net of liabilities, are summarized by operating segment as follows (in thousands):

 

September 30, 2017

   Industrial
Inkjet
     Productivity
Software
    Fiery      Corporate
and
Unallocated
Net Assets
     Total  

Goodwill

   $ 149,353      $ 164,525     $ 73,123      $ —        $ 387,001  

Identified intangible assets, net

     72,290        32,294       21,983        —          126,567  

Tangible assets, net of liabilities

     219,554        (35,624     11,833        129,341        325,104  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net tangible and intangible assets

   $ 441,197      $ 161,195     $ 106,939      $ 129,341      $ 838,672  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

December 31, 2016

                                 

Goodwill

   $ 141,068      $ 155,475     $ 63,298      $ —        $ 359,841  

Identified intangible assets, net

     84,465        38,440       92        —          122,997  

Tangible assets, net of liabilities

     153,699        (27,646 )       33,966        183,158        343,177  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net tangible and intangible assets

   $   379,232      $   166,269     $     97,356      $   183,158      $   826,015  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

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Corporate and unallocated assets consist of cash and cash equivalents, short-term investments, restricted investments and cash equivalents, corporate headquarters facility, convertible notes, imputed financing obligation, income taxes receivable, and income taxes payable.

Geographic Regions

Our revenue originates in the U.S., China, the Netherlands, Germany, Italy, France, the U.K., Spain, Israel, Brazil, India, Australia, and New Zealand. We report revenue by geographic region based on ship-to destination. Shipments to some of our significant printer manufacturer/distributor customers are made to centralized purchasing and manufacturing locations, which in turn sell through to other locations. As a result of these factors, we believe that sales to certain geographic locations might be higher or lower, as the ultimate destinations are difficult to ascertain.

Our revenue by ship-to destination during the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

Americas

   $ 129,488      $ 128,252      $ 353,397      $ 363,977  

Europe, Middle East and Africa (“EMEA”)

     85,089        85,009        274,635        264,469  

Asia Pacific (“APAC”)

     33,782        32,314        96,065        96,912  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 248,359      $ 245,575      $ 724,097      $ 725,358  
  

 

 

    

 

 

    

 

 

    

 

 

 

10. 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 market 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. ASC 815, Derivatives and Hedging, requires the fair value of all derivative instruments, including those embedded in other contracts, to be recorded as assets or liabilities in our Condensed Consolidated Balance Sheet. 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, Australia, New Zealand, and Canada, and to non-U.S. dollar-denominated operating expenses in Europe, India, Japan, the U.K., China, Israel, Brazil, and Australia. We hedge our operating expense cash flow exposure in Indian rupees. We hedge balance sheet remeasurement exposure associated with British pound sterling, Brazilian real, Israeli shekel, Japanese yen, Chinese renminbi, and Euro-denominated intercompany balances; Brazilian real, British pound sterling, Australian dollar, Canadian dollar, Israeli shekel, and Euro-denominated trade receivables; and British pound sterling, Indian rupee, Israeli shekel, Canadian dollar, and 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 (i.e., operating expense exposure in Indian rupees; the collection of trade receivables denominated in currencies other than their respective reporting entity’s functional currency, and the settlement of intercompany balances denominated in currencies other than their functional currency). 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 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.

 

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Cash Flow Hedges

Foreign currency derivative contracts with notional amounts of $3.8 million and $3.2 million have been designated as cash flow hedges of our Indian rupee operating expense exposure at September 30, 2017 and December 31, 2016, respectively. The fair value of the net assets (liabilities) related to these cash flow hedges are not material. The changes in fair value of these contracts are reported as a component of OCI 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

Forward contracts not designated for hedge accounting treatment with notional amounts of $188.0 and $158.7 million are used to hedge foreign currency balance sheet exposures at September 30, 2017 and December 31, 2016, respectively. They 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, net, in the same period as the remeasurement gain or loss of the related foreign currency denominated assets and liabilities. Forward contracts not designated for hedge accounting treatment consist of hedges of British pound sterling, Brazilian real, Israeli shekel, Japanese yen, Chinese renminbi, and Euro-denominated intercompany balances with notional amounts of $99.6 and $90.7 million; hedges of Brazilian real, British pound sterling, Australian dollar, Canadian dollar, Israeli shekel, and Euro-denominated trade receivables with notional amounts of $46.5 and $39.8 million; and hedges of British pounds sterling, Indian rupee, Israeli shekel, Canadian dollar, and Euro-denominated other net monetary assets with notional amounts of $41.9 and $28.2 million at September 30, 2017 and December 31, 2016, respectively.

11. Restructuring and Other

During the three and nine months ended September 30, 2017 and 2016, cost reduction actions were taken to lower our operating expense run rate as we analyze and re-align our cost structure following our business acquisitions. These charges primarily relate to integrating recently acquired businesses, consolidating facilities, and lowering our operating expense run rate. Restructuring and other consists primarily of restructuring, severance, retention, facility downsizing and relocation, and acquisition integration expenses. Our restructuring and other plans are accounted for in accordance with ASC 420, Exit or Disposal Cost Obligations, ASC 712, Compensation – Non-Retirement Postemployment Benefits, and ASC 820.

Restructuring and other costs were $0.8 and $5.4 million during the three and nine months ended September 30, 2017, respectively, and $1.3 and $5.7 million during the three and nine months ended September 30, 2016, respectively. Restructuring and other costs include severance charges of $0.3 and $3.8 million related to reductions in head count of 15 and 128 during the three and nine months ended September 30, 2017, respectively, and $0.6 and $3.7 million related to reduction in head count of 16 and 114 during the three and nine months ended September 30, 2016, respectively. Severance costs include severance payments, related employee benefits, outplacement fees, and employee relocation costs.

Facilities relocation and downsizing expenses were $0.4 and $0.6 million during the three and nine months ended September 30, 2017, respectively, and $0.1 and $0.6 million during the three and nine months ended September 30, 2016, primarily related to the relocation of certain administrative locations due to reduced space requirements. Integration expenses of $0.2 and $1.0 million during the three and nine months ended September 30, 2017, respectively, and $0.6 and $1.5 million during the three and nine months ended September 30, 2016, respectively, were required to integrate our business acquisitions.

Restructuring and other reserve activities during the nine months ended September 30, 2017 and 2016 are summarized as follows (in thousands):

 

     2017      2016  

Reserve balance at January 1,

   $ 1,824      $ 3,019  

Restructuring charges

     4,101        2,878  

Other charges

     1,321        2,856  

Non-cash restructuring and other

     (182      (403

Cash payments

     (4,720      (6,174
  

 

 

    

 

 

 

Reserve balance at September 30,

   $ 2,344      $ 2,176  
  

 

 

    

 

 

 

 

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12. Stock-based Compensation

We account for stock-based payment awards in accordance with ASC 718, Stock Compensation, which requires the measurement and recognition of compensation expense for all equity awards granted to our employees and directors, including RSUs, ESPP purchase rights, and employee stock options related to all stock-based compensation plans based on the fair value of such awards on the date of grant. We amortize stock-based compensation cost on a graded vesting basis over the vesting period reduced by actual forfeitures, after assessing the probability of achieving the requisite performance criteria with respect to performance-based awards. Stock-based compensation cost is recognized over the requisite service period for each separately vesting tranche of the award as though the award were, in substance, multiple awards.

Stock-based compensation expense related to stock options, ESPP purchase rights, and RSUs during the three and nine months ended September 30, 2017 and 2016 is summarized as follows (in thousands):

 

     Three months ended September 30,      Nine months ended September 30,  
     2017      2016      2017      2016  

Stock-based compensation expense by type of award:

           

RSUs

   $ 3,545      $ 7,979      $ 18,875      $ 24,931  

ESPP purchase rights

     1,103        574        3,666        1,932  

Employee stock options

     —          —          —          79  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

     4,648        8,553        22,541        26,942  

Income tax benefit

     (1,525      (3,649      (6,929      (7,895
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock-based compensation expense, net of tax

   $ 3,123      $ 4,904      $ 15,612      $ 19,047  
  

 

 

    

 

 

    

 

 

    

 

 

 

Valuation Assumptions for Stock Options and ESPP Purchase Rights

We use the Black-Scholes-Merton (“BSM”) option pricing model to value stock-based compensation for all equity awards, except market-based awards, which are valued using the Monte Carlo valuation model.

The BSM model determines the fair value of stock-based payment awards based on the stock price on the date of grant and is affected by assumptions regarding highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, expected term, interest rates, and actual and projected employee stock option exercise behavior. Expected volatility is based on the historical volatility of our stock over a preceding period commensurate with the expected term of the option. The expected term is based upon management’s consideration of the historical life, vesting period, and contractual period of the options granted. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected dividend yield was not considered in the option pricing formula since we do not pay dividends and have no current plans to do so in the future.

Stock options were not granted during the three and nine months ended September 30, 2017 and 2016. The estimated weighted average fair value per share of ESPP purchase rights issued and the underlying weighted average assumptions for the three and nine months ended September 30, 2017 and 2016 are as follows:

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2017     2016     2017     2016  

Weighted average fair value per share

   $ 13.14     $ 12.00     $ 12.09     $ 10.69  

Expected volatility

     25% - 28     26% - 32     24% - 28     22% - 32

Risk-free interest rate

     1.2% - 1.3     0.4% - 0.7     0.7% - 1.3     0.4% - 0.8

Expected term (in years)

     0.5 - 2.0       0.5 - 2.0       0.5 - 2.0       0.5 - 2.0  

 

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Stock options outstanding and exercisable, including performance-based and market-based options, as of September 30, 2017, and activity during the nine months ended September 30, 2017 are summarized below (in thousands, except weighted average exercise price and remaining contractual term):

 

     Shares
outstanding
     Weighted
average
exercise price
     Weighted
average
remaining
contractual
term (years)
     Aggregate
intrinsic value
 

Options outstanding at January 1, 2017

     315      $ 13.86        

Options exercised

     (140      12.22        
  

 

 

    

 

 

       

Options outstanding at September 30, 2017

     175      $ 15.18        1.32      $ 4,812  
  

 

 

    

 

 

    

 

 

    

 

 

 

Options vested and expected to vest at September 30, 2017

     175      $ 15.18        1.32      $ 4,812  
  

 

 

    

 

 

    

 

 

    

 

 

 

Options exercisable at September 30, 2017

     175      $ 15.18        1.32      $ 4,812  
  

 

 

    

 

 

    

 

 

    

 

 

 

Aggregate intrinsic value for stock options represents the difference between the closing price per share of our common stock on the last trading day of the fiscal period and the option exercise price multiplied by the number of in-the-money stock options outstanding, vested and expected to vest, and exercisable at September 30, 2017.

Non-vested RSUs as of September 30, 2017, and activity during the nine months ended September 30, 2017 are summarized below (shares in thousands):

 

     Time-based      Performance-based      Market-based      Total  
     Shares     Weighted
average grant
date fair value
     Shares     Weighted
average grant
date fair value
     Shares      Weighted
average grant
date fair value
     Shares     Weighted
average grant
date fair value
 

Non-vested at January 1, 2017

     795     $ 43.79        1,265     $ 42.64        23      $ 33.16        2,083     $ 43.34  

Granted

     120       45.98        371       46.93        —          —          491       46.70  

Vested

     (417     43.88        (276     40.83        —          —          (693     42.66  

Forfeited

     (49     43.72        (437     41.29        —          —          (486     41.53  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Non-vested at September 30, 2017

     449     $ 44.30        923     $ 45.55        23      $ 33.16        1,395     $ 45.49  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Vested RSUs

Performance-based RSUs that vested based on financial results are included in “Vested RSUs” in the table above in the period that the performance and related service criteria were met. The grant date fair value of RSUs vested during the nine months ended September 30, 2017 was $29.6 million. The aggregate intrinsic value at September 30, 2017 for RSUs expected to vest was $34.1 million and the remaining weighted average vesting period was 1.0 year. Aggregate intrinsic value for RSUs vested and expected to vest represents the closing price per share of our common stock on the last trading day of the fiscal period, multiplied by the number of RSUs vested and expected to vest as of September 30, 2017. RSUs expected to vest represent time-based RSUs unvested and outstanding at September 30, 2017, and performance-based RSUs for which the requisite service period has not been rendered, but are expected to vest based on the achievement of performance conditions.

Performance-based and Market-based RSUs and Stock Options

Performance-based stock options, market-based RSUs, and market-based stock options were not granted during the nine months ended September 30, 2017 and 2016. We use the BSM option pricing model to value performance-based RSUs. The weighted average grant date fair value per share of performance-based RSUs granted and the assumptions used to estimate grant date fair value during the nine months ended September 30, 2017 and 2016 are as follows:

 

     Performance-based  
     RSUs  
     Short-term      Long-term  

Nine months ended September 30, 2017 Grants

     

Grant date fair value per share

   $ 47.23      $ 45.96  

Service period (years)

     1.0        2.0 - 3.0  

Nine months ended September 30, 2016 Grants

     

Grant date fair value per share

   $ 39.79      $ 45.62  

Service period (years)

     1.0        2.0 - 3.0  

 

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Our performance-based RSUs generally vest when specified performance criteria are met based on bookings, revenue, cash provided by operating activities, non-GAAP operating income, non-GAAP earnings per share, revenue growth compared to market comparables, non-GAAP earnings per share growth compared to cash flow from operating activities growth, or other targets during the service period; otherwise, they are forfeited. Non-GAAP operating income is defined as operating income determined in accordance with GAAP, adjusted to remove the impact of certain expenses and gains. Non-GAAP earnings per share is defined as net income determined in accordance with GAAP, adjusted to remove the impact of certain expenses and gains, and the related tax effects, divided by the weighted average number of common shares and dilutive potential common shares outstanding during the period as more fully defined in Note 2 – Earnings Per Share of the Notes to Condensed Consolidated Financial Statements.

The grant date fair value per share determined in accordance with the BSM valuation model is being amortized over the service period of the performance-based awards. The probability of achieving the awards was determined based on review of the actual results achieved thus far by each business unit compared with the operating plan during the pertinent service period as well as the overall strength of the business unit. Stock-based compensation expense was adjusted based on this probability assessment. As actual results are achieved during the service period, the probability assessment is updated and stock-based compensation expense adjusted accordingly.

Market-based awards that were granted in prior periods vest when our average closing stock price exceeds defined multiples of the closing stock price for 90 consecutive trading days. If these multiples were not achieved by the expiration date, the awards are forfeited. The grant date fair value is being amortized over the average derived service period of the awards. The average derived service period and total fair value were determined using a Monte Carlo valuation model based on our assumptions, which include a risk-free interest rate and implied volatility.

2017 Equity Incentive Plan

Our stockholders approved the 2017 Equity Incentive Plan (“2017 Plan”) on June 7, 2017, which includes:

 

   

1.2 million shares of our common stock reserved for issuance pursuant to such plan;

 

   

1,593,660 common stock shares that were available for future grants under the 2009 Equity Incentive Award Plan (“Prior Plan”) immediately prior to termination of authority to grant new awards under the Prior Plan on June 7, 2017;

 

   

shares subject to stock options granted under the Prior Plan and outstanding as of June 7, 2017, which expire, or for any reason are cancelled or terminated, after that date without being exercised; and

 

   

shares subject to restricted stock unit awards granted under the Prior Plan that are outstanding and unvested as of June 7, 2017 which are forfeited, terminated, cancelled, or otherwise reacquired after that date without having become vested.

No additional grants will be made under the Prior Plan. The 2017 Plan replaces the Prior Plan and will be used to help attract, retain and motivate employees, consultants, and directors.

13. Common Stock Repurchase Programs

On November 9, 2015, the board of directors approved the repurchase of $150 million of outstanding common stock commencing January 1, 2016. On September 11, 2017, the board of directors approved the repurchase of an additional $125 million for our share repurchase program commencing September 11, 2017. At that time, $28.8 million remained available for repurchase under the 2015 authorization. The 2017 authorization thereby increased the repurchase authorization to $153.8 million of our common stock. This authorization expires December 31, 2018. Under this publicly announced plan, we repurchased 0.3 and 1.0 million shares for an aggregate purchase price of $12.5 and $47.0 million during the three and nine months ended September 30, 2017, respectively. We repurchased 0.4 and 1.4 million shares for an aggregate purchase price of $18.0 and $57.7 million during the nine months ended September 30, 2016, respectively.

Our employees have the option to surrender shares of common stock to satisfy their tax withholding obligations that arise on the vesting of RSUs. In connection with stock option exercises, certain employees can surrender shares to satisfy the exercise price of certain stock options and any tax withholding obligations incurred in connection with such exercises. Employees surrendered less than 0.1 and 0.2 million shares for an aggregate purchase price of $3.1 and $10.0 million during the three and nine months ended September 30, 2017, respectively, and less than 0.1 and 0.2 million shares for an aggregate purchase price of $3.4 and $7.6 million during the three and nine months ended September 30, 2016, respectively.

 

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These repurchased shares reduce shares outstanding and are recorded as treasury stock under the cost method thereby reducing stockholders’ equity by the cost of the repurchased shares. Our repurchase program is limited by SEC regulations and is subject to compliance with our insider trading policy.

14. Accounts Receivable

Financing Receivables

ASC 310, Receivables, requires disclosure regarding the credit quality of our financing receivables and allowance for credit losses including disclosure of credit quality indicators, past due information, and modifications of our financing receivables. Our financing receivables of $30.7 and $31.0 million consisted of $17.6 and $17.8 million of sales-type lease receivables, included within other current assets and other assets at September 30, 2017 and December 31, 2016, respectively, and $13.1 and $13.2 million of trade receivables having an original contractual maturity in excess of one year, included within accounts receivable, net of allowance, at September 30, 2017 and December 31, 2016, respectively. The trade receivables of $13.1 and $13.2 million having an original total contractual maturity in excess of one year at September 30, 2017 and December 31, 2016, include $5.7 and $7.1 million, respectively, which are scheduled to be received in less than one year. 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

In accordance with ASC 860-20, Transfers and Servicing, 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 at September 30, 2017 and December 31, 2016.

We have facilities in the U.S. and Italy 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, which are subject to a servicing obligation. Trade receivables sold under these facilities were $5.9 and $15.3 million during the three and nine months ended September 30, 2017, respectively, and $19.8 million during the year ended December 31, 2016, which approximates the cash received.

We have facilities in Spain and Italy 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 with payment due dates of less than one year, which are secured by international letters of credit. Trade receivables sold under these facilities were $2.1 and $3.1 million during the three and nine months ended September 30, 2017, respectively, and $3.5 million during the year ended December 31, 2016, 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.

15. Subsequent Events

Acquisition of Escada

On October 1, 2017, we acquired privately held Escada Innovations Limited, a private limited company incorporated in England and Wales which is headquartered in Hull, East Yorkshire, United Kingdom, and Escada Systems, Inc., a Delaware corporation headquartered in Decatur, Georgia (collectively, “Escada”), for approximately $11.3 million in cash consideration, plus a potential future cash earnout of $4.8 million contingent on achieving certain performance targets. This acquisition will be accounted for as a purchase business combination and, accordingly, the total purchase price will be allocated to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values on October 1, 2017.

Escada provides corrugator control systems for the corrugated packaging market, which provides comprehensive control and traceability for the entire corrugation process. Escada will be integrated into the Productivity Software operating segment.

 

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Xeikon Agreement

On November 1, 2017 (“Effective Date”), we entered into a Support Services and License Agreement (“Agreement”) with Xeikon, N.V. (“Xeikon”), which is a division of the Flint Group headquartered in Luxembourg. Pursuant to the Agreement, we will provide Xeikon access to the Jetrion customer list. Access to the customer list will enable Xeikon to assume the relationship with the third-party outsourcing company that manufactures Jetrion printers for us and resell the printers to our current customer base. Xeikon will purchase Jetrion ink exclusively from us and resell to both our current customer base as well as new Xeikon inkjet customers. Also, we will cease sales of Jetrion products for four years after the Effective Date. We will receive cash consideration of $2 million in the first year followed by three annual volume-based payments that are tied to Xeikon’s ink purchases from us.

 

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

This Quarterly Report on Form 10-Q (“Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and the future results of the Company that are based on current expectations, estimates, forecasts, and projections about the industry in which the Company operates and the beliefs and assumptions of the management of the Company. Words such as “address,” “anticipate,” “believe,” “consider,” “continue,” “develop,” “estimate,” “expect,” “further,” “goal,” “intend,” “may,” “plan,” “potential,” “project,” “seek,” “should,” “target,” “will,” variations of such words, and similar expressions are intended to identify such forward-looking statements. Such statements reflect the current views of the Company and its management with respect to future events and are subject to certain risks, uncertainties, and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, the Company’s actual results, performance, or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in this Report under the section entitled “Risk Factors” in Item 1A of Part II of this report and Item 1A of Part I of our Annual Report on Form 10-K, as amended in Amendment No. 2, for the year ended December 31, 2016 and elsewhere and in other reports the Company files with the SEC. The following discussion should be read in conjunction with our Annual Report on Form 10-K, as amended in Amendment No. 2, for the fiscal year ended December 31, 2016 and the condensed consolidated financial statements and notes thereto included elsewhere in this Report. The Company assumes no obligation to revise or update these forward-looking statements to reflect actual results, events, or changes in factors or assumptions affecting such forward-looking statements

Business Overview

We are a world leader in customer-centric digital printing innovation focused on the transformation of the printing, packaging, ceramic tile decoration, and textile industries from the use of traditional analog based printing to digital on-demand printing.

Our products include industrial super-wide and wide format display graphics, label and packaging, corrugated packaging, textile, and ceramic tile decoration digital inkjet printers that utilize our digital ink, industrial digital inkjet printer parts, and professional services; print production workflow, web-to-print, cross-media marketing, fashion design, and business process automation solutions; and color printing DFEs creating an on-demand digital printing ecosystem. Our ink includes digital UV curable, LED curable, ceramic, water-based, and thermoforming ink, as well as a variety of textile ink including dye sublimation, pigmented, reactive dye, acid dye, pure disperse dye, and water-based dispersed printing ink. Our award-winning business process automation solutions are integrated from creation to print and are vertically integrated with our industrial digital inkjet printers and products produced by the leading production digital color page printer manufacturers that are driven by our Fiery DFEs.

Our product portfolio includes industrial super-wide and wide format digital inkjet products (“Industrial Inkjet”) including VUTEk and Matan display graphics super-wide and wide format, Reggiani textile, Jetrion label and packaging, Nozomi corrugated packaging, and Cretaprint ceramic tile decoration and construction material industrial digital inkjet printers and ink; print production workflow, web-to-print, cross-media marketing, Optitex textile two-dimensional (“2D”) and three-dimensional (“3D”) fashion CAD applications, and business process automation software (“Productivity Software”), which provides corporate printing, label and packaging, publishing, and mailing and fulfillment solutions for the printing and packaging industry; and Fiery DFEs (“Fiery”). Our integrated solutions and award-winning technologies are designed to automate print and business processes, streamline workflow, provide profitable value-added services, and produce accurate digital output.

 

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Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make judgments, assumptions, and estimates that affect the amounts reported. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. Management believes there have been no significant changes during the nine months ended September 30, 2017 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K, as amended in Amendment No. 2, for the year ended December 31, 2016, with the exception of the following:

Bill and Hold Transactions

We recognize revenue related to certain industrial inkjet printer sales under bill and hold arrangements. For any bill and hold arrangement, judgment is required to evaluate whether the sale qualifies for revenue recognition in accordance with the following criteria and factors requiring consideration:

 

   

The customer requests that the transaction be on a bill and hold basis and has a substantial business purpose for the arrangement. Such business purpose is related to customer site readiness.

 

   

The scheduled delivery date must be reasonable and consistent with the customer’s business purpose (e.g., customary in the industry).

 

   

The customer has made a fixed commitment to purchase the printer in written documentation.

 

   

The printer is segregated from our inventory and is not available to fill any other customer orders.

 

   

The risk of ownership has passed to the customer.

 

   

The customer has the risk of loss in the event of loss, destruction, or a decline in the market value of goods.

 

   

The printer is complete and ready for shipment.

 

   

The date is determined by which we expect payment and we have not modified our normal billing and credit terms for the customer.

 

   

Evaluation of our past experience with bill and hold transactions.

 

   

We have not retained any specific performance obligations indicating the earnings process is not complete.

 

   

Whether our custodial risks are insurable and insured.

 

   

Extended procedures are not necessary to assure that there are no exceptions to the customer’s commitment to accept and pay for the printer.

Recent Accounting Pronouncements

See Note 1 of our Notes to Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption.

Overview

As discussed more fully in Note 1 – Basis of Presentation and Significant Accounting Policies of our Notes to Condensed Consolidated Financial Statements, during the nine months ended September 30, 2017, we recorded out-of-period adjustments related to certain bill and hold transactions, which decreased revenue by $3.4 million, decreased gross profit by $0.5 million, and decreased net income by $0.3 million (or $0.01 per diluted share).

 

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Key financial results during the three and nine months ended September 30, 2017 were as follows:

 

   

Our results of operations during the three and nine months ended September 30, 2017 compared with the three and nine months ended September 30, 2016 reflect increased revenue for the three months and comparable revenue for the nine months ended September 30, 2017, comparable gross profit as a percentage of revenue, and increased operating expenses as a percentage of revenue. We completed our acquisitions of GD, CRC, and FFPS in 2017, and of Rialco and Optitex in 2016. Their results are included in our results of operations commencing on their respective acquisition dates. Acquisition-related transaction costs were $1.8 and $1.7 million during the nine months ended September 30, 2017 and 2016, respectively, related to all acquisitions.

 

   

Our consolidated revenue increased by 1%, or $2.8 million during the three months ended September 30, 2017, compared with the three months ended September 30, 2016. Fiery revenue increased by $5.4 million, which was partially offset by decreased Productivity Software revenue of $2.5 million during the three months ended September 30, 2017, compared with the three months ended September 30, 2016.

 

   

Our consolidated revenue during the nine months ended September 30, 2017, was comparable to the nine months ended September 30, 2016. Industrial Inkjet and Fiery revenue decreased by $1.0 and $3.0 million, respectively, while Productivity Software revenue increased by $2.7 million during the nine months ended September 30, 2017, as compared with the same period in the prior year.

 

   

Recurring ink and maintenance revenue increased by 5% and 8% during the three and nine months ended September 30, 2017, respectively, compared with the same periods in the prior year, and represented 34% of consolidated revenue during the three and nine months ended September 30, 2017.

 

   

Our gross profit percentage was comparable at 51% during the three months and increased to 52% during the nine months ended September 30, 2017, respectively, from 51% during the nine months ended September 30, 2016. The gross profit percentage during the three months ended September 30, 2017 reflected a two percentage point increase in the Industrial Inkjet operating segment, partially offset by a four and two percentage point decrease in the Productivity Software and Fiery operating segment gross profit percentages, respectively. The increase in the gross profit percentage during the nine months ended September 30, 2017 was primarily due to a three percentage point increase in the Industrial Inkjet operating segment gross profit percentage. The improved Industrial Inkjet gross profit percentage during the nine months ended September 30, 2017 was due to improvements in manufacturing efficiency, reduced warranty costs due to improved printer quality, and higher margin ink revenue representing an increased percentage of product mix.

 

   

Operating expenses increased by $4.3 million to $120.1 million and by $14.2 million to $354.7 million during the three and nine months ended September 30, 2017, respectively, from $115.8 and $340.6 million during the three and nine months ended September 30, 2016, respectively. The increase in operating expenses was primarily due to head count increases related to our business acquisitions, FFPS sustaining engineering, prototype and non-recurring engineering expenses related to future product launches, amortization of intangible assets, and legal and accounting revenue recognition review and assessment, partially offset by decreased change in the fair value of contingent consideration, trade show and marketing, stock-based compensation, and restructuring and other expenses.

 

   

Interest expense increased by $0.4 and $1.3 million during the three and nine months ended September 30, 2017, respectively, compared with the three and nine months ended September 30, 2016, respectively, primarily due to interest accretion related to the FFPS purchase liability, the Reggiani non-compete agreement liability, and our Notes.

 

   

Interest income and other income, net, increased to $1.8 and $2.8 million during the three and nine months ended September 30, 2017, respectively, from $0.9 and $1.1 million during the three and nine months ended September 30, 2016, respectively, primarily due to increased investment income and decreased foreign currency exchange losses.

 

   

We recognized tax provisions of $0.8 million on pre-tax net income of $4.2 and $11.8 million during the three and nine months ended September 30, 2017, respectively, compared to tax benefits of $11.8 and $9.0 million on pre-tax net income of $5.8 and $16.0 million during the three and nine months ended September 30, 2016, respectively. The decrease in the income tax provisions are primarily due to decreased tax benefits from a significantly lower reversal of uncertain tax positions in 2017 as compared to the amounts reversed in 2016.

 

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Results of Operations

Our Condensed Consolidated Statements of Operations as a percentage of total revenue during the three and nine months ended September 30, 2017 and 2016 is as follows:

 

     Three months ended September 30,     Nine months ended September 30,  
     2017     2016     2017     2016  

Revenue

     100     100     100     100

Gross profit

     51       51       52       51  

Operating expenses:

        

Research and development

     16       15       16       15  

Sales and marketing

     17       17       18       18  

General and administrative

     10       10       9       9  

Restructuring and other

     —         1       1       1  

Amortization of identified intangibles

     5       4       5       4  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     48       47       49       47  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     3       4       3       4  

Interest expense

     (2     (2     (2     (2

Interest income and other income, net

     1       —         1       —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     2       2       2       2  

Benefit from (provisions for) income taxes

     (1     5       —         1  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     1     7     2     3
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue

We classify our revenue, gross profit, assets, and liabilities in accordance with our three operating segments as follows:

“Industrial Inkjet,” which consists of our VUTEk and Matan super-wide and wide format display graphics, Reggiani textile, Jetrion label and packaging, Nozomi corrugated packaging, and Cretaprint ceramic tile decoration and construction material industrial digital inkjet printers; digital UV curable, LED curable, ceramic, water-based, and thermoforming ink, as well as a variety of textile ink including dye sublimation, pigmented, reactive dye, acid dye, pure disperse dye, and water-based dispersed printing ink; 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,” which 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; (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 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 fashion CAD software, which facilitates fast fashion and increased efficiency in the textile and fashion industries.

“Fiery,” which consists of DFEs, including the recently acquired FFPS DFE from Xerox, that transform digital copiers and printers into high performance networked printing devices for the office, industrial, and commercial 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, Generation Digital, 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 solutions.

 

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Ex-Currency. To better understand trends in our business, we believe it is helpful to adjust our Condensed Consolidated Statements of Operations to exclude the impact of year-over-year changes in the translation of foreign currencies into U.S. dollars. This is a non-GAAP measure that is calculated by adjusting revenue, gross profit, and operating expenses by using historical exchange rates in effect during the comparable prior period and removing the balance sheet currency remeasurement impact from interest income and other income, net, including removal of any hedging gains and losses. We refer to these adjustments as “ex-currency.” The year-over-year currency impact can be determined as the difference between year-over-year actual growth rates and year-over-year ex-currency growth rates.

Management believes the ex-currency measures provide investors with an additional perspective on year-over-year financial trends and enables investors to analyze our operating results in the same way management does. A reconciliation of the ex-currency adjustments to GAAP results for the three and nine months ended September 30, 2017 and 2016 and an explanation of how management uses non-GAAP financial information to evaluate its business, the substance behind management’s decision to use this non-GAAP financial information, the material limitations associated with the use of non-GAAP financial information, the manner in which management compensates for those limitations, and the substantive reasons management believes that this non-GAAP financial information provides useful information to investors is included under “Non-GAAP Financial Information” below.

Revenue by Operating Segment during the Three Months Ended September  30, 2017 and 2016

Our revenue by operating segment during the three months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three months ended September 30,  
            Percent            Percent     Change  
     2017      of total     2016      of total     $     %  

Industrial Inkjet

   $ 142,930        58   $ 143,004        58   $ (74     —  

Productivity Software

     37,171        15       39,663        16       (2,492     (6

Fiery

     68,258        27       62,908        26       5,350       9  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total revenue

   $ 248,359        100   $ 245,575        100   $ 2,784       1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Overview

Our consolidated revenue increased by 1% (zero percent ex-currency), or $2.8 million, to $248.4 million during the three months ended September 30, 2017 from $245.6 million for the three months ended September 30, 2016, primarily due to increased Fiery revenue, partially offset by decreased Productivity Software revenue.

Industrial Inkjet

Industrial Inkjet revenue decreased by less than 1% (2% ex-currency) during the three months ended September 30, 2017 compared with the three months ended September 30, 2016. Industrial Inkjet revenue decreased primarily due to:

 

   

decreased digital inkjet printer revenue due to reduced demand, partially offset by

 

   

increased ink revenue due to the increase in our installed printer base and the high utilization that our industrial digital inkjet printers are experiencing in the field, and

 

   

increased revenue from parts and service.

Productivity Software

Productivity Software revenue decreased by 6% (7% ex-currency) during the three months ended September 30, 2017 compared with the three months ended September 30, 2016 primarily due to decreased license revenue, partially offset by post-acquisition CRC revenue, which was acquired in May 2017, and increased maintenance revenue, which was partially due to annual price increases related to our maintenance contracts.

 

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Fiery

Fiery revenue increased by 9% (8% ex-currency) during the three months ended September 30, 2017 compared with the three months ended September 30, 2016. Although end customer and reseller preference for Fiery products drives demand, most Fiery revenue relies on printer manufacturers to design, develop, and integrate Fiery technology into their print engines. The leading printer manufacturers increased demand during the quarter as they increased their inventory levels. Also contributing to the increase was post-acquisition FFPS revenue, which was acquired in January 2017, and a small amount of post-acquisition GD revenue, which was acquired in August 2017.

Revenue by Operating Segment during the Nine Months Ended September 30, 2017 and 2016

Our revenue by operating segment during the nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Nine months ended September 30,  
            Percent            Percent     Change  
     2017      of total     2016      of total     $     %  

Industrial Inkjet

   $ 407,886        56   $ 408,926        56   $ (1,040     —  

Productivity Software

     111,292        16       108,554        15       2,738       3  

Fiery

     204,919        28       207,878        29       (2,959     (1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total revenue

   $ 724,097        100   $ 725,358        100   $ (1,261     —  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Overview

Our consolidated revenue decreased by less than 1% (zero percent ex-currency), or $1.3 million, to $724.1 million during the nine months ended September 30, 2017 from $725.4 million for the nine months ended September 30, 2016, primarily due to decreased Industrial Inkjet and Fiery revenue, partially offset by increased Productivity Software revenue.

Industrial Inkjet

Industrial Inkjet revenue decreased by less than 1% (zero percent ex-currency) during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016. Industrial Inkjet revenue decreased primarily due to:

 

   

decreased digital inkjet printer revenue due to reduced demand and

 

   

printer revenue, which would have been higher by $3.4 million when considering out-of-period adjustments related to certain bill and hold transactions, which were recorded during the nine months ended September 30, 2017, partially offset by

 

   

a full nine months of post-acquisition Rialco ink products revenue, which closed in March 2016,

 

   

increased ink revenue due to the increase in our installed printer base and the high utilization that our industrial digital inkjet printers are experiencing in the field, and

 

   

increased revenue from parts and service.

Productivity Software

Productivity Software revenue increased by 3% (also 3% ex-currency) during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016 primarily due to post-acquisition Optitex revenue, which was acquired in June 2016, post-acquisition CRC revenue, which was acquired in May 2017, increased service revenue, and annual price increases related to our maintenance contracts, partially offset by decreased license revenue.

Fiery

Fiery revenue decreased by 1% (also 1% ex-currency) during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016. Although end customer and reseller preference for Fiery products drives demand, most Fiery revenue relies on printer manufacturers to design, develop, and integrate Fiery technology into their print engines. The leading printer manufacturers tightly managed their inventory levels in the first half of 2017, which decreased demand, which was partially offset by increased inventory levels and increased demand during the three months ended September 30, 2017. This decrease was partially offset by post-acquisition FFPS revenue, which was acquired in January 2017, and a small amount of GD revenue, which was acquired in August 2017.

 

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Revenue by Geographic Area during the Three Months Ended September  30, 2017 and 2016

Shipments to some of our significant printer manufacturer customers are made to centralized purchasing and manufacturing locations, which in turn ship to other locations, making it difficult to obtain accurate geographical shipment data. Accordingly, we believe that export sales of our products into each region may differ from what is reported.

Our revenue by geographic area during the three months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three months ended September 30,  
            Percent            Percent     Change  
     2017      of total     2016      of total     $      %  

Americas

   $ 129,488        52   $ 128,252        52   $ 1,236        1

EMEA

     85,089        34       85,009        35       80        0  

APAC

     33,782        14       32,314        13       1,468        5  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue

   $ 248,359        100   $ 245,575        100   $ 2,784        1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Overview

Our consolidated revenue increased by 1% (zero percent ex-currency), or $2.8 million, to $248.4 million during the three months ended September 30, 2017 from $245.6 million during the three months ended September 30, 2016, primarily due to increased Americas and APAC revenue.

Americas

Americas revenue increased by $1.2 million, or 1% (also 1% ex-currency), during the three months ended September 30, 2017 compared with the three months ended September 30, 2016 due to increased industrial digital inkjet printer and maintenance revenue, partially offset by decreased license and Fiery revenue.

EMEA

EMEA revenue increased by $0.1 million, or less than 1% (decreased by 3% ex-currency), during the three months ended September 30, 2017 compared with the three months ended September 30, 2016 primarily due to increased Fiery revenue, partially offset by decreased industrial digital inkjet printer revenue.

APAC

APAC revenue increased by $1.5 million, or 5% (3% ex-currency), during the three months ended September 30, 2017 compared with the three months ended September 30, 2016 primarily due to increased industrial digital inkjet printer and Fiery revenue, partially offset by decreased license revenue.

Revenue by Geographic Area during the Nine Months Ended September  30, 2017 and 2016

Our revenue by geographic area during the nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Nine months ended September 30,  
            Percent            Percent     Change  
     2017      of total     2016      of total     $     %  

Americas

   $ 353,397        49   $ 363,977        50   $ (10,580     (3 )% 

EMEA

     274,635        38       264,469        37       10,166       4  

APAC

     96,065        13       96,912        13       (847     (1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total revenue

   $ 724,097        100   $ 725,358        100   $ (1,261     (0 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Overview

Our consolidated revenue decreased by less than 1% (zero percent ex-currency), or $1.3 million, to $724.1 million during the nine months ended September 30, 2017 from $725.4 million during the nine months ended September 30, 2016, primarily due to decreased Americas and APAC revenue, partially offset by increased EMEA revenue.

 

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Americas

Americas revenue decreased by $10.6 million, or 3% (also 3% ex-currency), during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016 primarily due to decreased industrial digital inkjet printer revenue due to reduced demand in anticipation of future product launches, decreased Fiery revenue, and that industrial digital inkjet revenue would have been higher by $3.4 million when considering out-of-period adjustments related to certain bill and hold transactions, partially offset by increased ink and Productivity Software revenue. Increased Productivity Software revenue resulted primarily from our acquisition of Optitex in June 2016, and our acquisition of CRC in May 2017, partially offset by decreased license revenue.

EMEA

EMEA revenue increased by $10.2 million, or 4% (5% ex-currency), during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016 primarily due to increased industrial digital inkjet printer, post-acquisition Optitex, and Fiery revenue, partially offset by decreased license revenue.

APAC

APAC revenue decreased by $0.8 million, or 1% (also 1% ex-currency), during the nine months ended September 30, 2017 compared with the nine months ended September 30, 2016 primarily due to decreased industrial digital inkjet printer revenue, partially offset by post-acquisition Optitex revenue and Fiery revenue.

Revenue Concentration

A substantial portion of our revenue over the years has been attributable to sales of products through the leading printer manufacturers and independent distributor channels. We have a direct relationship with several leading printer manufacturers and work closely to design, develop, and integrate Fiery technology into their print engines. The printer manufacturers act as distributors and sell our DFE products to end customers through reseller channels. End customer and reseller channel preference for our DFE and software solutions drive demand for Fiery products through the printer manufacturers.

Although end customer and reseller channel preference for Fiery products drives demand, most Fiery revenue relies on printer manufacturers to design, develop, and integrate Fiery technology into their print engines. A significant portion of our revenue is, and has been, generated by sales of our Fiery DFE products to a relatively small number of leading printer manufacturers. During the three and nine months ended September 30, 2017, Xerox provided 11% and 10% of our consolidated revenue, respectively. During the three and nine months ended September 30, 2016, we did not have any customers contributing more than 10% of our consolidated revenue. We expect that if we increase our revenue in the Industrial Inkjet and Productivity Software operating segments in the future, the percentage of our revenue from the leading printer manufacturer customers will decrease.

Gross Profit

Gross profit by operating segment, excluding stock-based compensation, during the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2017     2016     2017     2016  

Industrial Inkjet

        

Revenue

   $ 142,930     $ 143,004     $ 407,886     $ 408,926  

Gross profit

     53,392       50,433       154,972       141,927  

Gross profit percentages

     37.4     35.3     38.0     34.7

Productivity Software

        

Revenue

   $ 37,171     $ 39,663     $ 111,292     $ 108,554  

Gross profit

     26,667       30,041       81,431       80,961  

Gross profit percentages

     71.7     75.7     73.2     74.6

Fiery

        

Revenue

   $ 68,258     $ 62,908     $ 204,919     $ 207,878  

Gross profit

     47,885       45,362       143,821       147,938  

Gross profit percentages

     70.2     72.1     70.2     71.2

 

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A reconciliation of our segment gross profit to our Condensed Consolidated Statements of Operations during the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2017      2016      2017      2016  

Segment gross profit

   $ 127,944      $ 125,836      $ 380,224      $ 370,826  

Stock-based compensation expense

     (486      (642      (1,985      (1,873

Other items excluded from segment profit

     —          —          —          (315
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

   $ 127,458      $ 125,194      $ 378,239      $ 368,638  
  

 

 

    

 

 

    

 

 

    

 

 

 

The Fiery gross profit percentage is impacted by less than $0.1 and $1.3 million during the three and nine months ended September 30, 2017, respectively, charged to cost of revenue, which reflects the cost of manufacturing plus a portion of the expected profit margin related to the acquired FFPs inventories. Inventory acquired in the acquisition of FFPS was required to be recorded at fair value rather than historical cost in accordance with ASC 805. This amount is not included in the financial information regularly reviewed by management as this acquisition-related charge is not indicative of the gross margin trends in the FFPS business. Excluding this charge, the Fiery gross profit percentage would be 70.3% and 70.8% during the three and nine months ended September 30, 2017, respectively.

Overview

Our gross profit percentage was comparable at 51% during the three months and increased to 52% during the nine months ended September 30, 2017, respectively, from 51% during the nine months ended September 30, 2016. The gross profit percentage during the three months ended September 30, 2017 reflected a two percentage point improvement in the Industrial Inkjet operating segment, partially offset by a four and two percentage point decrease in the Productivity Software and Fiery operating segment gross profit percentages, respectively. The increase in the gross profit percentage during the nine months ended September 30, 2017 was primarily due to a three percentage point increase in the Industrial Inkjet operating segment gross profit percentage. Excluding FFPS acquisition-related inventory fair value adjustments of less than $0.1 and $1.3 million for the three and nine months ended September 30, 2017, respectively, our gross profit percentage remains at 51% and 52% during the three and nine months ended September 30, 2017, respectively.

Industrial Inkjet Gross Profit

The Industrial Inkjet gross profit percentage increased to 37.4% and 38.0% (37.0% ex-currency and 38.0% ex-currency) during the three and nine months ended September 30, 2017, respectively, from 35.3% and 34.7% during the three and nine months ended September 30, 2016, respectively. Gross profit percentages improved in digital inkjet printers, ink, parts, and service.

Productivity Software Gross Profit

The Productivity Software gross profit percentages decreased to 71.7% and 73.2% (71.7% and 73.0% ex-currency) during the three and nine months ended September 30, 2017, from 75.7% and 74.6% during the three and nine months ended September 30, 2016, respectively. The decrease was primarily due to decreased license revenue and increased product maintenance costs, partially offset by price increases on annual maintenance renewal contracts.

Fiery Gross Profit

The Fiery gross profit percentage decreased to 70.2% (also 70.2% ex-currency) during the three and nine months ended September 30, 2017 from 72.1% and 71.2% during the three and nine months ended September 30, 2016, respectively. The Fiery gross profit percentage, excluding the fair value adjustment related to acquired FFPS inventories of less than $0.1 and $1.3 million, respectively, decreased to 70.3% and 70.8% (also 70.3% and 70.8% ex-currency) during the three and nine months ended September 30, 2017 from 72.1% and 71.2% during the three and nine months ended September 30, 2016, respectively. The revenue mix between standalone and embedded DFEs, which have a lower margin compared with higher margin software options, accounts for this margin fluctuation between the periods.

 

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Operating Expenses

Operating expenses during the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands):

 

     Three months ended September 30,     Nine months ended September 30,  
                   Change                   Change  
     2017      2016      $     %     2017      2016      $     %  

Research and development

   $ 39,585      $ 36,933      $ 2,652       7   $ 118,201      $ 111,731      $ 6,470       6

Sales and marketing

     42,269        43,060        (791     (2     129,018        127,360        1,658       1  

General and administrative

     25,075        24,088        987       4       67,239        66,366        873       1  

Restructuring and other

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