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 2016 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, 2017, we recorded an income tax provision of $19.6 million compared to an income tax provision of $5.0 million and $3.5 million in the years ended December 31, 2016 and 2015, respectively. Our 2017 income tax provision includes $13.5 million in non-cash charges associated with increases to the valuation allowance applied against the carrying value of our deferred tax attributes, combined with a $10.9 million non-cash charge necessary to present our deferred tax attributes at a level reflecting the anticipated future economic benefit we expect to receive upon their reversal. 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, 2017, we had gross deferred tax assets of $21.7 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 $21.7 million and $8.2 million against the carrying value of our gross deferred tax attributes as of December 31, 2017 and 2016, 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 2017 periodic assessments 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 assessments, we noted the following positive and negative evidence:

Positive Evidence:

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The Company’s 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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The Company was in a cumulative loss position over the past three fiscal years (largely due to our 2017 operating performance).

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The Company did not utilize any of the Company’s existing federal and state net operating loss carryforwards in 2017 as originally expected.

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Foreign operations are generating a larger portion of the Company’s consolidated profit before income taxes.

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The majority of the Company’s 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.

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The Company did not achieve 100% of its plans and/or projections in 2017

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The Company’s forecasts continue to have increased risk associated of performance due to prolonged disruption in our sales pipeline attributable to our channel partners pushing customers toward cloud-based service offerings and away from on-premiseapplications.

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. Additionally, the Company, during its evaluations, placed significant weighting upon being in a cumulative loss position over the past three fiscal years. This fact provided strong objective and verifiable evidence that it was not more likely than not that the Company would be able to realize future economic benefit from its deferred tax attributes. Accordingly, the Company recorded an increase in the valuation allowance applied against the carrying value of its deferred tax assets in both the second quarter (recording a $1.1 million increase to the valuation allowance) and fourth quarter (recording a $12.4 million increase to the valuation allowance) of 2017. The combined effect of these increases results in a full valuation allowance being provided against the deferred tax attributes as of December 31, 2017, reflecting the more likely than not anticipated future economic benefit to be realized from the assets.

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

Positive Evidence:

◾

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

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The Company’s forecasts of future taxable income indicated that the Company’s pre-tax income and taxable income would increase in the future.

Negative Evidence:

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

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Foreign operations are generating a larger portion of the Company’s consolidated profit before income taxes.

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

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The Company’s 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.

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

2017 Tax Cuts and Jobs Act:

On December 22, 2017, the Tax Cuts and Jobs Act the (“Act”) was enacted in the United States. The Act reduces the U.S. federal corporate tax rate from a graduated rate of 35% to a flat rate of 21%. Accordingly, in connection with the reduction in the U.S. federal corporate tax rate, we recorded a $10.9 million non-cash charge in order to present our deferred tax attributes at a level reflecting the anticipated future economic benefit we expect to receive upon their reversal.

Additionally, the Act requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. In December 2017, the Securities and Exchange Commission (“SEC”) issued guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”) directing taxpayers to consider the impact of the U.S. legislation as “provisional” when it does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. As of December 31, 2017, the Company has not yet completed its accounting for all of the tax effects of the enactment of the Act, however, the Company has made a reasonable estimate of the effects on our existing deferred tax balances and one-time transition tax. For the year ended December 31, 2017, the Company recognized an additional $266 thousand in taxable income associated with one-time transition tax.

Income tax provision:

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


	Year Ended December 31,
	2017			2016			2015
	(In Thousands)
Current tax expense:
Federal	$	-		$	-		$	-
State		(42	)		185			161
Foreign		347			(9	)		264

		305			176			425
Deferred tax expense (benefit):
Federal		6,825			801			(544	)
State		(1,016	)		344			476
Foreign		-			9			205
Change in valuation allowance		13,526			3,700			3,000

		19,335			4,854			3,137
Unrecognized tax benefit		(25	)		-			(33	)

Income tax provision	$	19,615		$	5,030		$	3,529

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


	Year Ended December 31,
	2017			2016		2015
Domestic	$	(9,971	)	$	399	$	(1,875	)
Foreign		450			1,797		1,344

Income (loss) before income taxes	$	(9,521	)	$	2,196	$	(531	)

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, 2017 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 (loss) income result from the following:


	Year Ended December 31,
	2017						2016					2015
	Amount			Rate			Amount		Rate			Amount			Rate
	(Dollar Amounts In Thousands)
Income tax at statutory rate	$	(3,237	)		34.0	%	$	747		34.0	%	$	(195	)		34.0	%
Add (deduct):
State income taxes, net of federal tax benefit		(859	)		(39.1	)		429		19.6			484			(84.4	)
Tax rate difference on foreign income taxes		46			2.1			17		0.8			(36	)		6.2
Non-deductible items		162			7.4			126		5.7			155			(27.1	)
Increase in valuation allowance against certain deferred tax assets		13,526			615.9			3,700		168.5			3,000			(523.8	)
Unrecognized tax benefits		(25	)		(1.1	)		-		-			(33	)		5.8
Income tax reform impact		10,877			495.3			-		-			-			-
Other, net		(875	)		(39.9	)		11		0.5			154			(27.0	)

	$	19,615			1,074.6	%	$	5,030		229.1	%	$	3,529			(616.3	)%

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, 2017 and 2016 are as follows:


	December 31,
	2017			2016
	(In Thousands)
Deferred income tax assets:
Net operating loss carryforwards and credits	$	14,713		$	16,090
Acquired intangible assets		4,370			6,561
Reserves and accruals		1,984			2,209
Share-based compensation		1,549			2,837
Depreciation		269			395

Total deferred income tax assets		22,885			28,092
Deferred income tax liabilities:
Acquired intangible assets		(780	)		(549	)
Other		(379	)		(312	)

Total deferred income tax liabilities		(1,159	)		(861	)
Valuation allowance		(21,726	)		(8,200	)

Deferred income tax asset, net	$	-		$	19,031

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, 2017, we had gross net operating loss carryforwards for both federal and state income tax purposes of approximately $80.7 million and worker’s opportunity credits of approximately $1.0 million, which expire at various intervals through 2037. However, $36.5 million of the Company’s gross federal net operating loss carryforwards and the $1.0 million of worker’s opportunity tax credits are set to expire in 2020.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting “ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, forfeiture rates, and classification on the statement of cash flows. ASU 2016-09 was effective for fiscal years beginning after December 15, 2016. As a result of adopting FASB ASU 2016-09 in the first quarter of 2017, the Company recorded a cumulative-effect adjustment to retained earnings of $1.4 million to record a net deferred tax asset related to excess equity-based compensation tax deductions relative to these tax attribute carryforwards.

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 $1.6 million which expire at various intervals through 2037.

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


	Year Ended December 31,
	2017		2016		2015
	(In Thousands)
Balance, beginning of year	$	8,200	$	4,500	$	1,500
Additions		13,526		3,700		3,000

Balance, end of year	$	21,726	$	8,200	$	4,500

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,
	2017		2016		2015
	(In Thousands)
Gross unrecognized tax benefits, beginning of year	$	-	$	-	$	9
Increase in tax position in current year		-		-		-
Settlement/Expiration of statute		-		-		-
De-recognition through administrative policy		-		-		(9	)

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

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 loss. There was no accrual for interest and penalties as of December 31, 2017, 2016 and 2015.

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.