Note 13—Income Taxes

The Company does not file a consolidated return with its foreign subsidiaries. The Company files federal and state returns and its foreign subsidiaries file returns in their respective jurisdiction.

For the years ended 2013, 2014 and 2015, the provision for income taxes, which included federal, state and foreign income taxes, was an expense of $2.6 million, $3.7 million, and $3.4 million reflecting effective tax provision rates of (5.1%), 14.7% and 12.9%, respectively.

For the year ended 2013 and 2014, provision for income taxes includes federal, state and foreign income taxes at effective tax rates of (5. l %) and 14.7%. Exclusive of discrete items, the effective tax provision rate would be (5.8%) in 2013 and 13.6% in 2014. The decrease in the effective rate absent discrete items was primarily due to the foreign rate differential between the United States and Hong Kong. The rate exclusive of discrete items can be materially impacted by the proportion of Hong Kong earnings to consolidated earnings.

The 2015 tax expense of $3.4 million included a discrete tax expense of $0.9 million primarily comprised of return to provision adjustments. Absent these discrete tax expenses, the Company’s effective tax rate for 2015 was 9.5%; primarily due to a full valuation allowance on the Company’s United States deferred tax assets and the foreign rate differential, and is impacted by the proportion of Hong Kong earnings to overall earnings and is expected to vary depending on the level of consolidated earnings.

For years ended 2014 and 2015, the Company had net deferred tax liabilities of approximately $2.6 million and $2.3 million, respectively, related to foreign jurisdictions.

Provision for income taxes reflected in the accompanying consolidated statements of operations are comprised of the following (in thousands):

	2013			2014			2015
Federal	$	(1,862	)	$	(4	)	$	—
State and local		(390	)		287			708
Foreign		4,894			3,887			3,044
Total Current		2,642			4,170			3,752
APIC		(160	)		(84	)		—
Deferred		129			(371	)		(329	)
Total	$	2,611		$	3,715		$	3,423

The components of deferred tax assets/(liabilities) are as follows (in thousands):

	2014			2015
Net deferred tax assets/(liabilities):
Current:
Reserve for sales allowances and possible losses	$	1,034		$	797
Accrued expenses		8,231			1,252
Prepaid royalties		16,322			13,869
Accrued royalties		5,029			4,178
Inventory		4,065			3,495
State income taxes		(8,206	)		(7,231	)
Other		709			487
Gross current		27,184			16,847
Valuation allowance		(23,826	)		(19,586	)
Net current		3,358			(2,739	)
Long Term:
Federal and state net operating loss carryforwards		29,383			37,473
Property and equipment		4,542			4,039
Original issue discount interest		(13,561	)		(10,419	)
Goodwill and intangibles		43,269			36,990
Share based compensation		2,309			2,487
Other		11,037			11,228
Gross long-term		76,979			81,798
Valuation allowance		(82,959	)		(81,352	)
Net long-term		(5,980	)		446
Total net deferred tax assets/(liabilities)	$	(2,622	)	$	(2,293	)

Provision for income taxes varies from the U.S. federal statutory rate. The following reconciliation shows the significant differences in the tax at statutory and effective rates:

	2013			2014			2015
Federal income tax expense		35.0	%		35.0	%		35.0	%
State income tax expense, net of federal tax effect		6.2			―			1.0
Effect of differences in U.S. and Foreign statutory rates		4.8			(14.1	)		(9.4	)
Uncertain tax positions		0.4			―			0.3
Earn out adjustments		―			―			(7.4	)
Provision to return		―			―			12.2
Other		4.3			(0.4	)		1.6
Foreign deemed dividend		(45.3	)		―			1.7
Foreign tax credit		21.4			―			(0.5	)
Valuation allowance		(31.9	)		(5.8	)		(21.6	)
		(5.1	)%		14.7	%		12.9	%

Deferred taxes result from temporary differences between tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. The temporary differences result from costs required to be capitalized for tax purposes by the U.S. Internal Revenue Code (“IRC”), and certain items accrued for financial reporting purposes in the year incurred but not deductible for tax purposes until paid. The Company has established a full valuation allowance on net deferred tax assets in the United States since, in the opinion of management, it is not more likely than not that the U.S. net deferred tax assets will be realized.

The components of income (loss) before provision (benefit) for income taxes are as follows (in thousands):

	2013			2014		2015
Domestic	$	(66,470	)	$	5,358	$	11,692
Foreign		15,175			19,866		14,901
	$	(51,295	)	$	25,224	$	26,593

The Company has approximately $252 million of cumulative undistributed earnings of non-U.S. subsidiaries for which U.S. taxes have not been provided as of December 31, 2015. These earnings are intended to be permanently reinvested outside the U.S. If future events necessitate that these earnings should be repatriated to the U.S., an additional tax expense and related liability may be required. The determination of the amount of unrecognized U.S. deferred tax liability for undistributed earnings of non-U.S. subsidiaries is not practicable. The Company also does not provide deferred taxes on foreign currency translation adjustments under the indefinite reversal exception.

The Company uses a recognition threshold and measurement process for recording in the consolidated financial statements uncertain tax positions (“UTP”) taken or expected to be taken in a tax return.

$1.8 million of additional UTPs related to Hong Kong mold depreciation were recognized in 2015. In addition, approximately $2.1 million of California audit and R&D Credit based UTPs became de-recognized during 2015, due to the closing of a California income tax audit. These items were included in the 2015 income tax provision. During 2014, approximately $44,000 of the liability for UTP was de-recognized.

Current interest on uncertain income tax liabilities is recognized as interest expense and penalties are recognized in selling, general and administrative expenses in the consolidated statement of operations. During 2013, the Company recognized $120,000 of current year interest expense relating to UTPs. During 2014, the Company recognized $150,000 of current year interest expense relating to UTPs. During 2015, the Company did not recognize any current year interest expense relating to UTPs.

The following table provides further information of UTPs that would affect the effective tax rate, if recognized, as of December 31, 2015 (in millions):

Balance, January 1, 2013	$	4.8
Current year additions		0.3
Current year reduction due to lapse of applicable statute of limitations		(2.5	)
Balance, December 31, 2013		2.6
Current year additions		—
Current year reduction due to lapse of applicable statute of limitations		(0.1	)
Balance, December 31, 2014		2.5
Current year additions		1.8
Current year reduction due to audit settlement		(2.1	)
Balance, December 31, 2015	$	2.2

Tax years 2012 through 2014 remain subject to examination in the United States. The tax years 2010 through 2014 are generally still subject to examination in the various states. The tax years 2009 through 2014 are still subject to examination in Hong Kong. In the normal course of business, the Company is audited by federal, state, and foreign tax authorities. The U.S. Internal Revenue Service is not currently examining any of the tax years.

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets by jurisdiction. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended December 31, 2015. Such objective evidence limits the ability to consider other subjective evidence such as the Company’s projections for future growth. The Company is required to establish a valuation allowance for the U.S. deferred tax assets and record a charge to income if Management determines, based upon available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets may not be realized.

For the three-year period ended December 31, 2015, the Company was in a cumulative pre-tax loss position in the U.S. On the basis of this evaluation, as of December 31, 2015, a valuation allowance of $100.9 million has been recorded against the U.S. deferred tax assets that more likely than not will not be realized. For the year ended December 31, 2015, the valuation allowance decreased by $5.9 million from $106.8 million at December 31, 2014 to $100.9 million at December 31, 2015. The net deferred tax liabilities of $2.3 million represent the net deferred tax liabilities in the foreign jurisdiction, where the Company is in a cumulative income position. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased, or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as the Company’s projections for growth.

At December 31, 2015, the Company had U.S. federal net operating loss carryforwards, or "NOLs," of approximately $76 million, which will begin to expire in 2031. At December 31, 2015, the Company's state NOLs were mainly from California. The majority of the approximately $110 million of California NOLs will begin to expire in 2031. At December 31, 2015, the Company had foreign tax credit carryforwards of approximately $12.6 million, which will begin to expire in 2022. At December 31, 2015, the Company had federal research and development tax credit carryforwards ("credit carryforwards") of approximately $0.5 million, which will begin to expire in 2029. At December 31, 2015, the Company had state research and development tax credits of approximately $140,000, which carry forward indefinitely. Utilization of certain NOLs and research credit carryforwards may be subject to an annual limitation due to ownership change limitations set forth in Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, and comparable state income tax laws. Any future annual limitation may result in the expiration of NOLs and credit carryforwards before utilization.