Income Taxes

The domestic and international components of income before income tax for the fiscal years ended November 1, 2014, October 26, 2013, and October 27, 2012, are presented as follows (in thousands):



	Fiscal Year Ended
	November 1, 2014		October 26, 2013		October 27, 2012
United States	$	192,730	$	176,536	$	115,736
International	160,891		153,925		108,665
Total	$	353,621	$	330,461	$	224,401

The income tax expense (benefit) for the fiscal years ended November 1, 2014, October 26, 2013, and October 27, 2012, consisted of the following (in thousands):



	Fiscal Year Ended
	November 1, 2014			October 26, 2013			October 27, 2012
U.S. federal taxes:
Current	$	61,666		$	(13,666	)	$	(11,750	)
Deferred	33,065			46,313			33,981
Total U.S. federal taxes	94,731			32,647			22,231
State taxes:
Current	16,597			8,091			613
Deferred	(2,599		)	78,106			(2,412		)
Total state taxes	13,998			86,197			(1,799		)
Non-U.S. taxes:
Current	6,655			2,837			8,770
Deferred	266			157			18
Total non-U.S. taxes	6,921			2,994			8,788
Total	$	115,650		$	121,838		$	29,220

The difference between the U.S. Federal statutory income tax rate and the Company’s effective tax rate for fiscal years ended November 1, 2014, October 26, 2013, and October 27, 2012, consisted of the following:



	Fiscal Year Ended
	November 1, 2014		October 26, 2013		October 27, 2012
U.S. Federal statutory income tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal tax benefit	3.1		4.1		3.8
Foreign income taxed at other than U.S. rates	(16.9	)	(17.6	)	(17.7	)
Stock-based compensation	2.3		1.9		3.5
Research and development credit	(3.1	)	(5.6	)	(3.5	)
Permanent items	0.3		0.3		0.3
Change in liabilities for uncertain tax positions	0.5		(5.1	)	(6.5	)
Goodwill impairment charge	8.3		—		—
Audit settlement and reinstated tax credit	0.1		1.3		(2.9	)
Change in valuation allowance	1.6		23.7		—
Other	1.5		(1.1	)	1.0
Effective tax rate	32.7	%	36.9	%	13.0	%

In general, the Company’s provision for income taxes differs from the tax computed at the U.S. Federal statutory tax rate of 35% due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and goodwill impairment charge, and adjustments to unrecognized tax benefits.

The effective tax rate in fiscal year 2014 is lower than the 35% U.S. Federal statutory rate primarily due to earnings in our subsidiaries outside of the U.S. in jurisdictions where our effective tax rate is lower than in the United States, and a discrete benefit from release of tax reserves due to expired statute of limitations, partially offset by an increase in certain unrecognized tax benefits. In addition, the effective tax rate for fiscal year 2014 was negatively impacted by a goodwill impairment charge of $83.4 million, which is nondeductible for tax purposes, and a lower benefit from the federal research and development tax credit which expired on December 31, 2013, and, therefore, was not applicable in calendar year 2014.

The effective tax rate in fiscal year 2013 is higher than the 35% U.S. Federal statutory rate, and the effective tax rate for fiscal years 2014 and 2012 are lower compared to the same period in fiscal year 2013, primarily due to a discrete charge of $78.2 million in fiscal year 2013 to reduce previously recognized California deferred tax assets due to changes in California law resulting from the passage of Proposition 39 during fiscal year 2013.

As of November 1, 2014, U.S. Federal income taxes and foreign withholding taxes were not provided for on an estimated cumulative total of $686.6 million of undistributed earnings of the Company’s foreign subsidiaries. The Company intends to reinvest current and accumulated earnings of its foreign subsidiaries for expansion of its business operations outside the United States for an indefinite period of time. Our existing cash, cash equivalents, and short-term investments totaled $1,255.0 million as of November 1, 2014. Of this amount, approximately 61% was held by our foreign subsidiaries. If these earnings were distributed to the United States in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, the Company could be subject to additional U.S. income taxes, net of foreign tax credits, and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

The components of deferred tax assets and deferred tax liabilities for the fiscal years ended November 1, 2014, and October 26, 2013, are presented as follows (in thousands):



	November 1, 2014			October 26, 2013
Net operating loss carryforwards	$	8,679		$	10,525
Stock-based compensation expense	14,202			17,664
Tax credit carryforwards	84,930			141,975
Reserves and accruals	101,301			63,765
Capitalized research and development expenditures	183			621
Net unrealized losses on investments	370			396
Gross deferred tax assets	209,665			234,946
Less: Valuation allowance	(83,489		)	(81,116		)
Total deferred tax assets	126,176			153,830
Acquired intangibles and goodwill	(15,433		)	(22,307		)
Fixed assets	(31,231		)	(29,878		)
Other	(13,368		)	(2,042		)
Total deferred tax liabilities	(60,032		)	(54,227		)
Total net deferred tax assets	$	66,144		$	99,603

As of November 1, 2014, the Company believes that sufficient positive evidence exists from historical operations and projections of taxable income in future years to conclude that it is more likely than not that the Company will realize its deferred tax assets except for California deferred tax assets and capital loss carryforwards. Accordingly, the Company applies a valuation allowance to the California deferred tax assets due to the change in California law that occurred in November 2012, and to capital loss carryforwards due to the limited carryforward periods of these tax assets.

As of November 1, 2014, the Company had federal net operating loss carryforwards of $152.0 million, California state net operating loss carryforwards of $51.6 million and other significant state net operating loss carryforwards of approximately $143.4 million. Additionally, the Company had federal tax credit carryforwards of $156.7 million and state tax credit carryforwards of $177.3 million. The federal net operating loss and tax credit carryforwards expire on various dates between fiscal year 2017 through 2034. The state net operating loss and credit carryforwards expire on various dates between fiscal year 2015 through 2032. The federal net operating loss carryforwards and federal tax credit carryforwards include excess tax deductions related to stock-based compensation. Under the current tax law, net operating loss and credit carryforwards available to offset future income in any given year may be limited by statute or upon the occurrence of certain events, including significant changes in ownership interests. As a result of the McDATA, Foundry, and other acquisitions, all of the tax attributes from these companies are subject to an annual limitation, but the Company expects to use a majority of the tax attributes before expiration.

The Company applies a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation process. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority.

A reconciliation of the beginning and ending amount of total gross unrecognized tax benefits, excluding accrued net interest and penalties, is as follows (in thousands):



	November 1, 2014			October 26, 2013
Unrecognized tax benefits, beginning balance	$	112,479		$	119,253
Gross increases for tax positions taken in prior periods	3,325			3,472
Gross decreases for tax positions taken in prior periods	(4,784		)	(12,970		)
Gross increases for tax positions taken in current period	15,426			14,875
Changes due to settlements with taxing authorities	—			(9,442		)
Reductions resulting from lapses of statutes of limitations	(6,831		)	(2,709		)
Unrecognized tax benefits, ending balance	$	119,615		$	112,479

As of November 1, 2014, the Company had net unrecognized tax benefits of $82.4 million, all of which, if recognized, would result in a reduction of the Company’s effective tax rate.

The IRS and other tax authorities regularly examine the Company’s income tax returns. In November 2011, the Company was notified by the IRS that the Company’s domestic federal income tax return for the fiscal years ended October 25, 2009 and October 26, 2010, were subject to audit. In October 2014, the IRS issued a Revenue Agent’s Report related to its field examination of the Company’s federal income tax return for the fiscal years 2009 and 2010. The IRS is contesting the Company’s transfer pricing for the cost sharing and buy-in arrangements with its foreign subsidiaries. On November 3, 2014, subsequent to the end of fiscal year 2014, the Company filed a protest to challenge the proposed adjustment and to move the issue to Appeals. In addition, we are in negotiations with Switzerland tax authorities to obtain correlative relief on transfer pricing adjustments previously settled with the IRS. In October 2014, the Geneva Tax Administration issued its final assessments for fiscal years 2003 to 2012. The Geneva Tax Administration is contesting the inter-cantonal transfer pricing methods for the fiscal years 2009 to 2012. In November 2014, subsequent to the end of fiscal year 2014, the Company filed a protest with the Geneva Tax Administration to challenge its final assessment. The Company believes its reserves are adequate to cover any potential assessments that may result from the examination and negotiation. However, given the unpredictable nature of the appeals and negotiation process, it is reasonably possible that our unrecognized tax benefits related to these tax positions could change within the next twelve months. The Company is unable to estimate the range of this possible change.

The Company believes that reserves for unrecognized tax benefits are adequate for all open tax years. The timing of income tax examinations, as well as the amounts and timing of related settlements, if any, are highly uncertain. The Company believes that before the end of fiscal year 2014, it is reasonably possible that either certain audits will conclude or the statutes of limitations relating to certain income tax examination periods will expire, or both. After the Company reaches settlement with the tax authorities, the Company expects to record a corresponding adjustment to our unrecognized tax benefits. Taking into consideration the inherent uncertainty as to settlement terms, the timing of payments, and the impact of such settlements on other uncertain tax positions, the Company estimates the range of potential decreases in underlying uncertain tax positions is between $0 and $4.0 million in the next 12 months.

The Company classifies interest and penalties related to unrecognized tax benefits (detriments) as a component of income tax expense. During the fiscal year ended November 1, 2014, the Company expensed $(0.1) million for net interest and penalties related to income tax liabilities through income tax expense. The total net interest and penalties accrued as of November 1, 2014, was $2.3 million. During the fiscal year ended October 26, 2013, the Company expensed $0.6 million for net interest and penalties related to income tax liabilities through income tax expense. The total net interest and penalties accrued as of October 26, 2013, was $2.3 million.

Of the total tax benefits (detriments) resulting from the exercise of employee stock options and employee participation in the Company’s equity compensation plans, the amounts recorded to stockholders’ equity were approximately $59.9 million benefit in fiscal year 2014, $(1.5) million in fiscal year 2013, and $(4.8) million in fiscal year 2012.