

15.	INCOME TAXES:

The components of income before income taxes are as follows (in thousands):



	Year ended December 31,
	2013			2012			2011
United States	$	57,258		$	20,069		$	3,729
Foreign	(18,250		)	(5,201		)	(1,288		)
Income before income tax	$	39,008		$	14,868		$	2,441

The components of the income tax benefit (expense) are as follows (in thousands):



	Year ended December 31,
	2013			2012			2011
Current income tax benefit (expense):
Federal	$	226		$	(225	)	$	—
State	—			—			2,660
Foreign	(6,600		)	(4,994		)	(1,946		)
	(6,374		)	(5,219		)	714
Deferred income tax (expense) benefit:
Federal	(16,811		)	—			—
State	(1,192		)	—			—
Foreign	69			11			—
	(17,934		)	11			—
Adjustments to the beginning-of-year valuation allowance	59,352			—			—
Income tax benefit (expense)	$	35,044		$	(5,208	)	$	714

Reconciliation of the statutory U.S. federal tax rate to the Company's effective tax rate is as follows:



	Year ended December 31,
	2013		2012		2011
Statutory U.S. federal income tax rate	35.0	%	34.0	%	34.0	%
State income taxes, net of federal benefit	(1.3	)%	(2.3	)%	8.1	%
State apportionment change	0.3	%	23.8	%	—	%
U.S. federal rate change	(3.6	)%	—	%	—	%
Effect of foreign operations	10.9	%	7.1	%	17.9	%
Subpart F income	15.6	%	—	%	—	%
Nondeductible employee compensation	2.3	%	4.2	%	6.9	%
Loss on stock warrant liability	—	%	—	%	58.4	%
Research tax credits	(3.4	)%	—	%	(34.7	)%
Change in valuation allowance	(146.4	)%	(29.3	)%	(182.2	)%
Sale of New Jersey tax attributes	—	%	—	%	50.8	%
Other	0.8	%	(2.5	)%	11.5	%
Effective tax rate	(89.8	)%	35.0	%	(29.3	)%

As of December 31, 2013, the Company had net operating loss and credit carry forwards. The Company’s net operating loss carry forwards below differ from the Company's accumulated deficit principally due to the timing of the recognition of certain revenues and expenses. A portion of the Company’s net operating loss carry forwards relates to tax deductions from stock-based compensation that will be accounted for as an increase to additional paid-in capital for financial reporting purposes to the extent such future deductions are utilized by the Company (see below). Pursuant to Internal Revenue Code (IRC) sections 382 and 383, utilization of the Company’s federal and state net operating loss and tax credit carry forwards could be subject to an annual limitation because of certain ownership changes.

The following table summarizes Company tax loss and tax credit carry forwards at December 31, 2013 (in thousands):



	Related Tax Deduction		Tax Benefit		Expiration Date
Loss carry forwards:
Federal net operating loss ⁽¹⁾	$	79,150	$	27,702	2026 to 2033
Foreign net operating loss	20,595		2,598		n/a
Total loss carry forwards	$	99,745	$	30,300
Tax credit carry forwards:
Research tax credits	n/a		$	10,360	2020 to 2033
Foreign tax credits	n/a		13,830		2020 to 2023
State research tax credits	n/a		2,775		2020 to 2028
Total credit carry forwards	n/a		$	26,965

_______________________________________________

(1) Includes $68.6 million (tax benefit of $24.0 million) related to excess tax benefits which are not included in deferred tax assets on the consolidated balance sheet and are not recognized until the deduction reduces taxes payable (see below).

Significant components of the Company's net deferred tax assets and liabilities are as follows (in thousands):



	December 31,
	2013			2012
Deferred tax asset:
Net operating loss carry forwards	$	6,280		$	36,866
Capitalized technology license	2,519			2,525
Capitalized research expenditures	14,012			2,009
Accruals and reserves	2,172			1,270
Retirement plan	3,315			3,432
Deferred revenue	1,393			2,591
Tax credit carry forwards	26,965			18,612
Stock-based compensation	1,389			1,326
Other	1,329			1,091
	59,374			69,722
Valuation allowance	(12,598		)	(69,711		)
Deferred tax assets	46,776			11

Deferred tax liability:
Subpart F income	(6,070		)	—
Deferred tax liabilities	(6,070		)	—

Net deferred tax assets	$	40,706		$	11

During 2013, the Company released valuation allowance of $59.4 million, with $12.6 million remaining that relates to UDC Ireland, U.S. foreign tax credits and New Jersey research and development credits.

Deferred tax assets and the gross valuation allowance, and the resulting reconciliation of the statutory U.S. federal tax rate to the Company's effective tax rate, previously reported in 2012 and 2011 have been adjusted to exclude the impact of the windfall tax benefits that were previously reflected as a deferred tax asset, as well as to adjust the net deferred tax assets for additional stock-based compensation related items. The adjustments had no effect on consolidated net income or the consolidated balance sheet as previously reported.

During the years ended December 31, 2013, 2012 and 2011, the Company paid foreign taxes on South Korean royalty and license fee income of $6.6 million, $4.9 million and $1.9 million, respectively, which were recorded as current income tax expense. For periods prior to May 2010, the Company filed for and was granted a five year exemption on withholding tax on royalty payments received from SDC under its patent license agreement as part of a tax incentive program in South Korea. The exemption was granted in May 2005 and remained in effect until May 2010. Since then, SDC has been required to withhold tax at a rate of 16.5% upon payment of royalties and license fees to the Company.

During the year ended December 31, 2011, the Company sold approximately $45.2 million of its state net operating losses and $232,000 of its state research and development tax credits under the New Jersey Technology Tax Certificate Transfer Program, and received net proceeds of $2.7 million. The Company recorded these sales as income tax benefit.

The Company has elected to recognize as earnings taxable in the United States, and to record related deferred tax liabilities with respect to, deferred Subpart F earnings related to foreign subsidiaries in the period the Subpart F earnings are generated, even though the income is not currently taxable based upon current tax laws which limit Subpart F income to the amount of earnings and profits of the subsidiary. During the year ended December 31, 2013, the Company recorded U.S. income tax expense and a corresponding deferred tax liability of $6.1 million for future recapture of the earnings for activities of UDC Ireland which currently has a deficit in earning and profits.

Due to the Company's net operating loss position, deferred tax assets relating to tax benefits of employee stock-based compensation have been reduced related to stock options exercised and restricted stock vested for which the tax deduction exceeded the aggregate compensation expense recorded for financial reporting purposes. Although these additional tax benefits or windfalls are reflected in net operating loss carryforwards in the tax return, the additional tax benefit associated with the windfalls is not recognized until the deduction reduces taxes payable. The Company follows the “with and without” approach (excluding indirect tax effects to items such as R&D credits) described in ASC 740 Income Taxes which gives primacy to continuing operations in determining realized tax benefits. Under the with and without approach, the excess tax benefit of deductions from stock-based compensation is reflected as an increase in additional paid-in capital only if an incremental benefit is provided after considering all other tax attributes available to the Company. Accordingly, windfall tax benefits are not considered to offset current year taxable income and a benefit is not recorded in paid-in-capital if the amount of available net operating loss and tax credit carryforwards generated from continuing operations is sufficient to offset current year taxable income before considering windfall tax benefits. Given the Company's net operating loss carry forward position, no incremental benefit has been recognized in paid-in capital for such excess tax benefits.

When recognizing deferred tax assets for employee stock based awards that may be subject to limitation under IRC Section 162(m), and calculating the resulting windfall benefit, the Company prioritizes the impact of future cash compensation over stock-based compensation. Accordingly, if the anticipated cash compensation is equal to or greater than the total tax deductible annual compensation amount for a covered employee, the Company does not record a deferred tax asset associated with any stock-based compensation for that individual. As noted above, in accounting for the indirect effect of stock-based compensation on the Company's research tax credits, the Company does not set apart these credits when measuring the windfall tax benefit; instead the Company follows the practice of recognizing the full effect of research tax credits in income from continuing operations. As of December 31, 2013 and 2012, windfalls included in net operating loss carryforwards but not reflected in deferred tax assets totaled $68.6 million and $63.8 million, respectively.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent on the Company's ability to generate future taxable income to obtain benefit from the reversal of temporary differences, net operating loss carryforwards and tax credits. As part of its assessment management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies. During the year ended December 31, 2013, based on previous earnings history, a current evaluation of expected future taxable income and other evidence, the Company determined it is more likely than not that its federal and the majority of its state deferred tax assets will be realized. Therefore, the Company released all valuation allowances except the portion that relates to UDC Ireland, New Jersey research and development credits and a portion of foreign tax credits. The Company's valuation allowance decreased by $57.1 million, $4.4 million and $4.5 million for the years ended December 31, 2013, 2012 and 2011, respectively.

The Company did not record a liability for uncertain tax positions as of December 31, 2013, 2012, and 2011, respectively. Company management does not anticipate any material change in its uncertain tax positions in the next twelve months. The Company’s federal income tax returns for 2010 through 2012 are open tax years and are subject to examination by the Internal Revenue Service. State tax years 2009 to 2012 remain open to examination by the jurisdictions (Pennsylvania and New Jersey) in which the Company is subject to tax. However, due to the Company's net operating losses, the Company's federal income tax returns for 1995 and later will remain subject to examination until the losses are utilized or expire; certain state returns remain subject to examination as well. In addition, the Company's foreign returns for 2010 and thereafter remain subject to examination.