INCOME TAX PROVISION
Applicable income tax expense (benefit) provision on continuing operations is as follows:
|
| | | | | | | | | | | |
| (In thousands) |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | — |
| | $ | — |
| | $ | — |
|
State | 35 |
| | 1 |
| | (7 | ) |
| 35 |
| | 1 |
| | (7 | ) |
Deferred | (11,095 | ) | | 2,456 |
| | 35,789 |
|
Total provision for income taxes | $ | (11,060 | ) | | $ | 2,457 |
| | $ | 35,782 |
|
Deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. At December 31, 2017 and 2016, the net deferred tax liability was $19.2 million and $30.4 million respectively.
Deferred tax assets and liabilities, shown as the sum of the appropriate tax effect for each significant type of temporary differences as of December 31, 2017 and 2016, are as follows:
|
| | | | | | | | | | | | | | | |
| (In thousands) |
| 2017 Deferred Tax | | 2016 Deferred Tax |
| Asset | | Liability | | Asset | | Liability |
Net operating loss | $ | 50,818 |
| | $ | — |
| | $ | 28,074 |
| | $ | — |
|
Accrued compensation | 2,979 |
| | — |
| | 2,452 |
| | — |
|
Stock based compensation | 2,811 |
| | — |
| | 4,984 |
| | — |
|
Tenant improvement allowance | 168 |
| | — |
| | 258 |
| | — |
|
Inventory reserves | 935 |
| | — |
| | — |
| | (30 | ) |
Other deferred tax assets | 2,149 |
| | — |
| | 2,206 |
| | — |
|
Tax credits | 1,665 |
| |
|
| | 1,734 |
| | — |
|
Other deferred tax liabilities |
|
| | (285 | ) | | — |
| | (258 | ) |
Convertible Debt | — |
| | (735 | ) | | — |
| | (1,753 | ) |
Deferred revenue – current | — |
| | (1,329 | ) | | — |
| | (997 | ) |
Prepaid expenses |
|
| | (128 | ) | | — |
| | (178 | ) |
Depreciation | 786 |
| | — |
| | — |
| | (409 | ) |
Intangible assets amortization – Definite Lived | 338 |
| | — |
| | 6,197 |
| | — |
|
Intangible assets amortization – Indefinite Lived | — |
| | (26,263 | ) | | — |
| | (31,125 | ) |
Internally developed software | — |
| | (377 | ) | | — |
| | (702 | ) |
Less: Valuation Allowance | (52,706 | ) | | — |
| | (40,862 | ) | | — |
|
| $ | 9,943 |
| | (29,117 | ) | | $ | 5,043 |
| | (35,452 | ) |
Net deferred liability | | | $ | (19,174 | ) | | | | $ | (30,409 | ) |
The Company has recorded a deferred tax asset reflecting the benefit of $156.7 million of federal net operating loss carry-forwards, $2.0 million of federal tax credits for research and development and alternative minimum tax, as well as $166.8 million of state net operating loss carry-forwards, and $0.1 million of state tax credits for research and development. In connection with the acquisition of Sotera, a portion of the net operating loss carryforward is limited under section 382 of the Internal Revenue Code. The annual limitation is equal to approximately $2.3 million and the total net operating loss available for use during the carryforward period is $47.7 million. Deferred tax assets including tax credits, net operating losses and charitable contribution carryforward are set to expire between 2018 and 2037.
As a result of the adoption of ASU 2016-09 in the first quarter of 2017, the Company recorded a cumulative effect adjustment to increase deferred tax assets for the federal and state net operating losses attributable to excess tax benefits from stock-based compensation that had not been previously recognized. The impact was an increase to the deferred tax assets associated with net operating losses of approximately $0.5 million, which was offset by a corresponding increase to the valuation allowance. All excess tax benefits and deficiencies in the current and future periods will be recognized within the quarterly provision for income taxes during the reporting period in which they occur. This may result in increased volatility in the Company’s effective tax rate.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation made significant changes in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforward and carryback, limitation of the tax deduction for interest expense, and a repeal of the corporate alternative minimum tax. The legislation did reduce the U.S. corporate tax rate from the current rate of 35% to 21%. As a result of the enacted law, the Company was required to revalue deferred tax assets and liability at the enacted rate. This revaluation resulted in the Company recording a benefit of $12.4 million to income tax through continuing operations and a corresponding reduction in the deferred tax liability. The revaluation also resulted in an adjustment to the value of deferred tax assets and liabilities and a corresponding adjustment to the valuation allowance. Additionally, the Company recorded an income tax benefit of $6.2 million as management has reassessed the ability to offset certain indefinite lived deferred tax liabilities with deferred tax assets, reducing the Company’s need for a valuation allowance by the portion of deferred tax assets that are considered to have indefinite lives under the new law. The other provisions of the Tax Cuts and Jobs Act did not have a material impact on the fiscal 2017 consolidated financial statements.
The Company has recorded provisional estimates for valuation allowance reversal to certain state deferred tax assets based upon existing state tax law conformity to federal tax laws. Management will continue to monitor state legislative actions in states where it files during 2018. The provisional estimates for state valuation allowance may change to the extent any state legislature modifies its conformity to the Tax Act. In other areas of the Tax Cuts and Jobs Act that had an impact, the Company was able to make reasonable estimates and has recorded provisional amounts. There are no material elements of the Tax Act for which the Company was unable to make a reasonable estimate. The Company expects to finalize its assessment during the one year measurement period as prescribed by the Staff Accounting Bulletin 118.
With the acquisition of Sotera in the second quarter of 2017, the Company determined at the acquisition that the acquired deferred tax assets should have a full valuation allowance established against them due to the uncertainty of the utilization in future periods. A full valuation allowance was established on KeyW’s deferred tax assets during the second quarter of 2015 due to the uncertainty of the utilization in future periods. In evaluating the Company’s ability to realize the deferred tax assets it considered all available positive and negative evidence, including cumulative historical earnings, reversal of temporary differences, projected taxable income and tax planning strategies. The Company has generated pretax losses and is unable to carry back current tax losses to recover taxes previously paid as all amounts have been recovered. As a result of a cumulative negative weighting, management believes that it is more likely than not a significant portion of the Company's deferred tax assets will not be realized. As described above, with the passage of the Tax Cuts and Jobs Act, the Company believes it can utilize certain deferred tax assets that are no longer considered to have definite lives. The valuation allowance at year end primarily relates to the Company’s federal net operating losses, state net operating losses, and deferred tax assets related to states in which the deferred tax assets are not considered to have indefinite lives. The Company’s deferred tax assets will be evaluated in subsequent reporting periods by management using the same weighted positive and negative evidence to determine if a change in valuation allowance is required.
As a result of the adoption of ASU 2015-17 in the first quarter of 2017, all deferred tax assets and liabilities are classified as non-current on the consolidated balance sheet.
A reconciliation of the difference between the statutory federal income tax rate and the effective tax rate for the Company's continuing operations for the years ended December 31, 2017, 2016 and 2015 is as follows:
|
| | | | | | | | |
| Percent of Pre-tax Income |
| 2017 | | 2016 | | 2015 |
Tax computed at statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes net of federal income tax benefit | (5.9 | )% | | 10.4 | % | | 5.9 | % |
Worthless Stock Deduction | 16.0 | % | | — | % | | — | % |
Meals and entertainment – non-deductible | (1.5 | )% | | 4.6 | % | | 3.4 | % |
Non-deductible acquisition costs | (0.8 | )% | | 3.4 | % | | 1.1 | % |
ESPP Expense | (0.2 | )% | | 0.8 | % | | 1.4 | % |
Other permanent items | 0.3 | % | | 3.8 | % | | (1.0 | )% |
Provision to return | — | % | | 1.8 | % | | 1.2 | % |
Tax credits | — | % | | (1.6 | )% | | (3.8 | )% |
Decrease in deferred tax assets before valuation allowance due to federal rate change | (50.5 | )% | | — | % | | — | % |
Decrease in valuation allowance on deferred assets that are considered to have indefinite lives due to tax reform | 28.7 | % | | — | % | | — | % |
Other changes in valuation allowance, including due to federal rate change | 29.1 | % | | (1.4 | )% | | 566.2 | % |
Effective tax rate | 50.2 | % | | 56.8 | % | | 609.4 | % |
The Company recognizes the benefit of an income tax position only if it is more likely than not (greater than 50%) that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit can be recognized. Additionally, companies are required to accrue interest and related penalties, if applicable, on all tax exposures for which reserves have been established consistent with jurisdictional tax laws.
The following table represents a reconciliation of the Company's total unrecognized tax benefits balance for the year ended December 31, 2017:
|
| | | |
| (In thousands) |
| Activity |
January 1, 2017 | $ | 4,629 |
|
Increases as a result of tax positions taken in a prior period | 2 |
|
Increase as a result of tax positions taken in prior periods rate change | 670 |
|
December 31, 2017 | $ | 5,301 |
|
As of the year ended December 31, 2017, the Company has certain income tax positions in federal and state jurisdictions that are not more likely than not to be sustained upon tax examination. As a result, the Company recorded an increase to the unrecognized tax benefit during the current year. The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are deemed immaterial and are not included in the above table or within the financial statements.
As of December 31, 2017, the following tax years remained subject to examination by the major tax jurisdictions indicated:
|
| | |
Major Jurisdictions | | Open Years |
United States | | 2012 through 2016 |
California | | 2013 through 2016 |
Maryland | | 2014 through 2016 |
Massachusetts | | 2014 through 2016 |
Virginia | | 2014 through 2016 |
During the year ended December 31, 2015, the Internal Revenue Service (IRS) initiated an audit of the Company's Federal returns for the years ended December 31, 2013 and 2014. Management has reviewed its ASC 740-10 FIN 48 positions and, although timing of the resolution and/or closure of audits is not certain, does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next twelve months. If an issue addressed during the IRS audit is resolved in a manner inconsistent with Management expectations, the Company would adjust its net operating loss carryback, other tax credits, and its net operating loss carryforward.