Income Taxes

On December 22, 2017, the Tax Act was enacted into law which changed U.S. tax law, including, but not limited to: (1) reducing the U.S. Federal corporate income tax rate from 35% to 21%; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. Federal corporate income taxes on dividends from foreign subsidiaries; (4) capitalizing R&D expenses which are amortized over five to 15 years; and (5) other changes to how foreign and domestic earnings are taxed.

As a result of the Company’s fiscal year being a non-calendar year, the lower U.S. statutory Federal income tax rate resulted in a blended U.S. Federal statutory rate of 26.9% for the Company’s fiscal year 2018. For the year ended July 31, 2018, the Company recognized provisional effects from the Tax Act, which include remeasurements of U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse and recorded a net charge of $35.0 million on Federal net deferred tax assets. In addition, as a result of changes in tax law under the Tax Act, the Company recorded a benefit of $6.1 million related to the change of valuation allowance against certain deferred tax assets that are more likely than not to be realized. The Company concluded that no tax will be due related to the one-time transition tax on the deemed repatriation of deferred foreign income.

The Tax Act includes a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries and a base erosion abuse tax measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. These provisions of the Tax Act will be effective for the Company beginning August 1, 2018. Under U.S. GAAP, the Company can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. The Company has elected the current period expense method. The SEC staff issued Staff Accounting Bulletin No. 118 which provides for a measurement period of up to one year after the enactment date of the Tax Act to finalize the related income tax impacts. The Company expects to complete the accounting for the Tax Act during this measurement period.

The Company’s income before provision for income taxes for the years ended July 31, 2018, 2017 and 2016 is as follows:



	Fiscal years ended July 31,
	2018			2017		2016
	(in thousands)
Domestic	$	(5,207	)	$	26,474	$	11,209
International	5,225			6,803		9,573
Income before provision for income taxes	$	18		$	33,277	$	20,782

The provision for income taxes consisted of the following:



	Fiscal years ended July 31,
	2018			2017			2016
	(in thousands)
Current:
U.S. Federal	$	2,047		$	7,793		$	4,936
State	249			1,974			1,006
Foreign	2,203			3,595			4,350
Total current	4,499			13,362			10,292
Deferred:
U.S. Federal	16,820			(686		)	(4,867		)
State	(1,328		)	(429		)	631
Foreign	(308		)	(194		)	(250		)
Total deferred	15,184			(1,309		)	(4,486		)
Total provision for income taxes	$	19,683		$	12,053		$	5,806

Differences between income taxes calculated using the statutory Federal income tax rate of 26.9% in the fiscal year ended July 31, 2018 and 35% in the fiscal years ended July 31, 2017 and 2016 and the provision for income taxes are as follows:



	Fiscal years ended July 31,
	2018			2017			2016
	(in thousands)
Statutory Federal income tax	$	5		$	11,647		$	7,274
State taxes, net of Federal benefit	(859		)	900			1,261
Share-based compensation	(8,715		)	2,517			2,670
Non-deductible officers' compensation	3,229			959			—
Foreign income taxed at different rates	1,022			(819		)	(1,190		)
Research tax credits	(5,822		)	(2,377		)	(3,827		)
Re-measurement of U.S. deferred taxes	34,979			—			—
Non-deductible acquisition costs	1,270			270			354
Domestic production activity deduction	—			(1,514		)	(1,189		)
Permanent differences and others	666			470			453
Change in valuation allowance	(6,092		)	—			—
Total provision for income taxes	$	19,683		$	12,053		$	5,806

The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities are as follows:



	As of July 31,
	2018		2017
	(in thousands)
Accruals and reserves	$	12,129	$	11,612
Stock-based compensation	7,658		8,519
Deferred revenue	3,688		3,848
Property and equipment	1,268		1,189
Net operating loss carryforwards	53,885		16,720
Tax credits	60,450		11,919
Total deferred tax assets	139,078		53,807
Less valuation allowance	28,310		12,583
Net deferred tax assets	110,768		41,224
Less deferred tax liabilities:
Intangible assets	11,461		3,794
Convertible debt	11,567		—
Unremitted foreign earnings	258		—
Total deferred tax liabilities	23,286		3,794
Deferred tax assets, net	87,482		37,430
Less foreign deferred revenue	69		—
Total net deferred tax assets	$	87,413	$	37,430

The Company adopted ASU 2016-09 effective August 1, 2017 and recorded $85.7 million of deferred tax assets related to excess tax benefits from share-based award activity as of July 31, 2017, which was offset by an increase to the valuation allowance of $0.6 million.

As a result of the Company’s convertible note offering in March 2018, the Company recorded a net deferred tax liability (“DTL”) of $11.7 million. The initial DTL was recorded as a reduction to additional paid in capital.

The Company considered both positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, historic book profit/loss, prior taxable income/loss, and results of future operations, and determined that a valuation allowance was not required for a significant portion of its deferred tax assets. A valuation allowance of $28.3 million and $12.6 million remained as of July 31, 2018 and 2017, respectively. The increase of $15.7 million in valuation allowances in the current year relate primarily to net operating losses and income tax credits incurred in certain tax jurisdictions for which no tax benefit was recognized.

As of July 31, 2018, the Company had U. S. Federal, California and other states net operating loss (“NOL”) carryforwards of $207.0 million, $66.2 million, and $105.7 million, respectively. The U. S. Federal and California NOL carryforwards will start to expire in 2027 and 2019, respectively.

As of July 31, 2018, the Company had research and development tax credit (“R&D credit”) carryforwards of the following (in thousands):



U.S. Federal	$	33,074
California	28,531
Total R&D credit carryforwards	$	61,605

The U.S. Federal R&D credit will start to expire in 2023. California R&D tax credits have no expiration.

Federal and California laws impose restrictions on the utilization of net operating loss carryforwards and R&D credit carryforwards in the event of a change in ownership of the Company, which constitutes an “ownership change” as defined by Internal Revenue Code Sections 382 and 383. The Company experienced an ownership change in the past that does not materially impact the availability of its net operating losses and tax credits. However, should there be an ownership change in the future, the Company’s ability to utilize existing carryforwards could be substantially restricted.

The Company provides U.S. income taxes on the earnings of foreign subsidiaries, unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of July 31, 2018, the Company has recorded a provisional estimate for U.S. income taxes on undistributed earnings from foreign subsidiaries of $0.3 million. The Company may repatriate foreign earnings that have been taxed in the United States in the future to the extent that the repatriation is not restricted by local laws or there are no substantial incremental costs associated with such repatriation.

Unrecognized Tax Benefits

Activity related to unrecognized tax benefits is as follows:



	Fiscal years ended July 31,
	2018			2017			2016
	(in thousands)
Unrecognized tax benefit - beginning of period	$	9,346		$	7,687		$	6,109
Gross increases - prior period tax positions	729			712			177
Gross decreases - prior period tax positions	(878		)	(691		)	(216		)
Gross increases - current period tax positions	1,124			1,638			1,617
Unrecognized tax benefit - end of period	$	10,321		$	9,346		$	7,687

During the year ended July 31, 2018, the Company’s unrecognized tax benefits increased by $1.0 million, primarily associated with the Company’s U.S. Federal and California R&D tax credits. As of July 31, 2018, the Company had unrecognized tax benefits of $5.4 million that, if recognized, would affect the Company’s effective tax rate. An estimate of the range of possible change within the next 12 months cannot be made at this time.

The Company or one of its subsidiaries files income taxes in the U.S. Federal jurisdiction and various state and foreign jurisdictions. If the Company utilizes net operating losses or tax credits in future years, the U.S. Federal, state and local, and non-U.S. tax authorities may examine the tax returns covering the period in which the net operating losses and tax credits arose. As a result, the Company’s tax returns in the U.S. and California remain open to examination from fiscal years 2002 through 2018. As of July 31, 2018, the Company has no income tax audits in progress in the U.S. or foreign jurisdictions.