Income Taxes

Income before income taxes included the following components for the years ended December 31 (in thousands):



	2016			2015			2014
United States	$	38,414		$	42,761		$	32,751
Foreign	(6,917		)	(7,400		)	(440		)
Total	$	31,497		$	35,361		$	32,311

Significant components of the Company’s deferred income tax assets and liabilities are as follows at December 31 (in thousands):



	2016			2015
Deferred income tax assets:
Net operating loss carryforward	$	2,405		$	649
Deferred revenue	11,537			6,762
Deferred compensation	1,695			1,252
Inventory reserve	1,126			956
Non-qualified and non-employee stock option expense	4,410			3,393
Capitalized research and development	1,991			3,348
Research and development tax credit carryforward	2,722			2,386
Reserves, accruals, and other	1,239			1,067
Total deferred income tax assets	27,125			19,813
Deferred income tax liabilities:
Depreciation	(2,364		)	(2,228		)
Amortization	(1,473		)	(1,979		)
Other	(294		)	(187		)
Total deferred income tax liabilities	(4,131		)	(4,394		)
Net deferred income tax assets before valuation allowance	22,994			15,419
Valuation allowance	(3,479		)	(1,700		)
Net deferred income tax assets	$	19,515		$	13,719

For the years ended December 31, 2016, 2015 and 2014 the provision for income taxes includes $1.4 million, $6.9 million and $8.0 million, respectively, of tax expense resulting from stock-based compensation tax benefits that have been recorded as increases to additional paid-in capital on the consolidated statement of changes in stockholders’ equity.

The Company has $1.8 million of state net operating losses ("NOLs") which expire at various dates between 2029 and 2034. The Company also has Federal NOLs of $0.9 million which expire between 2032 and 2034, and are subject to limitation under IRC Section 382. The Company has $43,000 of federal research and development ("R&D") credits which expire in 2022 and 2023, and are also subject to limitation under IRC Section 382. The Company has $6.4 million of Arizona R&D credits carrying forward, which expire at various dates between 2018 and 2032, In Australia, the UK, Canada, and Germany, the Company has $1.5 million, $5.5 million, $0.7 million, and $1.1 million of NOLs, respectively, which expire at various dates or may be carried forward indefinitely.

In preparing the Company’s consolidated financial statements, management has assessed the likelihood that deferred income tax assets will be realized from future taxable income. In evaluating the ability to recover its deferred income tax assets, management considers all available evidence, positive and negative; including the Company’s operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred income tax assets will not be realized. Management exercises significant judgment in determining the Company’s provisions for income taxes, its deferred income tax assets and liabilities and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred income tax assets.

Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As of each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regards to future realization of deferred tax assets. As of December 31, 2016, the Company continues to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions; however, the Arizona R&D Tax Credits start to expire in 2018 with a significant tranche with a gross value of $1.2 million expiring in 2019. Under the Company’s new structure, it appears that long term investments which impact short term profits will likely result in some of the R&D credits expiring before they are utilized. Therefore, management has concluded that it is more likely than not that a portion of the Company’s U.S. deferred tax assets will not be realized.

As of December 31, 2016, the Company has cumulative losses in Australia, the UK, Canada, and Germany, which limits the ability to consider other subjective evidence, such as projections for future growth. On the basis of this evaluation, a full valuation allowance has been recorded for these jurisdictions. The amount of the deferred tax asset considered realizable, however, could be adjusted if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as projections for growth.

Significant components of the provision for income taxes are as follows for the years ended December 31 (in thousands)



	2016			2015			2014
Current:
Federal	$	16,346		$	13,594		$	7,793
State	1,534			996			800
Foreign	1,050			—			—
Total current	18,930			14,590			8,593
Deferred:
Federal	(4,145		)	288			2,656
State	(977		)	984			942
Foreign	(45		)	(278		)	—
Total deferred	(5,167		)	994			3,598
Tax provision recorded as an increase (decrease) in liability for unrecorded tax benefits	437			(156		)	202
Provision for income taxes	$	14,200		$	15,428		$	12,393

A reconciliation of the Company’s effective income tax rate to the federal statutory rate follows for the years ended December 31 (in thousands):



	2016			2015			2014
Federal income tax at the statutory rate	$	11,024		$	12,347		$	11,236
State income taxes, net of federal benefit	889			1,061			1,433
Difference between statutory and foreign tax rates ⁽ⁱ⁾	1,521			2,442			—
Permanent differences ⁽ⁱⁱ⁾	(457		)	(205		)	98
Research and development	(1,928		)	(1,050		)	(452		)
Return to provision adjustment	327			(67		)	28
Change in liability for unrecognized tax benefits	700			(156		)	202
Incentive stock option benefit	(77		)	(144		)	(616		)
Change in valuation allowance	1,779			1,200			500
Tax effects of intercompany transactions	630			—			—
Other	(208		)	—			(36		)
Provision for income taxes	$	14,200		$	15,428		$	12,393
Effective tax rate	45.1		%	43.6		%	38.4		%


⁽ⁱ⁾	The difference between statutory and foreign tax rates of $1.5 million was largely driven by losses incurred in a foreign entity for which no tax benefit will be realized, partially reduced by a tax benefit for foreign entities for which the statutory tax rate is lower than the U.S. statutory tax rate.


⁽ⁱⁱ⁾	Permanent differences include certain expenses that are not deductible for tax purposes including lobbying fees as well as favorable items including the domestic production activities deduction.

The Company has completed research and development tax credit studies which identified approximately $14.1 million in tax credits for federal, Arizona and California income tax purposes related to the 2003 through 2016 tax years. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credit will not be sustained on examination and recorded a liability for unrecognized tax benefits of $3.9 million as of December 31, 2016. In addition, management accrued approximately $0.2 million for estimated uncertain tax positions related to certain state income tax liabilities. Should the unrecognized tax benefit of $4.1 million be recognized, the Company’s effective tax rate would be favorably impacted.

The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying Consolidated Statement of Operations. As of December 31, 2016 and 2015, respectively, the Company had accrued interest of $98,000 and $55,000.

The following table presents a roll forward of the Company's liability for unrecognized tax benefits, exclusive of accrued interest, as of December 31 (in thousands):



	2016		2015			2014
Balance, beginning of period	$	3,396	$	3,325		$	3,110
Decrease in previous year tax positions	—		(389		)	—
Increase in current year tax positions	448		270			121
Decrease due to lapse of statute of limitations	—		(14		)	—
Increase related to adjustment of previous estimates of activity	206		204			94
Balance, end of period	$	4,050	$	3,396		$	3,325

Federal income tax returns for 2004 through 2016 remain open to examination by the U.S. Internal Revenue Service (the “IRS”), while state and local income tax returns for 2004 through 2016 also remain open to examination by state taxing authorities. The 2004 through 2011 income tax returns are only open to the extent that net operating loss or other tax attributes carrying forward from those years were utilized in 2012 through 2016. The foreign tax returns for 2013 through 2016 also remain open to examination. The Company has not been notified by any major federal, foreign, or state tax jurisdictions that it will be subject to examination.

The Company considers the earnings of certain non-U.S. subsidiaries to be indefinitely reinvested outside of the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash needs and the Company's specific plans for reinvestment of those subsidiary earnings. It is not practicable to estimate the amount of the deferred tax liability, if any, related to investments in those foreign subsidiaries. If the Company decides to repatriate the foreign earnings, it would need to adjust its income tax provision in the period it determined that the earnings will no longer be indefinitely invested outside the United States.