| (7) | Income Taxes |
The components of income tax expense for the years ended December 31, 2017, 2016 and 2015 are as follows (in thousands):
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Current provision (benefit): |
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Federal |
$ | — | $ | — | $ | — | ||||||
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State |
(26 | ) | 69 | 95 | ||||||||
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| $ | (26 | ) | $ | 69 | $ | 95 | ||||||
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Deferred provision: |
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Federal |
$ | 7 | $ | 6 | $ | (65 | ) | |||||
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State |
1 | 1 | (14 | ) | ||||||||
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| $ | 8 | $ | 7 | $ | (79 | ) | ||||||
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Total |
$ | (18 | ) | $ | 76 | $ | 16 | |||||
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A summary of the differences between the Company’s effective income tax rate and the Federal statutory income tax rate for the years ended December 31, 2017, 2016 and 2015 is as follows:
| 2017 | 2016 | 2015 | ||||||||||
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Federal statutory rate |
34.0 | % | 34.0 | % | 34.0 | % | ||||||
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State income taxes, net of federal benefit |
1.4 | % | 2.8 | % | 2.5 | % | ||||||
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Net state impact of deferred rate change |
(0.3 | %) | 0.2 | % | (0.1 | %) | ||||||
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Stock compensation expense |
(1.9 | %) | (3.2 | %) | (0.7 | %) | ||||||
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Tax amortization on goodwill |
(0.1 | %) | (0.1 | %) | 0.2 | % | ||||||
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Goodwill impairment |
(13.7 | %) | 0.0 | % | (10.0 | %) | ||||||
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Other permanent differences |
(0.4 | %) | (0.4 | %) | (0.1 | %) | ||||||
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Change in valuation allowance |
97.4 | % | (37.3 | %) | (26.6 | %) | ||||||
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Tax credits |
1.5 | % | 3.2 | % | 0.9 | % | ||||||
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Federal Rate Change |
(133.5 | %) | 0.0 | % | 0.0 | % | ||||||
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Accrual to TR |
(0.7 | %) | 0.0 | % | 0.0 | % | ||||||
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Increase Xoft NOLs under 382 Study |
16.2 | % | 0.0 | % | 0.0 | % | ||||||
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Effective income tax |
(0.10 | %) | (0.8 | %) | 0.1 | % | ||||||
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Deferred tax assets and liabilities are recognized for the expected future tax consequences of net operating loss carryforwards, tax credit carryforwards and temporary differences between the financial statement carrying amounts and the income tax basis of assets and liabilities. A valuation allowance is applied against any net deferred tax asset if, based on the available evidence, it is more likely than not that the deferred tax assets will not be realized.
Deferred income taxes reflect the impact of “temporary differences” between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The Company has fully reserved the net deferred tax assets, as it is more likely than not that the deferred tax assets will not be utilized. Deferred tax assets (liabilities) are composed of the following at December 31 (in thousands):
| 2017 | 2016 | |||||||
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Inventory (Section 263A) |
$ | 287 | $ | 418 | ||||
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Inventory reserves |
305 | 105 | ||||||
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Receivable reserves |
27 | 65 | ||||||
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Other accruals |
224 | 434 | ||||||
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Deferred revenue |
129 | 215 | ||||||
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Accumulated depreciation/amortization |
320 | 477 | ||||||
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Stock options |
1,901 | 2,558 | ||||||
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Developed technology |
2,201 | 3,594 | ||||||
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Tax credits |
3,130 | 3,090 | ||||||
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NOL carryforward |
31,113 | 40,865 | ||||||
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Net deferred tax assets |
39,637 | 51,821 | ||||||
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Valuation allowance |
(39,637 | ) | (51,821 | ) | ||||
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Goodwill tax amortization |
(14 | ) | (7 | ) | ||||
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Deferred tax liability |
$ | (14 | ) | $ | (7 | ) | ||
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The decrease in the net deferred tax assets and corresponding valuation allowance during the year ended December 31, 2017 related primarily to the decrease in corporate tax rate from 34% to 21% starting on January 1, 2018. The increase in net deferred tax assets and corresponding valuation allowance during the year ended December 31, 2016 is primarily attributable to additional net operating losses, additional research and development credits, and differences in amortization periods on the Company’s intangible assets. The Company completed an asset acquisition in January 2016 which resulted in $293,307 of goodwill. For book purposes, the goodwill was classified as an indefinite lived asset and tested for impairment each year. For tax, the Company is allowed amortization expense over a 15 year life. Due to the indefinite life of the asset for book purposes, the Company could not assume there would be a deferred tax asset available to offset the liability in future years. This created a tax expense equal to the tax effected amount of tax amortization, or $7,434 in 2017 and $6,844 in 2016.
As of December 31, 2017, the Company has net operating loss carryforwards totaling approximately $131.2 million expiring between 2019 and 2037. A portion of the total net operating loss carryforwards amounting to approximately $54.0 million relate to the acquisition of Xoft, Inc. As of December 31, 2017, the Company has provided a valuation allowance for its net operating loss carryforwards due to the uncertainty of the Company’s ability to generate sufficient taxable income in future years to obtain the benefit from the utilization of the net operating loss carryforwards. In the event of a deemed change in control, an annual limitation imposed on the utilization of the net operating losses may result in the expiration of all or a portion of the net operating loss carryforwards. There were no net operating losses utilized for the years ended December 31, 2017 or 2016.
The Company currently has approximately $9.9 million (including approximately $8.5 million that relate to Xoft, Inc.) in net operating losses that are subject to limitations, of which approximately $2.0 million (including approximately $656,000 that relates to Xoft, Inc.) can be used annually through 2029. The Company has available tax credit
carryforwards (adjusted to reflect provisions of the Tax Reform Act of 1986) to offset future income tax liabilities totaling approximately $3.1 million. The tax credits related to Xoft have been fully reserved for and as a result no deferred tax asset has been recorded. The credits expire in various years through 2037.
ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
As of December 31, 2017 and 2016, the Company had no unrecognized tax benefits and no adjustments to liabilities or operations were required under ASC 740-10. The Company’s practice is to recognize interest and penalty expenses related to uncertain tax positions in income tax expense, which was zero for the years ended December 31, 2017, 2016 and 2015. The Company files United States federal and various state income tax returns. Generally, the Company’s three preceding tax years remain subject to examination by federal and state taxing authorities. The Company completed an examination by the Internal Revenue Service with respect to the 2008 tax year in January 2011, which resulted in no changes to the tax return originally filed. The Company is not under examination by any other federal or state jurisdiction for any tax year.
The Company does not anticipate that it is reasonably possible that unrecognized tax benefits as of December 31, 2017 will significantly change within the next 12 months.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (“TCJA”) tax reform legislation. This legislation makes significant change in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation reduced the U.S. corporate tax rate from the current rate of 34% down to 21% starting on January 1, 2018. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the 21%. This revaluation resulted in a provision of $19.1 million to income tax expense in continuing operations and a corresponding reduction in the valuation allowance. As a result, there was no impact to the Company’s income statement as a result of reduction in tax rates. The other provisions of the TCJA did not have a material impact on our consolidated financial statements. Our preliminary estimate of the TCJA and the remeasurement of our deferred tax assets and liabilities is subject to the finalization of management’s analysis related to certain matters, such as developing interpretations of the provisions of the TCJA, changes to certain estimates and the filing of our tax returns. U.S. Treasury regulations, administrative interpretations or court decisions interpreting the TCJA may require further adjustments and changes in our estimates. The final determination of the TCJA and the remeasurement of our deferred assets and liabilities will be completed as additional information becomes available, but no later than one year from the enactment of the TCJA.