PROVISION FOR INCOME TAXES:

Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to the Company and its subsidiaries, adjusted for certain discrete items which are fully recognized in the period they occur.

In the quarter ended June 30, 2014, the Company reached a settlement with the IRS to close out the examination of the Company's federal income tax returns for the years 2007 through 2009. As a result, the Company adjusted its tax balances based on the settlement's facts, circumstances, and information available at the reporting date.

The provision for income tax in the second quarter of 2014 included a one-time benefit of $3.3 million comprising $2.8 million in federal income taxes and interest, and state income taxes of approximately $0.5 million. The one-time benefit includes the reversal of $4.1 million of related unrecognized tax benefits that had been recorded as non-current liabilities in the Company's consolidated balance sheets. The Company has now concluded all U.S. federal income tax matters for the years through 2009.

Reflecting the net impact of the benefits, the Company's effective tax rates for the three and six month periods ended June 30, 2014, were (15.1)% and (5.7)% respectively, compared with 1.3% and (6.2)% for the corresponding periods in 2013. The difference between the expected statutory rate of 35% and the Company's effective tax rate for the three and six months ended June 30, 2013, was primarily due to the beneficial impact of the geographic distribution of the Company's world-wide earnings and passage of the American Tax Relief Act of 2012, which was signed into law on January 2, 2013, causing the benefit of the 2012 federal research and development tax credit to be recorded in the quarter ended March 31, 2013.

The Company accounts for income taxes under the provisions of ASC 740. Under the provisions of ASC 740, deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, utilizing the tax rates that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities and projected future taxable income. In the event that the Company determines, based on available evidence and management judgment, that all or part of the net deferred tax assets will not be realized in the future, the Company would record a valuation allowance in the period the determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with the Company's expectations could have a material impact on its results of operations and financial position.

As of June 30, 2014, the Company recorded a full valuation allowance on its California and New Jersey deferred tax assets as the Company does not believe that it is more likely than not that the deferred tax assets will be fully realized. The Company also maintains a valuation allowance on capital losses for federal purposes and a valuation allowance with respect to certain of its deferred tax assets relating to tax credits in Canada.

The royalty arrangement between the Company and its foreign subsidiary concluded on October 31, 2012, resulting in a substantially lower effective tax rate for the Company in subsequent years. As a result of the royalty arrangement ending and to ensure an additional source of U.S. cash, the Company plans to repatriate a portion of its current year offshore earnings to the U.S. for domestic operations and accordingly has provided for estimated federal and state income taxes on such portion of its current year offshore earnings. If circumstances change and it becomes apparent that some or all of the undistributed earnings of the Company's offshore subsidiary will be remitted in the foreseeable future but income taxes have not been recognized, the Company will accrue income taxes attributable to such undistributed earnings.

Determining the consolidated provision for (benefit from) income tax expense, income tax liabilities and deferred tax assets and liabilities involves judgment. The Company calculates and provides for income taxes in each of the tax jurisdictions in which it operates, which involves estimating current tax exposures as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.

In July 2013, the FASB issued a new accounting standard that requires the presentation of certain unrecognized tax benefits as reductions to deferred tax assets rather than as liabilities in the Company's condensed consolidated balance sheets when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The Company adopted this new standard on a prospective basis in the first quarter of 2014. The impact of the adoption was a reduction to long-term deferred tax assets and non-current income tax payable of approximately $4.3 million.

Unrecognized Tax Benefits

The Company applies the provisions of ASC 740-10, relating to accounting for uncertain tax income taxes. Changes in the Company's unrecognized tax benefits during the six months ended June 30, 2014, was as follows (in thousands):



Unrecognized tax benefits balance at January 1, 2014	$	12,694
Gross increases for tax positions of current year	400
Gross increases for tax positions of prior years	285
Settlements	(4,361		)
Lapse of statute of limitations	—
Unrecognized tax benefits balance at June 30, 2014	$	9,018

The Company's total unrecognized tax benefits as of June 30, 2014 and December 31, 2013 was $9.0 million and $12.7 million, respectively. An income tax benefit of $4.0 million, net of valuation allowance adjustments, would be recorded if these unrecognized tax benefits are recognized. The Company cannot reasonably estimate the outcome at this time.

The Company's continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company has accrued interest and penalties at June 30, 2014, and December 31, 2013, of $0.1 million and $0.7 million, respectively, which have been recorded in long-term income taxes payable in the accompanying consolidated balance sheets.