Income Taxes from Continuing Operations
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted and implements comprehensive tax legislation which, among other changes, reduces the federal statutory corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously deferred, creates new provisions related to foreign sourced earnings, eliminates the domestic manufacturing deduction and moves to a territorial system. Additionally, in December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period, as defined in SAB 118, ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. During the measurement period, provisional amounts may also be adjusted for the effects, if any, of interpretative guidance issued after December 31, 2017, by U.S. regulatory and standard-setting bodies.
Based on the provisions of the Tax Act, the Company re-measured its U.S. deferred tax assets and liabilities and adjusted its deferred tax balances to reflect the lower U.S. corporate income tax rate at December 31, 2017. The re-measurement of the Company's U.S. deferred tax assets and liabilities at the lower enacted U.S. corporate tax rate resulted in an income tax benefit of $26.9 million which is included as a discrete item in the 2017 income tax benefit. The Company’s foreign subsidiaries do not have accumulated earnings that can be distributed; therefore, the provisions of the Act related to the repatriation of foreign earnings are not applicable to the Company at December 31, 2017.
The income tax provision (benefit) from continuing operations consisted of the following (in thousands):
|
| | | | | | | | | | | |
| Current | | Deferred | | Total |
Year ended December 31, 2017 | | | | | |
Federal | $ | 78,806 |
| | $ | (105,006 | ) | | $ | (26,200 | ) |
State | 1,706 |
| | (9,785 | ) | | (8,079 | ) |
Foreign | 89 |
| | (458 | ) | | (369 | ) |
| $ | 80,601 |
| | $ | (115,249 | ) | | $ | (34,648 | ) |
Year ended December 31, 2016 | |
| | |
| | |
|
Federal | $ | 107,818 |
| | $ | (26,377 | ) | | $ | 81,441 |
|
State | 11,247 |
| | (4,325 | ) | | 6,922 |
|
Foreign | — |
| | (1,306 | ) | | (1,306 | ) |
| $ | 119,065 |
| | $ | (32,008 | ) | | $ | 87,057 |
|
Year ended December 31, 2015 | |
| | |
| | |
|
Federal | $ | 116,375 |
| | $ | (41,477 | ) | | $ | 74,898 |
|
State | 11,113 |
| | (2,620 | ) | | 8,493 |
|
Foreign | — |
| | (2,033 | ) | | (2,033 | ) |
| $ | 127,488 |
| | $ | (46,130 | ) | | $ | 81,358 |
|
The income tax provision differs from the “expected” tax expense computed by applying the U.S. Federal corporate income tax rates of 35% to income from continuing operations before income taxes, as follows (in thousands):
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Computed “expected” tax provision | $ | (20,719 | ) | | $ | 94,955 |
| | $ | 81,255 |
|
Change in income taxes resulting from: | | | | | |
State income taxes, net of Federal income tax | (537 | ) | | 4,501 |
| | 5,520 |
|
Change in state income tax rate, net of Federal income tax | (4,714 | ) | | — |
| | — |
|
Foreign income tax provision (benefit) | 2,206 |
| | 1,580 |
| | (1,130 | ) |
Deduction for domestic production activities | (2,527 | ) | | (7,280 | ) | | (6,882 | ) |
Stock compensation | (1,316 | ) | | (11,395 | ) | | — |
|
R&D tax credits | (1,200 | ) | | (825 | ) | | (677 | ) |
Nondeductible acquisition fees | 1,974 |
| | 39 |
| | 165 |
|
Interest and penalties from Federal audit | 15,650 |
| | — |
| | — |
|
Federal rate change | (26,902 | ) | | — |
| | — |
|
Discrete adjustments to prior year | 1,561 |
| | — |
| | — |
|
Other expense, net | 1,201 |
| | 2,564 |
| | 682 |
|
Valuation allowance change | 675 |
| | 2,918 |
| | 2,425 |
|
Income tax provision | $ | (34,648 | ) | | $ | 87,057 |
| | $ | 81,358 |
|
The geographic allocation of the Company’s income from continuing operations before income taxes between U.S. and foreign operations was as follows (in thousands):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Pre-tax (loss) income from continuing U.S. operations | $ | (49,572 | ) | | $ | 287,880 |
| | $ | 241,665 |
|
Pre-tax loss from continuing foreign operations | (9,626 | ) | | (16,580 | ) | | (9,509 | ) |
Total pre-tax (loss) income from continuing operations | $ | (59,198 | ) | | $ | 271,300 |
| | $ | 232,156 |
|
Net deferred income taxes at December 31, 2017 and 2016 include (in thousands):
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Net operating loss carry-forward | $ | 25,100 |
| | $ | 25,657 |
|
Stock-based compensation | 7,668 |
| | 8,922 |
|
Chargeback reserves | 17,802 |
| | — |
|
Reserve for product returns | 9,479 |
| | 16,208 |
|
Inventory valuation reserve | 10,207 |
| | 11,503 |
|
Long-term debt | 3,084 |
| | 6,383 |
|
Other | 10,805 |
| | 18,808 |
|
Total deferred tax assets | $ | 84,145 |
| | $ | 87,481 |
|
Valuation allowance | (10,531 | ) | | (9,856 | ) |
Net deferred tax assets | $ | 73,614 |
| | $ | 77,625 |
|
Deferred tax liabilities: | |
| | |
|
Prepaid expenses | $ | (1,709 | ) | | $ | (3,091 | ) |
Depreciation & amortization – tax over book | (108,788 | ) | | $ | (226,855 | ) |
Total deferred tax liabilities | $ | (110,497 | ) | | $ | (229,946 | ) |
Net deferred income tax asset (liability) | $ | (36,883 | ) | | $ | (152,321 | ) |
The Company records a valuation allowance to reduce net deferred income tax assets to the amount that is more likely than not to be realized. In performing its analysis of whether a valuation allowance to reduce the deferred income tax asset was necessary, the Company evaluated the data and determined that as of December 31, 2014 it could not conclude that it was more likely than not that certain of the net operating losses of its Indian and Swiss subsidiaries would be realized. Accordingly, the Company established a valuation allowance of $10.5 million, $9.9 million and $8.8 million against its deferred tax assets as of December 31, 2017, 2016 and 2015, respectively.
The deferred tax balances have been reflected gross on the balance sheet and are netted only if they are in the same jurisdiction.
The Company’s net operating loss (“NOL”) carry-forwards as of December 31, 2017 consist of three component pieces: (i) U.S. Federal NOL carry-forwards valued at $3.7 million, (ii) foreign (Indian) NOLs of $21.0 million and (iii) foreign (Swiss) NOLs of $0.4 million. The U.S. Federal NOL carry-forwards were obtained through the Merck Acquisition completed in the fourth quarter of 2013. The Indian NOL carry-forwards relate to operating losses by the Company’s subsidiary in India, which was acquired in 2012. Of the $21.0 million Indian NOL, $10.1 million expires beginning in 2022; the Company has established a valuation allowance against this entire amount. The remaining $10.9 million of the Indian NOLs can be carried forward indefinitely, and the Company has concluded that they are more likely than not to be utilized and therefore has not established a valuation allowance against them. The Swiss NOL was obtained through the Akorn AG acquisition completed in the first quarter of 2015. It begins to expire in 2023 and, accordingly, the Company has established a valuation allowance against the entire amount.
The Company is currently undergoing an examination of its Federal income tax return for the year ended December 31, 2015 by the Internal Revenue Service. The Company’s U.S. Federal income tax returns filed for years 2014 through 2016 are open for examination by the Internal Revenue Service. The majority of the Company’s state and local income tax returns filed for years 2014 through 2016 remain open for examination as well.
In accordance with ASC 740-10-25 - Income Taxes — Recognition, the Company performs reviews of its tax positions to determine whether it is “more likely than not” that its tax positions will be sustained upon examination, and if any tax positions are deemed to fall short of that standard, the Company reserves based on the financial exposure and the likelihood of its tax positions not being sustained. Based on its review as of December 31, 2017, the Company determined that it would not recognize tax benefits as follows (in thousands):
|
| | | |
Balance at December 31, 2014 | $ | 2,010 |
|
Additions relating to 2015 | 356 |
|
Payments of amounts relating to prior years | (81 | ) |
Balance at December 31, 2015 | $ | 2,285 |
|
Additions relating to 2016 | 303 |
|
Payments of amounts relating to prior years | (1,287 | ) |
Balance at December 31, 2016 | $ | 1,301 |
|
Additions relating to 2017 | 416 |
|
Additions relating to prior years | 24,297 |
|
Terminations of exposures relating to prior years | (619 | ) |
Balance at December 31, 2017 | $ | 25,395 |
|
If recognized, $2.8 million of the above positions will impact the Company’s effective rate, while the remaining $22.6 million would result in adjustments to the Company’s deferred taxes. Due to the uncertainty of both timing and resolution of potential income tax examinations, the Company is unable to determine whether any amounts included in the December 31, 2017 balance of unrecognized tax benefits represent tax positions that could significantly change during the next twelve months. The Company accounts for interest and penalties as income tax expense. In the year ended December 31, 2017, the Company recorded penalties of $8.9 million and interest, net of tax benefit, of $5.9 million related to unrecognized tax benefits. At December 31, 2017, the Company had accrued a total of $8.9 million and $6.0 million of penalties and interest, respectively.