Income Taxes

In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017. The 2017 Tax Act also provides for a one-time transition tax on certain foreign earnings and the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes beginning in 2018, including repeal of the domestic manufacturing deduction, acceleration of tax revenue recognition, capitalization of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility of interest.

The Company recognized the income tax effects of the 2017 Tax Act in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law. As such, the Company’s financial results reflect the income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined.

The changes to existing U.S. tax laws as a result of the 2017 Tax Act, which we believe have the most significant impact on the Company’s federal income taxes are as follows:

Reduction of the U.S. Corporate Income Tax Rate

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, resulting in a $33.1 million increase in income tax expense for the year ended December 31, 2017 and a corresponding $33.1 million decrease in gross deferred tax assets as of December 31, 2017. These adjustments were offset with a $33.1 million corresponding adjustment to the valuation allowance.

Transition Tax on Foreign Earnings

The Company recognized a provisional income tax expense of $1.3 million for the year ended December 31, 2017 related to the one-time transition tax on certain foreign earnings. This resulted in a corresponding decrease in deferred tax assets due to the utilization of net operating loss carryforwards. The determination of the transition tax requires further analysis regarding the amount and composition of the Company’s historical foreign earnings, which is expected to be completed in 2018.

Domestic and foreign pre-tax income (loss) is as follows (in thousands):



	For the Years Ended December 31,
	2017			2016			2015
Domestic	$	(53,958	)	$	(12,040	)	$	(15,822	)
Foreign	5,081			4,223			2,886
Total pre-tax loss	$	(48,877	)	$	(7,817	)	$	(12,936	)

The income tax provision consists of the following (in thousands):



	For the Years Ended December 31,
	2017			2016			2015
Current provision:
Federal	$	—		$	—		$	—
State	73			78			30
Foreign	3,692			2,225			1,772
Total current provision	3,765			2,303			1,802
Deferred provision (benefit):
Federal	(309		)	(86		)	35
State	(10		)	(4		)	2
Foreign	281			221			(97		)
Total deferred provision	(38		)	131			(60		)
Total income tax provision	$	3,727		$	2,434		$	1,742

The income tax provision (benefit) differs from the amount computed by applying the statutory federal income tax rate to pretax income as a result of the following differences (dollar amounts in thousands):



	For the Years Ended December 31,
	2017					2016					2015
	$			%		$			%		$			%
Statutory federal tax (benefit) rate	$	(17,107	)	35.0	%	$	(2,736	)	35.0	%	$	(4,526	)	35.0	%
Increase (decrease) in rates resulting from:
State taxes	(749		)	1.5		(67		)	0.9		609			(4.7	)
Foreign dividends and unremitted earnings	(638		)	1.3		1,745			(22.3	)	1,493			(11.5	)
Impact from U.S. tax reform	36,311			(74.3	)	—			—		—			—
Tax audit settlement	1,497			(3.1	)	—			—		—			—
Valuation allowance	(16,363		)	33.5		1,596			(20.4	)	2,456			(19.0	)
Taxes on foreign income that differ from U.S. tax rate	(1,361		)	2.8		(901		)	11.5		(405		)	3.1
Executive Compensation limitation	17			—		1,005			(12.9	)	—			—
Non-deductible stock-based compensation expense	567			(1.2	)	135			(1.7	)	1,104			(8.5	)
Expiration of attributes	1,397			(2.9	)	1,478			(18.9	)	893			(6.9	)
Uncertain tax positions	302			(0.6	)	120			(1.5	)	435			(3.4	)
Other	(146		)	0.4		59			(0.8	)	(317		)	2.4
Effective tax rate	$	3,727		(7.6	)%	$	2,434		(31.1	)%	$	1,742		(13.5	)%

The components of deferred taxes consist of the following (in thousands):



	December 31, 2017			December 31, 2016
Deferred tax assets:
Accrued warranty	$	256		$	657
Inventory	6,114			3,631
Net operating loss carryforwards	39,534			57,294
Tax credit carryforwards	20,857			22,075
Stock-based compensation	978			1,995
Fixed assets	2,358			1,808
Goodwill and other identified intangibles	1,073			1,603
Deferred revenue	1,201			2,906
Subsidiary service accruals	4,870			1,702
Other	1,308			2,082
Total deferred tax assets	78,549			95,753
Less: valuation allowance	(77,437		)	(88,566		)
Net deferred tax assets	1,112			7,187
Deferred tax liabilities:
Intangible assets	—			(5,603		)
Other	(325		)	(467		)
Total deferred tax liabilities	(325		)	(6,070		)
Total net deferred tax assets	$	787		$	1,117

At December 31, 2017, the Company's unrecognized tax benefits associated with uncertain tax positions were $4.6 million, of which $4.4 million, if recognized, would favorably affect the effective tax rate.

The Company's ongoing practice is to recognize potential accrued interest and penalties related to unrecognized tax benefits within its global operations in income tax expense. During 2017, the Company recognized a net increase of approximately $0.2 million in potential interest and penalties associated with uncertain tax positions in the Consolidated Statements of Operations. The Company had approximately $1.0 million and $0.2 million of interest and penalties associated with uncertain tax positions at December 31, 2017, which are excluded from the unrecognized tax benefits table below.

The Company’s total amounts of unrecognized tax benefits at the beginning and end of the period are as follows (in thousands):



	Total
Balance as of December 31, 2015	$	3,680
Additions based on tax positions related to the current year	245
Additions for tax positions of prior years	24
Reductions for tax positions of prior years	(240		)
Reductions as a result of a lapse of applicable statute of limitations	(80		)
Reductions due to settlements	(6		)
Other	$	(74	)
Balance as of December 31, 2016	$	3,549
Additions based on tax positions related to the current year	1,124
Additions for tax positions of prior years	146
Reductions for tax positions of prior years	(278		)
Reductions as a result of a lapse of applicable statute of limitations	(56		)
Other	97
Balance as of December 31, 2017	$	4,582

The Company and its subsidiaries are subject to federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company's statutes of limitations are closed for all federal and state income tax years before 2014 and 2013 respectively. The statutes of limitations for the Company's other foreign subsidiaries are closed for all income tax years before 2005.

However, to the extent allowed by law, the taxing authorities may have the right to examine prior periods where net operating losses and credits were generated and carried forward, and make adjustments up to the net operating loss and credit carryforward amounts. It is reasonably possible that the Company's uncertain tax positions, including interest and penalties, could decrease by approximately $0.4 million in the next twelve months.

The Company is currently under tax examination in India and Canada. The periods under examination in India are the Company's financial years 2005, 2006, 2008 and 2011. The examinations are in various stages of appellate proceedings and all material uncertain tax positions associated with the examination have been taken into account in the ending balance of the unrecognized tax benefits at December 31, 2017. The periods under examination in Canada are the Company's fiscal years 2013 and 2014. The Company reduced its Canadian tax attribute carryforwards and valuation allowance by $1.5 million as a settlement position related to a proposed adjustment by the Canada Revenue Agency.

The Company had recorded valuation allowances of $77.4 million and $88.6 million as of December 31, 2017 and 2016. This represents a full valuation allowance against the Company's U.S. net deferred tax assets as well as a partial valuation allowance against the Company's Canadian and Chinese net deferred tax assets. In evaluating its valuation allowance, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance.

At December 31, 2017 the Company had total available federal and state net operating loss carryforwards of approximately $178.3 million and $51.5 million. The federal and state net operating loss carryforwards expire between 2018 and 2037. The net operating losses from acquisitions are stated net of limitations pursuant to Section 382 of the Internal Revenue Code. The Company also had net operating loss carryforwards of approximately $3.4 million from the United Kingdom (“U.K.”), and China. The U.K. net operating losses may be carried forward indefinitely provided certain requirements are met. The Chinese tax losses may be carried forward 5 years.

The Company had federal and California research and development tax credit and other federal credit carryforwards of approximately $15.3 million at December 31, 2017, to reduce future income tax liabilities. The federal credits expire between 2018 and 2031. The California research and development credits do not expire. The credits from acquisitions are stated net of limitations pursuant to Section 383 of the Internal Revenue Code. The Company's Canadian subsidiary also had approximately $2.8 million in investment tax credit and, $16.9 million of unclaimed scientific research and experimental expenditures to be carried forward and applied against future income in Canada.

Realization of the Company's foreign deferred tax assets is dependent on generating sufficient taxable income prior to the expiration of the net operating loss and tax credit carryforwards. Although realization is not assured, management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the balance of the deferred tax assets, net of the valuation allowance, as of December 31, 2017. The amount of the net deferred tax assets that is considered realizable, however, could be reduced if estimates of future taxable income during the carryforward periods are reduced. Should management determine that the Company would not be able to realize all or part of the net deferred tax assets in the future, adjustments to the valuation allowance for deferred tax assets may be required.

In connection with the implementation of the Tax Cuts and Jobs Act, the Company had changed its indefinite reinvestment assertion and is now fully providing on the unremitted earnings of its foreign subsidiaries.

In March 2016, FASB issued Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Shared-Based Payment Accounting (''ASU 2016-09''). ASU 2016-09 simplifies how several aspects of share-based payments are accounted for and presented in the financial statements. ASU 2016-09 is effective for public companies for annual reporting periods beginning after December 15, 2016. The Company adopted this ASU in the first quarter of 2017. The Company had excess tax benefits for which a benefit could not be previously recognized of approximately $4.3 million. Due to the full valuation allowance against the net U.S. deferred tax assets, the Company did not recognize a net cumulative-effect adjustment to retained earnings upon adoption.

In October 2016, the FASB issued Accounting standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (''ASU 2016-16''). ASU 2016-16 modifies how intra-entity transfer of assets other than inventory are accounted for and presented in the financial statements. ASU 2016-16 is effective for public companies for annual reporting periods beginning after December 15, 2017, however early adoption is allowed. The Company adopted this ASU in the first quarter of 2017. The Company recorded a $2.0 million cumulative-effect adjustment to retained earnings upon adoption.