| 11. |
Income Taxes |
The Company has incurred cumulative net operating losses since inception and, consequently, has not recorded any income tax expense for the years ended December 31, 2017 and 2016 due to its net operating loss position.
The reconciliation of the federal statutory income tax rate to the Company’s effective tax rate is as follows:
| Year Ended December 31, | ||||||||||||||||
| 2017 | 2016 | |||||||||||||||
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Federal statutory tax rate |
(34.00 | ) | % | (34.00 | ) | % | ||||||||||
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State statutory tax rate |
(5.83 | ) | % | (5.83 | ) | % | ||||||||||
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Change in effective tax rate |
18.17 | % | - | % | ||||||||||||
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Derecognition due to Section 382 and 383 |
30.19 | % | 231.11 | % | ||||||||||||
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Stock-based compensation |
1.11 | % | 1.00 | % | ||||||||||||
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Permanent items |
(2.51 | ) | % | (3.17 | ) | % | ||||||||||
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Change in valuation allowance |
(7.13 | ) | % | (189.11 | ) | % | ||||||||||
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| - | % | - | % | |||||||||||||
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Deferred income taxes reflect the net 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. As of December 31, 2017 and 2016, the Company had net deferred tax assets of $16.9 million and $18.9 million, respectively. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The net valuation allowance decreased by approximately $2.0 million and $56.9 million during the year ended December 31, 2017 and 2016, respectively.
Significant components of the Company’s net deferred tax assets and liabilities are as follows:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | |||||||||||
| (in thousands) | ||||||||||||
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Net operating loss carryforwards |
$ | 12,226 | $ | 14,034 | ||||||||
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Research and development credits |
3,245 | 2,617 | ||||||||||
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Depreciation and amortization |
640 | 345 | ||||||||||
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Accruals |
507 | 658 | ||||||||||
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Deferred rent |
113 | 1,066 | ||||||||||
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Capital loss carryforward |
23 | 33 | ||||||||||
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Stock-based compensation |
98 | 190 | ||||||||||
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Other |
1 | 2 | ||||||||||
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Net deferred tax assets |
16,853 | 18,945 | ||||||||||
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Valuation allowance |
(16,853 | ) | (18,945 | ) | ||||||||
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| $ | - | $ | - | |||||||||
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As of December 31, 2017, the Company had federal net operating loss carryforwards of approximately $43.8 million and state net operating loss carryforwards of approximately $43.5 million. As of December 31, 2016, the Company had federal net operating loss carryforwards of approximately $35.2 million and state net operating loss carryforwards of approximately $35.5 million. If not utilized, the federal net operating loss carryforwards will expire from 2027 through 2038, and state net operating loss carryforwards will expire from 2018 through 2038.
If the Company experiences a greater than 50 percentage point aggregate change in ownership over a three-year period (a Section 382 ownership change), utilization of its pre-change NOL carryforwards are subject to annual limitation under Section 382 of the Internal Revenue Code (California has similar provisions). The annual limitation is determined by multiplying the value of the Company’s stock at the time of such ownership change by the applicable long-term tax-exempt rate. Such limitations may result in expiration of a portion of the NOL carryforwards before utilization. As of December 31, 2017, the Company determined that ownership changes occurred on February 26, 2014, November 30, 2015 and March 22, 2017. As a result of the ownership changes, approximately $185.4 million and $176.6 million of the NOLs will expire unutilized for federal and California purposes, respectively. As of December 31, 2017, the Company has derecognized NOL related DTAs in the tax affected amounts of $38.9 million and $12.3 million for federal and California purposes, respectively. The ability of the Company to use its remaining NOL carryforwards may be further limited if the Company experiences a Section 382 ownership change as a result of future changes in its stock ownership.
As of December 31, 2017, the Company had federal and state research and development credit carryforwards of approximately $0.4 million and $4.6 million, respectively. As of December 31, 2016, the Company had federal and state research and development credit carryforwards of approximately $0.5 million and $4.2 million, respectively. If not utilized, the federal tax credits will begin to expire in 2026 and state tax credits currently do not expire. Research and development credits are subject to IRC section 383. In the event of a change in ownership as defined by this code section, the usage of the credits may be limited. As a result of the previously mentioned ownership changes, the Company has derecognized approximately $4.5 million of gross federal R&D credit-related DTAs due to the Section 383 limitation as of December 31, 2017. The Company has not derecognized any of the California R&D credit-related DTAs because the credit do not expire.
In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017. The 2017 Tax Act also provides for a one-time transition tax on certain foreign earnings and the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes beginning in 2018, including changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. Specifically, the 2017 Tax Act limits the amount the Company is able to deduct for net operating loss carryforwards generated in taxable years beginning after December 31, 2017 to 80% of taxable income however these net operating loss carryforwards can be carried forward indefinitely, repeal of the domestic manufacturing deduction, acceleration of tax revenue recognition, capitalization of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility of interest.
The changes to existing U.S. tax laws as a result of the 2017 Tax Act, which we believe have the most significant impact on the Company’s federal income taxes are as follows:
Reduction of the U.S. Corporate Income Tax Rate
The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, resulting in a $5.3 million decrease in net deferred tax assets and a corresponding $5.3 million decrease in the valuation allowance as of December 31, 2017.
Acceleration of Depreciation
The Company recognized a provisional reduction to net deferred tax assets and a corresponding reduction in valuation allowance of $0.4 million attributable to the accelerated depreciation for certain assets placed into service after September 27, 2017.
The Company files income tax returns in the U.S. federal and California state jurisdictions. The Company is subject to U.S. federal and state income tax examinations by authorities for all tax years due to the accumulated net operating losses that are being carried forward for tax purposes.
Uncertain Income Tax Positions
The Company only recognizes tax benefits if it is more likely than not that they will be sustained upon audit by the relevant tax authority based upon their technical merits. An uncertain tax position will not be recognized if it has less than a 50% likelihood of being sustained.
The Company had approximately $1.0 million of unrecognized tax benefits as of December 31, 2017 and approximately $0.9 million of unrecognized tax benefits as of December 31, 2016. As the Company has a full valuation allowance on its deferred tax assets, the unrecognized tax benefits will reduce the deferred tax assets and the valuation allowance in the same amount. The Company does not expect the amount of unrecognized tax benefits to materially change in the next twelve months. A reconciliation of the beginning and ending balance of the unrecognized tax benefits is as follows:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | |||||||||||
| (in thousands) | ||||||||||||
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Balance at the beginning of year |
$ | 943 | $ | 1,582 | ||||||||
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(Decrease) increase related to prior year tax positions |
- | (4 | ) | |||||||||
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(Decrease) increase related to current year tax positions |
63 | (635 | ) | |||||||||
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Balance at the end of year |
$ | 1,006 | $ | 943 | ||||||||
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Interest and penalty related to unrecognized tax benefits would be included as income tax expense in the Company’s consolidated statements of operations. As of December 31, 2017 and 2016, the Company had not recognized any tax-related penalties or interest in its consolidated financial statements.