Note 16—Income Taxes
Provision for Income Taxes
We file U.S. federal income tax returns and returns in various state, local and foreign jurisdictions. Generally, we are no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years before 2001. We are currently under audit by the Internal Revenue Service on our U.S. federal tax return for the fiscal year ended June 30, 2015 and by the Israeli Tax Authority on our 2012 to 2015 Israeli tax returns. We anticipate these audits will take several quarters to complete.
We permanently reinvest the earnings, if any, of our international subsidiaries and therefore we do not provide for U.S. income taxes that could result from the distribution of those earnings to the U.S. parent. If any such earnings were ultimately distributed to the U.S. in the form of dividends or otherwise, or if the shares of our international subsidiaries were sold or transferred, we would likely be subject to additional U.S. income taxes, net of the impact of any available foreign tax credits. It is not practicable to estimate the amount of unrecognized deferred U.S. taxes on these undistributed earnings.
Our provision for (benefit from) income taxes consisted of the following:
| Fiscal Year Ended June 30, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (in thousands) | ||||||||||||
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Current: |
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Federal |
$ | 41 | $ | (362 | ) | $ | 1,433 | |||||
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State |
32 | 43 | 188 | |||||||||
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Foreign |
2,786 | 4,215 | 4,570 | |||||||||
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| 2,859 | 3,896 | 6,191 | ||||||||||
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Deferred: |
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Federal |
700 | 1,004 | 14,720 | |||||||||
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State |
81 | 217 | 1,154 | |||||||||
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Foreign |
(8,777 | ) | (4,332 | ) | (3,701 | ) | ||||||
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| (7,996 | ) | (3,111 | ) | 12,173 | ||||||||
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| $ | (5,137 | ) | $ | 785 | $ | 18,364 | ||||||
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Our income tax expense (benefit) included a tax benefit of $0.3 million, $0.2 million and $0.2 million in fiscal years 2017, 2016 and 2015, respectively, relating to a reduction in our unrecognized tax benefits upon the expiration of certain statutes of limitations.
We recorded a decrease to other comprehensive income of $1.6 million during fiscal year 2017 as a result of the deferred tax consequence of minimum pension liability adjustments related to our Swiss pension.
Income (loss) before income taxes by geographic area is as follows:
| Fiscal Year Ended June 30, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (in thousands) | ||||||||||||
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North America |
$ | (25,315 | ) | $ | (19,892 | ) | $ | (18,277 | ) | |||
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United Kingdom |
7,263 | 15,400 | 16,728 | |||||||||
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Continental Europe |
86 | (2,191 | ) | (7,608 | ) | |||||||
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Asia-Pacific and Middle East |
(20,308 | ) | (12,180 | ) | (7,159 | ) | ||||||
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| $ | (38,274 | ) | $ | (18,863 | ) | $ | (16,316 | ) | ||||
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A reconciliation of the federal statutory rate to the effective income tax rate is as follows:
| Fiscal Year Ended June 30, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Tax benefit at federal statutory rate |
(35.0% | ) | (35.0% | ) | (35.0% | ) | ||||||
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State taxes, net of federal benefit |
(4.0% | ) | (4.3% | ) | (5.2% | ) | ||||||
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Change in valuation allowance |
30.3% | 16.8% | 98.6% | |||||||||
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Investment impairment |
(29.6% | ) | —% | —% | ||||||||
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Tax rate differential on foreign earnings |
9.3% | (3.5% | ) | (4.2% | ) | |||||||
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Goodwill impairment |
6.9% | —% | —% | |||||||||
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Foreign branch operations, net of foreign tax deductions |
2.7% | 19.0% | 33.1% | |||||||||
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Changes in uncertain tax positions |
2.2% | 8.6% | 13.0% | |||||||||
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Non-deductible executive compensation |
2.5% | 5.2% | 5.3% | |||||||||
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Non-deductible other expenses |
1.6% | 1.6% | 1.8% | |||||||||
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Non-deductible share-based payments |
1.2% | 3.7% | 3.6% | |||||||||
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Non-deductible acquisition costs |
0.8% | 0.5% | 3.0% | |||||||||
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Changes in tax laws or rates |
(0.2% | ) | 1.1% | (1.8% | ) | |||||||
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Research and development credit |
(2.9% | ) | (8.5% | ) | (2.7% | ) | ||||||
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Other |
0.8% | (1.0% | ) | 3.1% | ||||||||
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| (13.4% | ) | 4.2% | 112.6% | |||||||||
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The excess of our effective tax rate (or decrease in our effective tax benefit rate) over statutory tax rates was primarily due to the inability to benefit U.S. and Swiss losses, an increase of our U.S. valuation allowance in fiscal year 2015, and our inability to utilize certain foreign tax credits as a reduction to foreign income that is included in our U.S. tax return. This has the effect of taxing certain income twice, resulting in a higher overall tax rate.
Deferred Tax Assets and Liabilities
We recognize deferred tax assets and liabilities based on the differences between their financial reporting and tax basis by applying tax rates that are expected to be in effect when the differences reverse. Significant components of our deferred income taxes are as follows:
| June 30, | ||||||||
| 2017 | 2016 | |||||||
| (in thousands) | ||||||||
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Deferred tax assets: |
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Net operating loss carryforwards |
$ | 35,503 | $ | 18,951 | ||||
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Research and development and other credits |
6,755 | 6,095 | ||||||
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Deferred revenue |
6,433 | 9,083 | ||||||
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Stock compensation |
6,414 | 6,313 | ||||||
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Accrued pension |
3,898 | 5,116 | ||||||
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Various accrued expenses |
3,774 | 3,290 | ||||||
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Allowances and reserves |
252 | 273 | ||||||
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Property and equipment |
229 | 8 | ||||||
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Other |
98 | 38 | ||||||
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Total deferred tax assets |
$ | 63,356 | $ | 49,167 | ||||
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Valuation allowance |
(37,415 | ) | (26,506 | ) | ||||
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Deferred tax assets, net of valuation allowance |
25,941 | 22,661 | ||||||
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Deferred tax liabilities: |
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Intangible assets |
(26,229 | ) | (30,229 | ) | ||||
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Property and equipment, inclusive of capitalized software |
(14,434 | ) | (12,324 | ) | ||||
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Convertible debt |
(588 | ) | (1,876 | ) | ||||
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Other |
(123 | ) | (135 | ) | ||||
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Total deferred tax liabilities |
(41,374 | ) | (44,564 | ) | ||||
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Net deferred tax liabilities |
$ | (15,433 | ) | $ | (21,903 | ) | ||
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At June 30, 2017, we had U.S. net operating loss carryforwards of $104.8 million which expire at various times through fiscal year 2037. Included within this amount is approximately $55.6 million of excess tax deductions associated with restricted stock awards that have vested and with non-qualified stock options that have been exercised. Approximately $46.7 million of the aforementioned excess tax benefits have not been reflected as a component of our deferred tax assets at June 30, 2017, as these amounts would be recognized for financial reporting purposes only when they actually reduced currently payable income taxes. Historically, when these excess tax benefits actually resulted in a reduction to currently payable income taxes, the benefit would have been recorded as an increase to additional paid-in capital. However, upon adoption effective July 1, 2017 of the accounting standard relating to share-based payments, our deferred tax assets will be increased by this portion of excess tax benefits (net of any required valuation allowance), and future utilization of excess tax benefits will be recorded as a decrease to deferred tax assets.
From a foreign tax perspective, we had Swiss net operating loss carryforwards of $25.8 million which expire in fiscal year 2024, Canadian net operating loss carryforwards of $0.3 million which principally expire in fiscal year 2035, and foreign net operating loss carryforwards (primarily in Europe and Israel) of $22.1 million which have no statutory expiration date.
We utilized approximately $1.9 million of net operating losses in fiscal year 2017, consisting of $0.6 million utilized in the U.S. and $1.3 million utilized in our foreign operations, predominately in Europe.
We have approximately $6.0 million of research and development tax credit carryforwards available, which expire at various points through fiscal year 2037. Our operating losses and tax credit carryforwards may be subject to limitations under provisions of the Internal Revenue Code.
Valuation Allowance
We record a deferred tax asset if we believe that it is more likely than not that we will realize a future tax benefit. Ultimate realization of any deferred tax asset is dependent on our ability to generate sufficient future taxable income in the appropriate tax jurisdiction before the expiration of carryforward periods, if any. Our assessment of deferred tax asset recoverability considers many different factors including historical and projected operating results, the reversal of existing deferred tax liabilities that provide a source of future taxable income, the impact of current tax planning strategies and the availability of future tax planning strategies. We establish a valuation allowance against any deferred tax asset for which we are unable to conclude that recoverability is more likely than not. This is inherently judgmental, since we are required to assess many different factors and evaluate as much objective evidence as we can in reaching an overall conclusion. The particularly sensitive component of our evaluation is our projection of future operating results since this relies heavily on our estimates of future revenue and expense levels by tax jurisdiction.
At June 30, 2017 we have a $37.4 million valuation allowance against certain deferred tax assets given the uncertainty of recoverability of these amounts. The valuation allowance increased by $10.9 million in fiscal year 2017 from fiscal year 2016 primarily due to an increase to the U.S. and Switzerland valuation allowances.
For the fiscal year ended June 30, 2015, we established a significant valuation allowance against our U.S. deferred tax assets as we concluded that it was more likely than not that a portion of these assets may not be recovered. This analysis was based on both positive and negative factors. As a result, we increased our valuation allowance in fiscal year 2015 and recorded income tax expense in the amount of $16.0 million. The establishment of a valuation allowance has no effect on our ability to use the underlying deferred tax assets to reduce cash tax payments in the future to the extent that we generate U.S. taxable income.
Uncertain Tax Positions
As of June 30, 2017, we had approximately $8.7 million of total gross unrecognized tax benefits, of which approximately $1.4 million represented the amount of unrecognized tax benefits that, if recognized, would favorably affect our effective income tax rate in future periods. Approximately $4.1 million of the gross unrecognized tax benefits resulted in reductions to the deferred tax asset relating to net operating losses and to the valuation allowance, and approximately $3.2 million of the gross unrecognized tax benefits resulted in a reduction to tax credit carryforwards and other deferred tax assets. We currently anticipate that our unrecognized tax benefits will decrease within the next twelve months by approximately $0.4 million, as a result of the expiration of certain statutes of limitations associated with intercompany transactions subject to tax in multiple jurisdictions.
A summary of the changes in the gross amount of unrecognized tax benefits is shown below:
| (in thousands) | ||||
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Balance at July 1, 2014 |
$ | 4,085 | ||
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Additions related to current year tax positions |
2,392 | |||
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Additions related to prior year tax positions |
145 | |||
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Reductions due to lapse of statute of limitations |
(213 | ) | ||
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Foreign currency translation |
(104 | ) | ||
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Balance at July 1, 2015 |
6,305 | |||
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Additions related to current year tax positions |
1,647 | |||
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Additions related to prior year tax positions |
215 | |||
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Reductions due to lapse of statute of limitations |
(229 | ) | ||
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Foreign currency translation |
(129 | ) | ||
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Balance at July 1, 2016 |
7,809 | |||
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Additions related to current year tax positions |
1,160 | |||
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Additions related to prior year tax positions |
13 | |||
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Reductions due to lapse of statute of limitations |
(335 | ) | ||
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Foreign currency translation |
9 | |||
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Balance at July 1, 2017 |
$ | 8,656 | ||
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We recognize interest and penalties related to uncertain tax positions as a component of income tax expense. To the extent that the accrued interest and penalties do not ultimately become payable, the amounts accrued will be derecognized and reflected as an income tax benefit in the period that such a determination is made. Our accrued interest and penalties related to uncertain tax positions as of June 30, 2017 and 2016, and recorded in each of the annual periods ending June 30, 2017, 2016, and 2015, were not significant.