The Company’s geographical breakdown of income before income taxes is as follows:
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
| | (in thousands) |
Domestic | | $ | 34,914 |
| | $ | 28,982 |
| | $ | 22,540 |
|
Foreign | | 4,464 |
| | 1,447 |
| | 1,980 |
|
Income before income taxes | | $ | 39,378 |
| | $ | 30,429 |
| | $ | 24,520 |
|
The provision for (benefit from) income taxes consists of the following:
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
| | (in thousands) |
Current | | | | | | |
Federal | | $ | 22 |
| | $ | 8,334 |
| | $ | 115 |
|
State | | 23 |
| | 1,125 |
| | 1,041 |
|
Foreign | | 1,471 |
| | 963 |
| | 693 |
|
Total current provision | | 1,516 |
| | 10,422 |
| | 1,849 |
|
Deferred | | | | | | |
Federal | | (1,650 | ) | | 611 |
| | 7,115 |
|
State | | (996 | ) | | 126 |
| | (247 | ) |
Foreign | | 68 |
| | 46 |
| | (62 | ) |
Total deferred (benefit) provision | | (2,578 | ) | | 783 |
| | 6,806 |
|
Total (benefit from) provision for income taxes | | $ | (1,062 | ) | | $ | 11,205 |
| | $ | 8,655 |
|
The reconciliation of the statutory federal income tax rate to the Company’s effective tax rate is as follows:
|
| | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Federal statutory rate | | 35.0 | % | | 35.0 | % | | 35.0 | % |
State taxes | | (2.1 | ) | | 2.1 |
| | 2.2 |
|
Stock-based compensation | | (58.1 | ) | | 2.4 |
| | 0.5 |
|
Foreign source income | | (0.2 | ) | | 0.9 |
| | 0.6 |
|
Change in valuation allowance | | 2.8 |
| | 1.3 |
| | 1.3 |
|
Federal rate adjustment (due to 2017 Tax Act) | | 26.4 |
| | — |
| | — |
|
Federal and state research and development credit | | (5.3 | ) | | (3.6 | ) | | (3.9 | ) |
Other | | (1.2 | ) | | (1.3 | ) | | (0.4 | ) |
(Benefit from) provision for income taxes | | (2.7 | )% | | 36.8 | % | | 35.3 | % |
On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted into law. The new legislation contains several key tax provisions that impact the Company, including the reduction of the corporate income tax rate from 35% to 21% effective January 1, 2018. The new legislation also includes a variety of other changes, such as a one-time repatriation tax on accumulated foreign earnings (transition tax), acceleration of business asset expensing, and reduction in the amount of executive pay that could qualify as a tax deduction, among others. We have estimated our provision for income taxes in accordance with the 2017 Tax Act and guidance available as of the date of this filing and as a result have recorded $10.4 million as additional income tax expense due to the re-measurement of certain deferred tax assets and liabilities as a result of the reduction of the federal tax rate. No deferred taxes were recorded for the newly introduced provisions for Global Intangible Low Tax Income ("GILTI"), and no amount related to the one-time transition tax on the mandatory deemed repatriation of foreign earnings was recorded due to cumulative foreign losses of our subsidiaries.
On December 22, 2017, Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the 2017 Tax Act. In accordance with SAB 118, we have determined that the $10.4 million of the deferred tax expense recorded in connection with the re-measurement of certain deferred tax assets and liabilities and the $0 amount of transition tax on the mandatory deemed repatriation of foreign earnings were provisional amounts and reasonable estimates at December 31, 2017. A comprehensive analysis of GILTI, for which additional guidance is expected from the U.S. Internal Revenue Service, is required to finalize the amounts of our deferred tax assets and liabilities and a detailed analysis of historical foreign earnings and the potential correlative adjustments will be performed to verify the transitional tax does not apply. Subsequent adjustments resulting from the additional analysis to be completed will be recorded to current tax expense in the quarter of 2018 when the analysis is complete.
The 2017 Tax Act includes a mandatory one-time tax on accumulated earnings of foreign subsidiaries, and as a result, all previously unremitted earnings are no longer subject to U.S. tax after 2017. Depending on the jurisdiction, distributions of earnings could be subject to withholding taxes at rates applicable to the distributing jurisdiction. As the Company intends to continue to reinvest the earnings of foreign subsidiaries indefinitely, no U.S. income taxes or foreign withholding taxes have been provided on undistributed earnings earned by our foreign subsidiaries. The Company’s share of undistributed earnings of foreign subsidiaries that could be subject to foreign withholding taxes was $9.0 million and $5.7 million as of December 31, 2017 and 2016, respectively. Determination of the amount of unrecognized deferred tax liability for temporary differences related to investments in these non-U.S. subsidiaries that are essentially permanent in duration is not practicable.
As a result of the adoption of ASU 2016-09 on January 1, 2017 we recorded a cumulative effect adjustment to increase retained earnings by $7.7 million with a corresponding increase to deferred tax assets for the federal and state net operating losses and federal research credits attributable to excess tax benefits from stock-based compensation which had not been previously recognized. All excess tax benefits and deficiencies in the current and future periods will be recognized as income tax expense in our Consolidated Statement of Operations in the reporting period in which they occur. This will result in increased volatility in our effective tax rate. For the year ended December 31, 2017, we recognized a benefit of $27.1 million related to the excess tax benefits.
Deferred Income Taxes
Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of the Company’s deferred tax assets and liabilities are as follows:
|
| | | | | | | | |
| | December 31, |
| | 2017 | | 2016 |
| | (in thousands) |
Deferred tax assets | | | | |
Net operating loss carryforwards | | $ | 8,947 |
| | $ | 1,472 |
|
Research and development credit carryforwards | | 11,493 |
| | 3,334 |
|
Foreign tax credit carryforwards | | 1,149 |
| | — |
|
Accrued liabilities | | 470 |
| | 681 |
|
Deferred revenues | | 3,416 |
| | 5,018 |
|
Deferred rent | | 558 |
| | 74 |
|
Intangible assets | | 409 |
| | 409 |
|
Stock-based compensation | | 7,135 |
| | 12,513 |
|
Other | | 638 |
| | 1,225 |
|
Gross deferred tax assets | | 34,215 |
| | 24,726 |
|
Valuation allowance | | (5,773 | ) | | (3,688 | ) |
Net deferred tax assets | | 28,442 |
| | 21,038 |
|
Deferred tax liabilities | | | | |
Fixed assets | | (3,372 | ) | | (4,448 | ) |
Intangible assets | | (4 | ) | | — |
|
Total deferred tax liabilities | | (3,376 | ) | | (4,448 | ) |
Net deferred tax assets | | $ | 25,066 |
| | $ | 16,590 |
|
Realization of deferred tax assets is dependent upon future earnings, if any, and the timing and amount of such assets are uncertain. The Company believes it is more likely than not that its California deferred tax assets will not be realized because the income attributed to California is not expected to be sufficient to recognize these deferred tax assets. Accordingly, the Company continues to record the valuation allowance of $5.8 million as of December 31, 2017 for its California deferred tax assets. During the year ended December 31, 2017, the valuation allowance had increased by $2.1 million to $5.8 million.
At December 31, 2017, the Company had federal and state net operating loss carryforwards of approximately $39.1 million and $15.3 million, respectively, available to reduce federal and state taxable income. Federal net operating losses begin to expire in 2021, and state net operating losses expire from 2029 to 2037. Utilization of the Company’s net operating loss carryforwards may be subject to an annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. As of December 31, 2017, the Company had $8.7 million of federal and $8.7 million of state research and development credit carryforwards. Federal research and development credits expire in the years 2022 to 2037. State research and development credits do not expire. As of December 31, 2017, the Company had foreign tax credit carryforwards of $1.1 million which expire in the years 2024 to 2027.
The evaluation of an unrecognized tax position is a two-step process. The first step requires the Company to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. The second step requires the Company to recognize in the financial statement each tax position that meets the more likely than not criteria, measured at the amount of benefit that has a greater than fifty percent likelihood of being realized.
A reconciliation of the Company’s unrecognized tax benefits is as follows:
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
| | (in thousands) |
Unrecognized tax benefits beginning balance | | $ | 4,071 |
| | $ | 3,506 |
| | $ | 3,330 |
|
Gross increase for tax positions of prior years | | 66 |
| | 2 |
| | 20 |
|
Gross decrease for tax positions of prior years | | — |
| | (15 | ) | | (171 | ) |
Gross increase for tax positions of current year | | 1,101 |
| | 659 |
| | 418 |
|
Lapse of statute of limitations | | (126 | ) | | (81 | ) | | (91 | ) |
Total unrecognized tax benefits | | $ | 5,112 |
| | $ | 4,071 |
| | $ | 3,506 |
|
The unrecognized tax benefits, if recognized, would impact the income tax provision by $2.8 million, $2.4 million and $2.1 million as of December 31, 2017, 2016 and 2015, respectively.
The Company has elected to include interest and penalties as a component of income tax expense. The amounts were not material for 2017, 2016 and 2015.
The Company files income tax returns in the United States, including various state jurisdictions. The Company’s subsidiaries file tax returns in various foreign jurisdictions. The tax years 2012 to 2017 remain open to examination by the major taxing jurisdictions in which the Company is subject to tax, with the exception of France which remains open to examination for the 2013 through 2017 tax years only. As of December 31, 2017, the Company was not under examination by the Internal Revenue Service or any foreign or state tax jurisdiction.
A retroactive and permanent reinstatement of the federal research and development tax credit was signed into law on December 18, 2015 in accordance with the Protecting Americans from Tax Hikes Act of 2015. The Company recorded a 2017 federal research and development credit of $1.3 million, net of reserves, in the fourth quarter of 2017. The California research and development credit estimated for 2017, net of reserves, is $1.3 million.