

NOTE 9.	Income Taxes

The Company’s geographical breakdown of income before income taxes is as follows:



	Year Ended December 31,
	2015		2014		2013
	(in thousands)
Domestic	$	22,540	$	7,384	$	947
Foreign	1,980		1,229		1,094
Income before income taxes	$	24,520	$	8,613	$	2,041

The provision for (benefit from) income taxes consists of the following:



	Year Ended December 31,
	2015			2014			2013
	(in thousands)
Current
Federal	$	115		$	—		$	(40	)
State	1,041			317			154
Foreign	693			651			452
Total current provision	1,849			968			566
Deferred
Federal	7,115			(22,184		)	6
State	(247		)	(433		)	—
Foreign	(62		)	18			(72		)
Total deferred provision (benefit)	6,806			(22,599		)	(66		)
Total provision for (benefit from) income taxes	$	8,655		$	(21,631	)	$	500

The reconciliation of the statutory federal income tax rate to the Company’s effective tax rate is as follows:



	Year Ended December 31,
	2015		2014		2013
Federal statutory rate	35.0	%	35.0	%	34.0	%
State taxes	2.2		1.4		5.1
Stock-based compensation	0.5		1.3		9.1
Foreign source income	0.6		3.9		1.9
Change in valuation allowance	1.3		(270.5	)	(28.4	)
Incremental federal rate benefit previously not recognized	—		(7.0	)	—
Federal and state research and development credit	(3.9	)	(11.3	)	—
Other	(0.4	)	(3.9	)	2.8
Provision for (benefit from) income taxes	35.3	%	(251.1	)%	24.5	%

Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of the Company’s deferred tax assets and liabilities are as follows:



	December 31,
	2015			2014
	(in thousands)
Deferred tax assets
Net operating loss carryforwards	$	1,936		$	12,849
Research and development credit carryforwards	6,508			6,392
Accrued liabilities	614			583
Deferred revenues	3,838			3,291
Deferred rent	142			191
Intangible assets	246			401
Stock-based compensation	8,301			4,149
Other	1,396			903
Gross deferred tax assets	22,981			28,759
Valuation allowance	(3,303		)	(3,079		)
Net deferred tax assets	19,678			25,680
Deferred tax liabilities
Fixed assets	(3,599		)	(3,039		)
Intangible assets	—			(2		)
Total deferred tax liabilities	(3,599		)	(3,041		)
Net deferred tax assets	$	16,079		$	22,639

Realization of deferred tax assets is dependent upon future earnings, if any, and the timing and amount of such assets are uncertain. Prior to the fourth quarter of 2014, the Company had provided a valuation allowance for its U.S. federal and state deferred tax assets that it believed were not more likely than not realizable. Management determined that the objective and verifiable negative evidence, such as relatively low U.S. operating income and uncertainty of sustaining or growing future operating profits, continued to outweigh positive evidence that would be necessary to reduce the valuation allowance.

In the fourth quarter of 2014, the Company recorded a $23.7 million tax benefit for the recognition of its U.S. federal and certain state deferred tax assets, primarily due to the increased and expected sustainable profitability in its U.S. operations. In reaching this conclusion, management considered the Company's increasing realized profitability in the fourth quarter of 2014, forecasted future profitability, its ability to better absorb uncertainties in future profits, and the cumulative effect of changes in the macro-economic environment surrounding the IT security industry, which ultimately resulted in increased demand for its solutions.

The Company believes it is more likely than not that its California deferred tax assets will not be realized because the income attributed to California is not expected to be sufficient to recognize these deferred tax assets. Accordingly, the Company continues to record the valuation allowance of $3.3 million as of December 31, 2015 for its California deferred tax assets During the year ended December 31, 2015, the valuation allowance had increased by $0.2 million to $3.3 million.

At December 31, 2015, the Company had federal and state net operating loss carryforwards of approximately $35.6 million and $4.8 million respectively, available to reduce federal and state taxable income. The excess tax benefits included in net operating loss carryforwards but not reflected in deferred tax assets for federal and state are $30.8 million and $0.2 million, respectively. The Company’s federal net operating losses expire in the years 2022 to 2035, and its state net operating losses expire from 2016 to 2035. Utilization of the Company’s net operating loss carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. As of December 31, 2015, the Company had federal and state research and development credits of $5.0 million and $5.7 million, respectively. Federal research and development credits expire in the years 2023 to 2035. State research and development credits do not expire.

U.S. income taxes and foreign withholding taxes have not been provided on undistributed earnings for non-U.S. subsidiaries. The Company intends to continue to reinvest the earnings of these foreign subsidiaries indefinitely. The Company’s share of undistributed earnings of foreign subsidiaries that could be subject to additional U.S. income tax if remitted was approximately $8.7 million and $6.8 million as of December 31, 2015 and 2014, respectively. Determination of the amount of unrecognized deferred tax liability for temporary differences related to investments in these non-U.S. subsidiaries that are essentially permanent in duration is not practicable. If the undistributed earnings are remitted to the U.S. these amounts would be taxable in the U.S. at the current federal and state tax rates net of foreign tax credits. Also, depending on the jurisdiction any distribution would potentially be subject to withholding taxes at rates applicable to that jurisdiction.

The evaluation of a tax position is a two-step process. The first step requires the Company to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. The second step requires the Company to recognize in the financial statement each tax position that meets the more likely than not criteria, measured at the amount of benefit that has a greater than fifty percent likelihood of being realized.

A reconciliation of the Company’s unrecognized tax benefits is as follows:



	Year Ended December 31,
	2015			2014			2013
	(in thousands)
Unrecognized tax benefits beginning balance	$	3,330		$	3,255		$	2,647
Gross increase for tax positions of prior years	20			—			241
Gross decrease for tax positions of prior years	(171		)	(127		)	—
Gross increase for tax positions of current year	418			332			446
Lapse of statute of limitations	(91		)	(130		)	(79		)
Total unrecognized tax benefits	$	3,506		$	3,330		$	3,255

The unrecognized tax benefits, if recognized, would impact the income tax provision by $2.1 million, $2.1 million and $1.0 million as of December 31, 2015, 2014 and 2013, respectively.

The Company has elected to include interest and penalties as a component of income tax expense. The amounts were not material for 2015, 2014 and 2013.

The Company files income tax returns in the United States, including various state jurisdictions. The Company’s subsidiaries file tax returns in various foreign jurisdictions. The tax years 2010 to 2015 remain open to examination by the major taxing jurisdictions in which the Company is subject to tax, with the exception of France which remains open to examination for the 2012 through 2015 tax years only. As of December 31, 2015, the Company was not under examination by the Internal Revenue Service or any state tax jurisdictions.

A retroactive and permanent reinstatement of the federal research and development tax credit was signed into law on December 18, 2015 in accordance with the Protecting Americans from Tax Hikes Act of 2015. The Company recorded a 2015 federal research and development credit of $0.6 million, net of reserves, in the fourth quarter of 2015. The California research and development credit estimated for 2015, net of reserves, is $0.5 million.