INCOME TAXES
Income taxes are recognized for the amount of taxes payable for the current year and for the impact of deferred tax assets and liabilities, which represent consequences of events that have been recognized differently in the financial statements under GAAP than for tax purposes.
On December 22, 2017, the President of the United States signed into law H.R. 1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Tax Cuts and Jobs Act”). ASC Topic 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment. The Tax Cuts and Jobs Act made significant changes to existing U.S. tax law, including, but not limited to, a permanent reduction to the U.S. federal corporate income tax rate from 35% to 21%, imposition of a one-time tax on deferred foreign income (“Repatriation Transition Tax”), adoption of a participation exemption system with respect to the taxation of future dividends received from foreign corporations, and repeal of the corporate alternative minimum tax system. Other significant changes in the Tax Cuts and Jobs Act include taxing payments made to foreign related parties that are deemed to be excessive, imposing a minimum tax on certain foreign earnings, requiring (beginning after December 31, 2021) the capitalization and subsequent amortization of certain research and development related expenses, and placing additional limits on the use of net operating losses and the deductibility of certain executive compensation.
Given the significance of the Tax Cuts and Jobs Act, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin 118 (“SAB 118”) that expresses the views of the SEC regarding ASC Topic 740 in the reporting period that includes the date of enactment. The SEC staff issuing SAB 118 recognized that a company’s review of the income tax effects attributable to the enactment of the Tax Cuts and Jobs Act may be incomplete at the time financial statements are issued for the reporting period that included the date of enactment and allows a company to record provisional amounts during a one year measurement period similar to the principles adopted in ASC Topic 805, Business Combinations. During the measurement period, income tax effects attributable to the enactment of the Tax Cuts and Jobs Act are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be adjusted and recognized, as a discreet item in the applicable reporting period, as information becomes available, prepared or analyzed. The measurement period is deemed to have ended when the company has obtained, prepared and analyzed the information necessary to finalize its accounting.
SAB 118 summarizes a three-step process to be applied to each reporting period to account for and qualitatively disclose income tax effects attributable to the enactment of the Tax Cuts and Jobs Act: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (including subsequent adjustments to those amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with the law prior to the enactment of the Tax Cuts and Jobs Act.
Amounts recorded by the Company during the year ended December 31, 2017 where the accounting is considered to be complete relate to a reduction, in the amount of $28.9 million, in the carrying value of the Company’s U.S. deferred tax assets resulting from the Tax Cuts and Jobs Act’s reduction in the U.S. federal corporate income tax rate from 35% to 21%. The Tax Cuts and Jobs Act also includes a Repatriation Transaction Tax on the net accumulated and previously untaxed earnings and profits of a U.S. taxpayer’s foreign subsidiaries. As of December 31, 2017, the Company has recorded provisional tax expense, in the amount of $0.3 million, attributable to the Repatriation Transition Tax and provisional tax expense, in the amount of $0.3 million, as a result of the Company’s decision to no longer consider the undistributed earnings of its foreign subsidiaries to be permanently reinvested outside of the U.S. The Company has not had sufficient time to obtain, prepare and analyze historical tax returns, financial statements and related accounts that is required to finalize its accounting with respect to the items for which provisional tax expense has been recorded
A majority of the Company’s deferred tax assets result from net operating loss carryforwards and research and development tax credits. As of December 31, 2017, the Company had U.S. federal net operating loss carryforwards of approximately $72.6 million and U.S. federal research and development tax credit carryforwards of approximately $36.0 million. Upon the adoption of ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting in March of 2016, the Company recognized $16.6 million in deferred tax benefits from approximately $47.4 million of federal net operating losses attributable to share-based income tax deductions that exceeded amounts that had been recognized for financial reporting purposes. These deferred tax benefits were recorded as a cumulative-effect adjustment to accumulated deficit. The federal net operating loss carryforwards will expire from 2019 through 2037, and the federal research and development tax credits will expire from 2021 through 2037 if not utilized. Utilization of $21.2 million of the Company’s federal net operating loss carryforwards generated prior to May 10, 2001 is limited under Section 382 of the Internal Revenue Code to $4.3 million per year. As of December 31, 2017, the Company had approximately $7.1 million of foreign net operating loss carryforwards in various jurisdictions. Most of the Company’s foreign net operating losses can be carried forward indefinitely, with certain amounts expiring from 2018 to 2027.
Income (loss) before income taxes consisted of the following (in thousands):
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
United States | | $ | (53,201 | ) | | $ | 2,648 |
| | $ | 38,362 |
|
International | | 311 |
| | 7,273 |
| | 4,415 |
|
Total | | $ | (52,890 | ) | | $ | 9,921 |
| | $ | 42,777 |
|
The tax provision (benefit) for income taxes related to operations consisted of the following (in thousands):
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Current provision (benefit): | | | | | | |
Federal | | $ | 445 |
| | $ | 3 |
| | $ | 725 |
|
State | | 310 |
| | (279 | ) | | 1,389 |
|
Foreign | | 1,735 |
| | 1,443 |
| | 1,023 |
|
Total current provision | | 2,490 |
| | 1,167 |
| | 3,137 |
|
Deferred provision (benefit): | | | | | | |
Federal | | 77,152 |
| | (2,127 | ) | | 12,198 |
|
State | | 1,185 |
| | 416 |
| | (52 | ) |
Foreign | | 112 |
| | (150 | ) | | (43 | ) |
Total deferred provision (benefit) | | 78,449 |
| | (1,861 | ) | | 12,103 |
|
Total provision (benefit) for income taxes | | $ | 80,939 |
| | $ | (694 | ) | | $ | 15,240 |
|
The tax provision (benefit) differs from the amount computed by applying the federal statutory income tax rate as follows (in thousands):
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Income tax provision (benefit) at statutory rate | | $ | (18,511 | ) | | $ | 3,472 |
| | $ | 14,972 |
|
State taxes, net of federal benefit | | (1,066 | ) | | 89 |
| | 897 |
|
Foreign income taxes | | 135 |
| | (407 | ) | | (12 | ) |
Additional increases (deductions) from share-based compensation | | 1,036 |
| | (1,815 | ) | | — |
|
Deemed dividends for U.S. income tax purposes | | — |
| | 329 |
| | 407 |
|
Nondeductible expenses | | 222 |
| | 231 |
| | 283 |
|
Disallowed compensation | | 60 |
| | 331 |
| | 455 |
|
Audit accrual (settlement) | | 1,156 |
| | (297 | ) | | — |
|
Research and development tax credit | | (3,827 | ) | | (2,470 | ) | | (1,733 | ) |
Tax effect of repatriation transition tax on unremitted earnings | | 605 |
| | — |
| | — |
|
Gain on strategic transaction | | (1,568 | ) | | — |
| | — |
|
Deferred tax impact from tax rate change | | 28,907 |
| | — |
| | — |
|
Effect of change in valuation allowance on deferred tax assets | | 73,790 |
| | (157 | ) | | (29 | ) |
Effective income tax provision (benefit) | | $ | 80,939 |
| | $ | (694 | ) | | $ | 15,240 |
|
Significant components of the Company’s deferred income tax assets and liabilities follow (in thousands):
|
| | | | | | | | |
| | December 31, |
| | 2017 | | 2016 |
Deferred Income Tax Assets | | | | |
Inventory | | $ | 6,495 |
| | $ | 4,127 |
|
Accrued compensation | | 262 |
| | 511 |
|
Deferred revenue | | 8,285 |
| | 14,742 |
|
Research and development credit carryforwards | | 32,218 |
| | 28,241 |
|
Net operating loss carryforwards | | 22,775 |
| | 38,348 |
|
Property and equipment | | 4,136 |
| | 8,188 |
|
Goodwill | | 289 |
| | 106 |
|
Research and development expenses | | 9,944 |
| | — |
|
Share-based compensation | | 4,124 |
| | 7,016 |
|
Other | | 2,592 |
| | 12,939 |
|
Gross deferred tax assets | | 91,120 |
| | 114,218 |
|
Valuation allowance | | (82,875 | ) | | (8,727 | ) |
Deferred tax assets | | 8,245 |
| | 105,491 |
|
Deferred Income Tax Liabilities | | | | |
Investment in sales-type lease, net | | (3,084 | ) | | (13,728 | ) |
Intangible assets | | (205 | ) | | (421 | ) |
Other | | (3,850 | ) | | (5,729 | ) |
Deferred tax liabilities | | (7,139 | ) | | (19,878 | ) |
Net deferred tax asset | | $ | 1,106 |
| | $ | 85,613 |
|
The Company recorded income tax expense of $80.9 million during the year ended December 31, 2017, an income tax benefit of $0.7 million during the year ended December 31, 2016 and income tax expense of $15.2 million during the year ended December 31, 2015. The difference between the income tax benefit at the statutory rate and the Company’s effective income tax expense for the year ended December 31, 2017 was primarily attributable to the reduction in the U.S. federal corporate income tax rate as a result of the Tax Cuts and Jobs Act and its impact on the carrying value of the Company’s U.S. deferred tax assets and the Company’s decision after the Tax Cuts and Jobs Act was enacted to increase the valuation allowance held against its U.S. deferred tax assets, offset, in part, by research and development tax credits. The difference between the income tax provision at the statutory rate and the Company’s effective income tax benefit for the year ended December 31, 2016 was the result of research and development tax credits and additional tax deductions from share-based compensation, sometimes referred to as excess tax benefits, partially offset by state taxes, non-deductible expenses and other permanent items. Excess tax benefits arise when tax deductions recognized by the Company with respect to share-based compensation exceed the compensation cost attributable to share-based compensation that was recognized in the Company’s consolidated financial statements. The difference between the income tax provision at the statutory rate and the Company’s effective income tax provision for the year ended December 31, 2015 was the result of state taxes, non-deductible expenses and other permanent items, partially offset by research and development tax credits.
The valuation allowance on deferred tax assets increased by $74.1 million in 2017 and decreased by $0.8 million and $0.7 million in 2016 and 2015, respectively. Substantially all of the increase in the valuation allowance during 2017 was attributable to the Company’s decision to increase the valuation allowance held against its U.S. deferred tax assets on December 31, 2017.
The Company’s assessment of its ability to utilize its U.S. deferred tax assets was based upon all available positive and negative evidence, which included, among other things, the Company’s recent results of operations, forecasted domestic and international earnings over a number of years, all known business risks and industry trends, and applicable tax planning strategies. The Company considers its actual historical results over several years to have stronger weight than other more subjective indicators, including forecasts, when considering whether to establish or reduce a valuation allowance on deferred tax assets. The Company has significant difficulty projecting future results due to the nature of its business and the industry in which it operates. As of December 31, 2017, the Company had experienced a significant decline in revenue, gross profit, and operating income since 2015, had reported a cumulative pre-tax loss in recent years and is currently forecasting to a report a pre-tax loss for the year ending December 31, 2018. If the Company had determined that it was appropriate to increase the valuation allowance held against our U.S. deferred tax assets prior to enactment of the Tax Cuts and Jobs Act total tax expense for the year ended December 31, 2017 would not have changed. The decrease in the carrying value of our U.S. deferred tax assets as a result of the reduction in the U.S. federal corporate income tax rate would have been completely offset by a reduction in the valuation allowance that would have been previously established against those deferred tax assets.
The Company’s conclusion about the realizability of its deferred tax assets, and therefore the appropriateness of the valuation allowance, is reviewed quarterly and could change in future periods depending on the Company’s future assessment of all available evidence in support of the likelihood of realization of its deferred tax assets. If the Company’s conclusion about the realizability of its deferred tax assets and therefore the appropriateness of its valuation allowance changes in a future period, it could record a substantial tax benefit in the Consolidated Statements of Operations when that occurs.
The following table summarizes changes in the amount of the Company’s unrecognized tax benefits for uncertain tax positions for the three years ended December 31, 2017, 2016 and 2015 (in thousands):
|
| | | |
Balance at December 31, 2014 | $ | 5,630 |
|
Increase related to prior year income tax positions | 151 |
|
Increase related to current year income tax positions | 433 |
|
Balance at December 31, 2015 | $ | 6,214 |
|
Increase related to prior year income tax positions | 53 |
|
Decrease related to prior year income tax positions | (365 | ) |
Increase related to current year income tax positions | 565 |
|
Balance at December 31, 2016 | $ | 6,467 |
|
Increase related to prior year income tax positions | 1,440 |
|
Increase related to current year income tax positions | 673 |
|
Balance at December 31, 2017 | $ | 8,580 |
|
Included in the balance of unrecognized tax benefits as of December 31, 2017 was $1.2 million of tax benefits that, if recognized, would affect the effective tax rate. It is not anticipated that the balance of unrecognized tax benefits will significantly change over the next twelve months.
The Company or its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company defines its major tax jurisdictions to include United Kingdom and the United States. The Company is no longer subject to income tax examinations with respect to periods before 2016 in the United Kingdom and before 2014 in the United States, although in the United States net operating loss and tax credit carryforwards generated in a year are subject to examination and adjustment for at least three years following the year in which such losses or credits are actually used to offset taxable income.
Estimated interest and penalties are recorded as a component of interest expense and other expense, respectively. Such amounts were not material for 2017, 2016 and 2015.