NOTE 6 — INCOME TAXES

The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.

The following table presents the current and deferred provision (benefit) for income taxes for the years ended December 31 (in thousands):

	2015		2014		2013
Current:
Federal	$	—	$	—	$	(138	)
State		30		27		31
Foreign		87		25		(27	)
		117		52		(134	)
Deferred:
Federal		61		60		72
State		—		—		(118	)
Foreign		—		—		16
		61		60		(30	)
	$	178	$	112	$	(164	)

During the year ended December 31, 2013, the Company reversed certain tax liabilities associated with unrecognized tax benefits related to international operations due to expiring statutes and recognized tax benefits of $138,000 and recognized deferred tax assets related to certain indefinite-lived assets (federal alternative minimum tax credits and California R&D credits) that were used to offset deferred tax liabilities related to indefinite-lived intangible assets of $107,000 resulting in an overall tax benefit of $245,000. Management does not expect to record additional significant tax benefits in the foreseeable future.

The provision for income taxes differs from the amount that would result from applying the federal statutory rate as follows for the years ended December 31:

	2015				2014				2013
Statutory regular federal income tax rate		(34.0	)	%		(34.0	)	%		(34.0	)	%
Change in valuation allowance		40.2		%		37.4		%		27.0		%
Tax return to prior year provision adjustments		—		%		—		%		(0.9	)	%
Reduction of net operating loss attributes		—		%		—		%		(3.1	)	%
State tax benefit (net of federal benefit)		(3.1	)	%		(3.3	)	%		(4.2	)	%
Research credits		(3.1	)	%		(1.9	)	%		(2.1	)	%
Foreign amounts with no tax benefit		0.1		%		(0.1	)	%		(0.2	)	%
Non-deductible expenses		0.4		%		1.0		%		1.6		%
Effect of change in rate		0.9		%		2.3		%		14.2		%
Other		(0.5	)	%		(0.8	)	%		0.3		%
Total		0.9		%		0.6		%		(1.4	)	%

The components of the deferred income tax assets and liabilities as of December 31 (in thousands):

	2015			2014
Capitalized intangible assets for tax purposes	$	104		$	202
Reserves not currently deductible		2,527			1,871
Deferred revenue		8			8
Stock options		4,072			2,911
State taxes		9			8
Income tax credits		2,471			2,200
Inventory		905			1,225
Property and equipment		345			280
Other comprehensive income		320			222
Unrealized gain on foreign currency		136			136
Net operating losses		38,753			33,140
Total deferred tax assets		49,650			42,203
Valuation allowance		(49,514	)		(42,069	)
Net deferred tax assets		136			134
Capitalized intangible assets		(813	)		(752	)
Other		(61	)		(59	)
Total deferred tax liabilities		(874	)		(811	)
Net deferred tax liabilities	$	(738	)	$	(677	)

Based upon the Company’s operating losses incurred for each of three years ended December 31, 2015, and the available evidence, the Company has established a valuation allowance against its net deferred tax assets in the amount of $49.5 million as of December 31, 2015. Management considered factors such as the Company’s earnings history, future projected earnings, and tax planning strategies. If sufficient evidence of the Company’s ability to generate sufficient future taxable income tax benefits becomes apparent, the valuation allowance may be reduced, thereby resulting in tax benefits in the statement of operations and additional paid-in-capital. Management evaluates the potential realization of the Company’s deferred tax assets and assesses the need for reducing the valuation allowance periodically.

As of December 31, 2015, the Company had net operating loss (“NOL”) carryforwards for federal and state purposes of approximately $109.5 million and $71.8 million, respectively, which expire in 2018 through 2035. The utilization of NOL and credit carryforwards may be limited under the provisions of the Internal Revenue Code (“IRC”) Section 382 and similar state provisions. IRC Section 382 generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income where a corporation has undergone significant changes in stock ownership. As of December 31, 2015, the Company had research and development tax credit carryforwards for federal and state purposes of approximately $1.6 million and $1.2 million, respectively, which will begin to expire in 2018 through 2035 for federal purposes and will carry forward indefinitely for state purposes. An updated analysis may be required at the time the Company begins utilizing any of its net operating losses to determine if there is an IRC Section 382 limitation.

In addition to the NOL carryforwards included in the deferred tax asset and liability schedule are excess tax deductions relating to stock options that have not been realized. When the benefit of the NOLs containing these excess tax deductions are realized, the benefit will not affect earnings, but rather additional paid-in-capital. As of December 31, 2015 and 2014, the cumulative unrealized excess tax deductions amounted to approximately $6.9 million. These amounts have been excluded from the Company’s NOL carryforwards. To the extent that such excess tax deductions are realized in the future by virtue of reducing income taxes payable, the Company would expect additional paid-in-capital to increase by approximately $2.6 million for the years ended December 31, 2015 and 2014. The Company follows the appropriate ordering rules to determine when such NOLs have been realized.

Recently enacted tax laws may also affect the tax provision on the Company’s financial statements. The state of California requires the use of a single sales factor apportionment formula for tax years beginning on or after January 1, 2013. During the year ended December 31, 2013, the Company’s state deferred tax assets were revalued to account for the change in the tax law; however, the Company records a full valuation allowance against the state deferred tax assets therefore the California apportionment mandate did not have a material impact on the Company’s consolidated financial statements.

The following table summarizes the activity related to the Company’s unrecognized tax benefits during the year ended December 31, 2015 (in thousands):

Balance at January 1, 2015	$	568
Additions for tax positions related to the prior year		—
Lapse of statute of limitations		—
Balance at December 31, 2015	$	568

The Company expects resolution of unrecognized tax benefits, if created, would occur while the full valuation allowance of deferred tax assets is maintained. The Company does not expect to have any unrecognized tax benefits that, if recognized, would affect the effective tax rate. As of December 31, 2015 and 2014, the Company does not have liability for potential penalties or interest. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months.

The Company files U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2011 through 2015 tax years generally remain subject to examination by federal and most state tax authorities. In foreign jurisdictions, the 2009 through 2015 tax years remain subject to examination by their respective tax authorities.

U.S. income taxes or withholding taxes were provided for all the distributed earnings for the Company’s foreign subsidiaries as of December 31, 2015. There were no undistributed earnings from foreign subsidiaries as of December 31, 2015 or 2014. The Company intends to reinvest any earnings until such time a decision is made to liquidate the foreign operations.