. INCOME TAXES

The components of income before income taxes are as follows (in thousands):

	Year Ended December 31,
	2016			2015			2014
United States	$	(14,431	)	$	(247	)	$	3,173
International		71,695			42,738			33,219
Total income before income taxes	$	57,264		$	42,491		$	36,392

Management’s intent is to indefinitely reinvest any undistributed earnings from its foreign subsidiaries. Accordingly,

provision for Federal and state income or foreign withholding taxes has been provided thereon, nor is it practical to determine the amount of this liability. Upon distribution of those earnings in the form of dividends or otherwise, the Company will be subject to U.S. income taxes and potential foreign withholding taxes. As of

December

31,

2016

and

2015,

the unremitted earnings of foreign subsidiaries were

$284.8

million and

$214.3

million, respectively. The Company has sufficient cash reserves in the U.S. and intends to use the undistributed foreign earnings to fund foreign operations and research and development needs, planned capital outlay and expansion.

The components of the income tax provision are as follows (in thousands):

	Year Ended December 31,
	2016		2015		2014
Current:
Federal	$	2,527	$	6,042	$	18
State		-		2		(28	)
Foreign		2,013		1,213		943
Deferred:
Foreign		4		62		(36	)
Total income tax provision	$	4,544	$	7,319	$	897

The effective tax rate differs from the applicable U.S. statutory federal income tax rate as follows:

	Year Ended December 31,
	2016			2015			2014
U.S. statutory federal tax rate		34.0	%		34.0	%		34.0	%
Settlement with tax authorities		-			6.2			-
Foreign income at lower rates		(41.1	)		(43.1	)		(27.7	)
Changes in valuation allowance		11.0			17.6			5.9
Stock-based compensation		2.2			-			(9.3	)
Reserves and other		1.8			2.5			(0.4	)
Effective tax rate		7.9	%		17.2	%		2.5	%

The components of net deferred tax assets consist of the following (in thousands):

	December 31,
	2016			2015
Deferred tax assets:
Research tax credits	$	9,817		$	8,869
Deferred compensation		6,752			5,038
Stock-based compensation		7,283			1,912
Other expenses not currently deductible		3,974			3,519
Depreciation and amortization		161			(52	)
Total deferred tax assets		27,987			19,286
Valuation allowance		(27,354	)		(18,614	)
Net deferred tax assets	$	633		$	672

As a result of the cost sharing arrangements with the Company’s international subsidiaries (cost share arrangements), relatively small changes in costs that are not subject to sharing under the cost share arrangements can significantly impact the overall profitability of the U.S. entity. Because of the U.S. entity’s inconsistent earnings history and uncertainty of future earnings, the Company has determined that it is more likely than not that the U.S. deferred tax benefits would not be realized. The Company will continue to evaluate if its facts and circumstances warrant a reversal of the valuation allowance against the U.S. deferred tax benefits in future periods.

As of

December

31,

2016

and

2015,

the Company had a valuation allowance of

$27.4

million and

$18.6

million, respectively, attributable to management’s determination that it is more likely than not that most of the deferred tax assets in the U.S. will not be realized. Should it be determined that additional amounts of the net deferred tax asset will not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance will be charged to income in the period such determination is made. Likewise, in the event the Company were to determine that it is more likely than not that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would increase income in the period such determination was made.

As of

December

31,

2016,

the Company did not have federal net operating loss carryforwards. As of

December

31,

2016,

the state net operating loss carryforwards for income tax purposes were approximately

$20.3

million, which will expire beginning in

2017.

$20.3

million of the state net operating loss carryforwards were related to excess tax benefits as a result of stock option exercises and RSU releases and therefore was recorded in additional paid-in-capital in the period that they became realized. The Company has elected to follow the “with and without” approach to account for excess tax benefits from stock options exercises and RSU releases. In addition, the Company only considered the direct effects of stock option exercises and RSU releases when calculating the amount of windfalls or shortfalls.

As of

December

31,

2016,

the Company had research tax credit carryforwards of

$17.8

million for federal income tax purposes, which will begin to expire in

2026,

and

$18.3

million for state income tax purposes, which can be carried forward indefinitely.

$8.1

million of the federal research tax credit and

$1.8

million of the state research tax credit carryforwards were related to excess tax benefits as a result of stock option exercises and RSU releases and therefore were recorded in additional paid-in-capital in the period that they became realized.

Upon adoption of ASU No.

2016

January

2017,

all excess tax benefits and deficiencies related to equity awards will be recognized in the income tax provision in the Consolidated Statements of Operations prospectively, rather than in additional paid-in-capital in the Consolidated Balance Sheets. In addition, the standard eliminates the requirement to defer recognition of excess tax benefits until they are realized through a reduction to income taxes payable.

The Company applied the modified retrospective method and there was no adjustment to retained earnings as of

January

2017,

as the deferred tax assets would be fully offset by a valuation allowance. The Company expects increased volatility to the income tax provision in future periods dependent upon, among other variables, the price of its common stock and the timing and volume of equity award vesting.

In the event of a change in ownership, as defined under federal and state tax laws, the Company's net operating loss and tax credit carryforwards could be subject to annual limitations. The annual limitations could result in the expiration of the net operating loss and tax credit carryforwards prior to utilization.

The Protecting Americans from Tax Hikes (“PATH”) Act of

2015

permanently extends the R&D credit retroactively as of

January

2015.

The Company had an increase to its federal R&D credits of approximately

$2.2

million for qualifying amounts incurred in

2016.

However, due to the Company’s current valuation allowance position, the credit did not result in a tax benefit.

July

27,

2015,

Altera Corp. v. Commissioner

, the U.S. Tax Court issued an opinion related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision was issued in

December

2015,

and the IRS appealed the decision in

February

2016.

At this time, the U.S. Department of the Treasury has not withdrawn the requirement from its regulations to include stock-based compensation. Due to the uncertainty surrounding the status of the current regulations, questions related to the scope of potential benefits, and the risk of the Tax Court’s decision being overturned upon appeal, the Company has not recorded any adjustments as of

December

31,

2016.

The Company will continue to monitor developments related to this opinion and the potential impact on its financial statements.

December

31,

2016,

the Company had

$14.4

million of unrecognized tax benefits,

$3.5

million of which would affect its effective tax rate if recognized after considering the valuation allowance. At

December

31,

2015,

the Company had

$12.1

million of unrecognized tax benefits,

$2.7

million of which would affect its effective tax rate if recognized after considering the valuation allowance.

A reconciliation of the gross unrecognized tax benefits is as follows (in thousands):

Balance as at January 1, 2014	$	14,922
Increase for tax position of prior year		584
Increase for tax position of current year		1,760
Decrease due to lapse of statue of limitation		(860	)
Balance as of December 31, 2014		16,406
Increase for tax position of current year		1,964
Decrease related to settlement with tax authorities		(4,162	)
Decrease due to lapse of statue of limitation		(669	)
Decrease for tax position of prior year		(1,446	)
Balance as of December 31, 2015		12,093
Increase for tax position of prior year		243
Increase for tax position of current year		2,095
Balance as of December 31, 2016	$	14,431

The Company recognizes interest and penalties, if any, related to uncertain tax positions in its income tax provision. As of

December

31,

2016

and

2015,

the Company has approximately

$0.3

million and

$0.2

million, respectively, of accrued interest related to uncertain tax positions, which were recorded in long-term income tax liabilities in the Consolidated Balance Sheets.

Uncertain tax positions relate to the allocation of income and deductions among the Company’s global entities and to the determination of the research and development tax credit. It is reasonably possible that over the next

twelve

-month period, the Company

may

experience increases or decreases in its unrecognized tax benefits. However, it is not possible to determine either the magnitude or the range of increases or decreases at this time.

The Company currently has reduced tax rates in its subsidiaries in Chengdu and Hangzhou, China for performing research and development activities through

2017

and

2019,

respectively. In addition, the Company currently has a tax holiday in Switzerland, which allows for tax-free operations through

2018.

The tax holiday and tax incentives had an insignificant impact on earnings per share for the periods presented.

Income Tax Examinations

The Company is subject to examination of its income tax returns by the Internal Revenue Service (“IRS”) and other tax authorities. The Company’s U.S. Federal income tax return for the year ended

December

31,

2014

was under examination by the IRS in

2016.

January

2017,

the IRS completed its examination with no adjustments.

The Company’s U.S. Federal income tax returns for the years ended

December

31,

2005

through

December

31,

2007

were under examination by the IRS. In

April

2011,

the Company received from the IRS a Notice of Proposed Adjustment ("NOPA") relating to a cost-sharing agreement entered into by the Company and its international subsidiaries on

January

2004.

In the NOPA, the IRS objected to the Company’s allocation of certain litigation expenses between the Company and its international subsidiaries and the amount of "buy-in payments" made by the international subsidiaries to the Company in connection with the cost-sharing agreement, and proposed to increase the Company’s U.S. taxable income according to a few alternative methodologies. In

February

2012,

the Company received a revised NOPA from the IRS (“Revised NOPA”). In this Revised NOPA, the IRS raised the same issues as in the NOPA issued in

April

2011

but under a different methodology. Under the Revised NOPA, the largest potential federal income tax payment, if the IRS were to prevail on all matters in dispute, was

$10.5

million, plus interest and penalties, if any. The Company responded to the Revised NOPA in

May

2012.

June

2013,

the IRS responded and continued to disagree with the Company’s rebuttal. The Company met with the IRS Office of Appeals in

2014

and both parties engaged in continuous discussions for a resolution of the matter in the

first

quarter of

2015.

Meanwhile, the Company granted the IRS an extension of the statute of limitations for taxable years

2005

through

2007

September

30,

2015.

The IRS also audited the research and development credits carried forward into year

2005

and the credits generated in the years

2005

through

2007.

The Company received a NOPA from the IRS in

February

2011,

proposing to reduce the research and development credits generated in years

2005

through

2007

and the carryforwards, which would then reduce the value of such credits carried forward to subsequent tax years.

April

2015,

the Company reached a final resolution with the IRS in connection with the income tax audits for the years

2005

through

2007.

Under the agreement, the Company made a

one

-time buy-in payment of

$1.2

million for taxes related primarily to the revaluation of a license for certain intellectual property rights of the Company to

one

of its international subsidiaries. This buy-in payment was final and no additional payment would be required with respect to the intellectual property license for the years under examination or for a previous or subsequent tax year. In addition, the Company made an interest payment of

$1.0

million as well as a tax payment of

$0.1

million for the tax years

2008

2013

2015.

There were no penalties assessed on the Company as a result of the audits.

For the

second

quarter of

2015,

the Company's income tax provision included a

one

-time net charge of approximately

$2.7

million reflecting the taxes and interest, partially offset by the reversal of previously accrued tax liabilities and valuation allowances. Of the

$2.7

million charge, approximately

$1.6

million was related to taxes and

$1.1

million was related to interest.