9. INCOME TAXES:

General overview:

The Company is subject to U.S. federal tax as well as income tax in multiple states and local and foreign jurisdictions. The Company’s 2004 through 2015 tax years are open and may be subject to examination by these taxing authorities. Such examinations, if any, could result in challenges to tax positions taken and, accordingly, we may record adjustments to our tax provision based on the outcome of such matters.

The Company has elected to recognize interest and penalties related to income tax matters as a part of the income tax provision.

For the year ended December 31, 2016, we recorded an income tax provision of $5.0 million compared to an income tax provision of $3.5 million and $3.2 million in the years ended December 31, 2015 and 2014, respectively. The income tax provision recorded during 2016 includes a non-cash charge of $3.7 million associated with an increase to the valuation allowance provided against the carrying value of our deferred tax attributes. Similarly, our 2015 income tax provision includes non-cash charges associated with the impairment of a certain state income net operating loss carryforward and a $3.0 million increase to the valuation allowance provided against the carrying value of our deferred tax attributes.

Deferred tax asset valuation allowance:

As of December 31, 2016, we had gross deferred tax assets of $27.2 million. Our deferred tax assets have arisen as a result of timing differences (primarily generated in connection with historical goodwill and intangible asset impairment charges), net operating loss carryforwards and tax credits. These assets represent amounts that we are able to use to reduce our future taxable income.

We maintained a valuation allowance of $8.2 million and $4.5 million against the carrying value of our gross deferred tax attributes as of December 31, 2016 and 2015, respectively.

We assess the realizability of our deferred tax assets and assess the need for a valuation allowance on an ongoing basis. The periodic assessment of the net carrying value of our deferred tax assets under the applicable accounting rules is judgmental. We are required to consider all available positive and negative evidence in evaluating the likelihood that we will be able to realize the benefit of our deferred tax assets in the future. Such evidence includes scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and the results of recent operations. Since this evaluation requires consideration of events that may occur some years into the future, there is significant judgment involved, and our conclusion could be materially different should certain of our expectations not transpire.

During our 2016 periodic assessment of the need for a valuation allowance against the carrying value of our deferred tax assets, we noted a continued shift in objectively verifiable trends which lessened the strength of our previously identified positive evidence. Specifically, during our assessment, we noted the following positive and negative evidence:

Positive Evidence:

◾

We had generated U.S.-based pre-tax income of more than $8.9 million over the previous three years and had utilized some of our available tax assets to reduce tax liabilities that would have otherwise arisen in those periods.

◾

Our forecasts of future taxable income indicated that our pre-tax income and taxable income would increase in the future.

Negative Evidence:

◾

While we generated U.S.-based profit before income taxes during 2016, we did not utilize a significant amount of our federal and state net operating loss carryforwards in 2016 as originally expected.

◾

Foreign operations are generating a larger portion of our consolidated profit before income taxes.

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The majority of our federal net operating loss carryforwards expire in 2020, reducing the time period over which the Company has to generate sufficient income to realize future benefit from the loss carryforward amounts.

◾

The Company did not achieve 100% of its plans and/or projections in 2016.

◾

Our forecasts have increased risk associated with operations due to current disruption in our sales pipeline attributable to our channel partners pushing customers toward cloud-based service offerings and away from on-premise applications.

The Company, in connection with its determination of the future utilization of deferred tax assets, considered various future profitability scenarios. This analysis noted that there existed risk and uncertainty that the Company would be able to fully realize future economic benefit from all of the gross carrying value of its deferred tax attributes based upon the forecasted profitability. Accordingly, the Company recorded an increase of $3.7 million in the valuation allowance applied against the carrying value of its deferred tax assets, reducing the net carrying value to the more likely than not anticipated future economic benefit to be realized from the assets.

During our 2015 periodic assessment of the need for a valuation allowance against the carrying value of our deferred tax assets, we noted a shift in objectively verifiable trends which lessened the strength of our previously identified positive evidence. Specifically, during our assessment, we noted the following positive and negative evidence:

Positive Evidence:

◾

We had generated U.S.-based pre-tax income of more than $8.8 million over the previous three years and had utilized some of our available tax assets to reduce tax liabilities that would have otherwise arisen in those periods.

◾

Our forecasts of future taxable income indicated that our pre-tax income and taxable income would increase in the future.

Negative Evidence:

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We are reporting a loss in U.S.-based profit before income taxes during 2015 as a result we did not utilize a significant amount of our federal and state net operating loss carryforwards in 2015 as originally expected.

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The Company did not achieve 100% of its plans and/or projections in 2015.

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Our forecasts have increased risk associated with operations of newly acquired businesses.

The Company, in connection with its determination of the future utilization of deferred tax assets, considered various future profitability scenarios. This analysis noted that there existed risk and uncertainty that the Company would be able to fully realize future economic benefit from all of the gross carrying value of its deferred tax attributes based upon the forecasted profitability. Accordingly, the Company recorded an increase of $3.0 million in the valuation allowance applied against the carrying value of its deferred tax assets, reducing the net carrying value to the more likely than not anticipated future economic benefit to be realized from the assets.

Realization of our deferred tax assets is dependent on our generating sufficient taxable income in future periods. Although we believe it is more likely than not that future taxable income would be sufficient to allow us to recover substantially all of the value of our deferred tax assets, realization is not assured and future events could cause us to change our judgment. In the event that actual results differ from our estimates, or we adjust these estimates in the future periods, further adjustments to our valuation allowance may be recorded, which could materially impact our financial position and net income (loss) in the period of the adjustment.

Income tax provision:

Significant components of the Company’s income tax provision (benefit) consisted of the following:


	Year Ended December 31,
	2016		2015			2014
	(In Thousands)
Current tax expense:
Federal	$	-	$	-		$	-
State		185		161			377
Foreign		(9)		264			68

		176		425			445
Deferred tax expense (benefit):
Federal		801		(544	)		2,092
State		344		476			709
Foreign		9		205			301
Change in valuation allowance		3,700		3,000			-

		4,854		3,137			3,102
Unrecognized tax benefit		-		(33	)		(370	)

Income tax provision	$	5,030	$	3,529		$	3,177

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


	Year Ended December 31,
	2016		2015			2014
Domestic	$	1,568	$	(1,875	)	$	6,259
Foreign		628		1,344			982

Income (loss) before income taxes	$	2,196	$	(531	)	$	7,241

In general, it is the practice and intention of the Company to reinvest the earnings of its foreign subsidiary in those operations. However, as of December 31, 2016 the Company’s foreign subsidiary is in a cumulative loss position which results in the tax basis of the subsidiary exceeding its book basis. As a result, no deferred tax asset is necessary to record in the financial statements as this temporary difference is not expected to reverse in the foreseeable future.

The differences in income taxes determined by applying the statutory federal tax rate of 34% to income from continuing operations before income taxes and the amounts recorded in the accompanying consolidated statements of comprehensive income (loss) result from the following:


	Year Ended December 31,
	2016					2015						2014
	Amount		Rate			Amount			Rate			Amount			Rate
	(Dollar Amounts In Thousands)
Income tax at statutory rate	$	747		34.0	%	$	(195	)		34.0	%	$	2,468			34.0	%
Add (deduct):
State income taxes, net of federal tax benefit		429		19.6			484			(84.4	)		556			7.7
Tax rate difference on foreign income taxes		17		0.8			(36	)		6.2			26			0.4
Tax effect of rate change on deferred tax assets		-		-			-			0.0			252			3.5
Non-deductible items		126		5.7			155			(27.1	)		112			1.6
Net decrease in deferred tax attributes		-		-			-			-			183			2.5
Increase in valuation allowance against certain deferred tax assets		3,700		168.5			3,000			(523.8	)		-			-
Unrecognized tax benefits		-		-			(33	)		5.8			(370	)		(5.1	)
Other, net		11		0.5			154			(27.0	)		(50	)		(0.7	)

		$5,030		229.1	%	$	3,529			(616.3	)%	$	3,177			43.9	%

Deferred income taxes:

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. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2016 and 2015 are as follows:


	December 31,
	2016			2015
	(In Thousands)
Deferred income tax assets:
Net operating loss carryforwards and credits	$	16,090		$	16,753
Acquired intangible assets		6,561			6,517
Reserves and accruals		2,209			2,115
Share-based compensation		2,837			3,092
Depreciation		395			397

Total deferred income tax assets		28,092			28,874
Deferred income tax liabilities:
Acquired intangible assets		(549	)		(180	)
Other		(312	)		(162	)

Total deferred income tax liabilities		(861	)		(342	)
Valuation allowance		(8,200	)		(4,500	)

Deferred income tax asset, net	$	19,031		$	24,032

As of December 31, 2015, the Company elected to early adopt the provisions of FASB Accounting Standards Update No. 2015-17, Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes (ASU 2015-17). The adoption of ASU 2015-17 resulted in the reclassification of $2.0 million of current deferred tax assets to noncurrent deferred tax assets as of December 31, 2015. Adoption of this standard did not impact results of operations, retained earnings, or cash flows in the current or previous interim and annual reporting periods.

Significant deferred tax attributes and current activity within the Company’s deferred tax accounts included the following:

Net Operating Loss Carryforwards and Credits: As of December 31, 2016, we had net operating loss carryforwards for both federal and state income tax purposes of approximately $48.0 million and alternative minimum and worker’s opportunity credits of approximately $2.1 million, which expire at various intervals through 2030. However, $35.8 million of the Company’s federal net operating loss carryforwards and $1.0 million of worker’s opportunity tax credits are set to expire in 2020.

Not included in the federal net operating loss carryforwards are $4.0 million of excess tax deductions from stock option exercises during fiscal 2016, 2015 and 2014. Pursuant to the guidance on accounting for stock-based compensation, the deferred tax asset relating to excess tax benefits from these exercises was not recognized for financial statement purposes. The future benefit from these deductions will be recorded as a credit to additional paid-in capital when taxes payable are reduced on the income tax return.

Additionally, the Internal Revenue Code contains provisions that limit the amount of net operating loss and tax credit carryforwards available to be used in any given year in the event of certain circumstances, including significant changes in ownership interests. These limitations may result in the expiration of our historical net operating loss carryforwards and tax credits prior to their utilization. The Company has various tax-effected net operating loss carryforwards for state income tax purposes of approximately $442 thousand which expire at various intervals through 2036.

Annual changes to the deferred tax valuation allowance are as follows:


	Year Ended December 31,
	2016		2015		2014
	(In Thousands)
Balance, beginning of year	$	4,500	$	1,500	$	1,500
Additions		3,700		3,000		-

Balance, end of year	$	8,200	$	4,500	$	1,500

Unrecognized tax benefits:

In accordance with our evaluation of unrecognized tax benefits, we have established a liability representing our estimated amount of unrecognized tax benefits, plus an additional provision for penalties and interest. A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows:


	Year Ended December 31,
	2016		2015			2014
	(In Thousands)
Gross unrecognized tax benefits, beginning of year	$	-	$	9		$	108
Increase in tax position in current year		-		-			-
Settlement/Expiration of statute		-		-			-
De-recognition through administrative policy		-		(9	)		(99	)

Gross unrecognized tax benefits, end of year	$	-	$	-		$	9

The Company’s policy is to recognize accrued interest and penalties related to unrecognized tax benefits and income tax liabilities, when applicable, as part of income tax expense in its consolidated statements of comprehensive income (loss). There was no accrual for interest and penalties as of December 31, 2016 and 2015. Accrued interest and penalties totaled $49 thousand as of December 31, 2014.

As of December 31, 2015, we no longer maintain an accrual associated with unrecognized tax benefits. We do not expect our unrecognized tax benefits to change significantly over the next twelve months.