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Income Taxes

12 Months Ended

Dec. 31, 2019

Note 10.

Income Taxes

United States and foreign (loss) income before income taxes was as follows (in thousands):


	Year ended December 31,
	2019		2018		2017
United States	$	(50,339)	$	(14,776)	$	12,543
Foreign		303		2,408		(12,542)
Total	$	(50,036)	$	(12,368)	$	1

The income tax (benefit) provision was as follows (in thousands):


	December 31,
	2019		2018		2017
Current:
Federal	$	237	$	—	$	235
State		122		274		93
Foreign		487		309		—
		846		583		328
Deferred:
Federal		(58,368)		—		(235)
State		(7,938)		—		—
Foreign		—		—		—
		(66,306)		—		(235)
Income tax (benefit) provision	$	(65,460)	$	583	$	93

The reconciliations of the U.S. federal statutory tax expense to the combined effective tax (benefit) provision are as follows:


		Year ended
		December 31,
(amounts in thousands)		2019		2018		2017
Statutory rate of tax benefit	$	(10,508)	$	(2,597)	$	-
State income taxes, net of federal benefit		(2,418)		(1,518)		(17)
Permanent and other items		4,371		1,349		279
Stock-based compensation		(5,006)		(6,007)		(5,478)
Research credits		(3,594)		(2,556)		(2,215)
Uncertain tax positions		1,780		6,143		1,108
Change in tax rate		419		(250)		1,013
Tax Cuts and Jobs Act		-		-		25,216
ASU 2016-09 Implementation & ASC 842 Adoption in 2019		(104)		-		-
Valuation allowance		(50,400)		6,019		(19,813)
Income tax (benefit) provision	$	(65,460)	$	583	$	93

Significant components of the Company’s net deferred tax assets at December 31, 2019 and December 31, 2018 are as follows (in thousands):


	December 31,
	2019		2018
Deferred tax assets:
Net operating loss carryforwards	$	69,571	$	40,041
Tax credits		11,590		7,754
Depreciation and amortization		—		9,356
Stock-based compensation		19,268		9,838
Reserves and accruals		7,996		5,030
Lease liability		18,422		—
Other, net		147	$	(65)
Total deferred tax assets		126,994		71,954

Deferred tax liabilities:
Depreciation and amortization		(81,174)		—
ROU Lease Asset		(17,333)		—
Inventory		(6,030)		—
Total deferred tax liabilities	$	(104,537)		—

Valuation allowance		(32,089)		(71,954)
Net deferred tax liability	$	(9,632)	$	—

Based on the weight of available evidence, management has established a valuation allowance for a portion of its deferred tax assets which it expects will not be realized on a more likely than not basis. In connection with the Avedro Merger, the Company recorded a valuation allowance of $10.7 million which increased the amount of net deferred tax liability and goodwill recorded in purchase accounting. The Company recorded $75.9 million of net deferred tax liabilities as a result of the Avedro Merger. These deferred tax liabilities provide a source of future taxable income to realize the Company’s deferred tax assets. As a result of the Company's valuation allowance, $66.3 million was reduced and recorded as a deferred tax benefit in the Company's consolidated statement of operations.

As of December 31, 2019, the Company had indefinite-lived deferred tax assets for federal and certain state net operating loss (NOL) carryforwards generated after 2017 and California R&D credit carryforwards. The Company also had indefinite-lived deferred tax liabilities for certain identified intellectual property of Avedro. In determining the amount of valuation allowance to record as of December 31, 2019, the Company has elected to offset its indefinite-lived deferred tax assets and liabilities. The net change in the valuation allowance was $(39.9) million in 2019.

At December 31, 2019, the Company had approximately $355.6 million, $144.0 million and $13.3 million of NOL carryforwards for federal, state and foreign purposes, respectively, available to offset future taxable income. The federal NOL carryforwards incurred prior to 2018 will begin to expire in 2022. A federal NOL carryforward of $103.1 million will not expire, but can only be used to offset 80 percent of future taxable income. The state NOL carryforwards will begin to expire in 2021. The foreign NOL carryforwards will begin to expire in 2023.

At December 31, 2019, the Company had federal and state R&D credit carryforwards of $28.9 million and $12.8 million, respectively. Federal credits begin to expire in 2021, and the state credits of $2.9 million begin to expire in 2023. The remaining state credits of $9.8 million carry over indefinitely.

Utilization of the NOL and tax credit carryforwards will be subject to annual limitations under the Internal Revenue Code of 1986 (IRC) Section 382 and Section 383 and similar state provisions due to several ownership changes that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL and tax credit carryforwards and other deferred tax assets that can be utilized to offset future taxable income and tax. In general, all ownership changes as defined by IRC Section 382 result from transactions increasing ownership of certain stockholders in the stock of the Company by more than 50 percentage points over a three-year period. An analysis was performed by the Company which indicated that several ownership changes have occurred in previous years which created annual limitations on the Company’s ability to utilize net operating loss and tax credit carryforwards.

The Company is in the process of completing a Section 382 and Section 383 analysis through December 31, 2019. Approximately $10.6 million of the Glaukos federal NOL carryforwards and $0.3 million of federal R&D tax credits are expected to expire unutilized due to the limitations provided by Section 382 and Section 383. As noted below, certain of the tax NOL and credit carryforwards of the Company's subsidiaries are expected to expire unutilized.

As previously discussed in Note 1, Organization and Basis of Presentation, the DOSE Merger was accounted for as an acquisition of certain assets including equipment and IPR&D. For tax purposes, the DOSE Merger is treated as a taxable acquisition of the stock of DOSE and accordingly, DOSE became a wholly-owned subsidiary of Glaukos on June 27, 2019. DOSE will be included in the Company’s 2019 consolidated U.S. federal income tax return and its combined California income tax return from the date of acquisition. As of June 27, 2019, DOSE's federal and California NOL carryforwards were $2.9 million and $0.7 million, respectively, and DOSE’s federal and California R&D tax credit carryforwards were $0.1 million and $0.2 million, respectively. The NOL and R&D tax credit carryforwards are subject to limitation pursuant to Section 382 and Section 383 of the IRC. As a result of the limitations, the federal R&D credit will expire unutilized, and a portion of the California NOL will likely expire unutilized. The federal NOL and California R&D credits do not expire, therefore the Company has provided deferred tax assets for these tax attributes.

As previously discussed in Note 1, Organization and Basis of Presentation, the Avedro Merger was accounted for as a business combination. For tax purposes, the Company acquired Avedro via a tax deferred merger for $437.8 million in Glaukos stock. Following the Avedro Merger, Avedro became a wholly-owned subsidiary of the Company on November 21, 2019. Avedro will be included in the Company’s 2019 consolidated U.S. federal income tax return from the date of acquisition. As of November 21, 2019, Avedro's federal NOL carryforward was $178.8 million, its federal R&D credit carryforward was $17.3 million, its state NOL carryforwards were $97.2 million and its Massachusetts tax credits were $3.0 million. These attributes are subject to limitation under Section 382 and Section 383. As a result of these limitations, approximately $80.2 million of Avedro's federal NOLs, $14.7 million of its federal R&D tax credits, $36.4 million of its state NOLs and $1.5 million of its Massachusetts tax credit carryforwards will expire unutilized. The Company recorded deferred tax assets for these tax attributes which do not exceed the Section 382 and Section 383 limitations. The Company recorded deferred tax assets and liabilities for the differences between the fair market value of Avedro's assets and liabilities and their respective tax basis in purchase accounting. The net deferred tax liability recorded in purchase accounting of $75.9 million increased goodwill.

Certain foreign subsidiary earnings are subject to U.S. taxation under The Tax Cuts and Jobs Act of 2017 (the Act), which also repeals U.S. taxation on the subsequent repatriation of those earnings. The Company intends to invest substantially all of its foreign earnings, as well as its capital in the foreign subsidiaries, indefinitely outside of the U.S. in those jurisdictions in which the Company would incur significant, additional costs upon repatriation of such amounts.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for the years ended December 31, 2019, December 31, 2018 and December 31, 2017, excluding interest and penalties, is as follows (in thousands):


	December 31,
	2019		2018		2017
Balance at beginning of the year	$	13,486	$	7,227	$	5,947
Net addition for tax positions - prior years		230		4,558		—
Net additions for tax positions - current year		2,339		1,701		1,280
Subtractions from tax positions - prior years		(537)		—		—
Subtractions from tax positions - current year		(442)		—		—
Balance at end of the year	$	15,076	$	13,486	$	7,227

As of December 31, 2019, approximately $0.4 million of unrecognized tax benefits would reduce the Company’s annual effective tax rate if recognized.

The Company’s policy is to recognize interest expense and penalties related to income tax matters as a component of its income tax (benefit) provision. There was no accrued interest and penalties associated with uncertain tax positions as of December 31, 2019, December 31, 2018 and December 31, 2017. It is not anticipated that there will be a significant change in the unrecognized tax benefits over the next 12 months.

Due to the Company’s NOL carryforwards, its federal, state and foreign income tax returns are open to examination by the Internal Revenue Service and state jurisdictions for all years since inception. In November 2019, the Internal Revenue Service (IRS) commenced an examination of the Company’s 2017 federal income tax return. The examination is in its preliminary stages and management does not anticipate material adjustments at this time.

The Act subjects a U.S. Shareholder to tax on global intangible low-taxed income (GILTI) earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or to provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. The Company elects to provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only.