Income Taxes

12 Months Ended

Sep. 30, 2012

Income Taxes

Income Taxes

9. Income Taxes

        In 2010, Headwaters' income tax benefit rate related to continuing operations was approximately 36%. Headwaters utilized its 2009 and prior year federal net operating losses (NOLs) by carrying those amounts back to prior years, receiving significant income tax refunds in 2010. NOLs and tax credit carryforwards for 2010 were offset by Headwaters' existing deferred income tax liabilities resulting in a near $0 deferred tax position as of September 30, 2010. In both 2011 and 2012, Headwaters recorded a full valuation allowance on its net amortizable deferred tax assets and recorded a minimal income tax benefit in 2011 and approximately $0.7 million of income tax expense in 2012. The reported income tax rate for 2011 of near 0% and the negative income tax rate of (3)% for 2012 were due to the combination of not recognizing benefit for pre-tax losses and tax credits, but recognizing current state income taxes in certain state jurisdictions where Headwaters generated taxable income. A valuation allowance is required when there is significant uncertainty as to the realizability of deferred tax assets. Because the realization of Headwaters' deferred tax assets is dependent upon future income in domestic and foreign jurisdictions that have generated losses, management determined that Headwaters does not meet the "more likely than not" threshold that NOLs, tax credits and deferred tax assets will be realized. Accordingly, a valuation allowance is required.

        As of September 30, 2012, Headwaters' NOL and capital loss carryforwards totaled approximately $69.3 million (tax effected). The U.S. and state NOLs and capital losses expire from 2013 to 2032. Substantially all of the non-U.S. NOLs, which are not material, do not expire. In addition, there are approximately $23.8 million of tax credit carryforwards as of September 30, 2012, which expire from 2014 to 2032.

        The income tax benefit (provision) consisted of the following for the years ended September 30:

(in thousands)	2010			2011			2012
Current tax benefit (provision):
Federal	$	17,586		$	1,109		$	1,267
State		1,979			(968	)		(1,717	)
Total current tax benefit (provision)		19,565			141			(450	)
Deferred tax benefit (provision):
Federal		(7,635	)		30			(211	)
State		(267	)		0			0
Total deferred tax benefit (provision)		(7,902	)		30			(211	)
Total income tax benefit (provision)	$	11,663		$	171		$	(661	)

        The benefit (provision) for income taxes differs from the amount computed using the statutory federal income tax rate due to the following:

(in thousands)	2010			2011			2012
Tax benefit at U.S. statutory rate	$	11,460		$	46,936		$	9,019
State income taxes, net of federal tax effect		1,055			(968	)		(1,717	)
Estimated tax credits		765			0			107
Valuation allowance		(928	)		(45,310	)		(8,913	)
Unrecognized tax benefits		655			1,110			1,268
Other		(1,344	)		(1,597	)		(425	)
Income tax benefit (provision)	$	11,663		$	171		$	(661	)

        The components of Headwaters' deferred income tax assets and liabilities were as follows as of September 30:

(in thousands)	2011			2012
Deferred tax assets:
NOL and capital loss carryforwards	$	63,427		$	69,252
Tax credit carryforwards		21,221			23,779
Debt repurchase premium		20,297			18,221
Estimated liabilities		3,199			15,819
Stock-based compensation		9,365			9,306
Reserves and allowances		3,857			2,409
Convertible note hedge		4,796			1,279
Other		2,261			2,534
Valuation allowances		(104,531	)		(127,795	)
Total deferred tax assets		23,892			14,804
Deferred tax liabilities:
Property, plant and equipment basis differences		(9,834	)		(11,066	)
Goodwill and intangible asset basis differences		(8,589	)		(2,381	)
Convertible debt discount		(5,469	)		(1,357	)
Indefinite lived liabilities		(2,280	)		(2,505	)
Total deferred tax liabilities		(26,172	)		(17,309	)
Net deferred tax liability	$	(2,280	)	$	(2,505	)

        A reconciliation of the change in the amount of gross unrecognized income tax benefits is as follows.

(in thousands)	2010			2011			2012
Gross unrecognized income tax benefits at beginning of year	$	9,024		$	11,843		$	8,312
Changes based on tax positions related to the current year		93			(872	)		(370	)
Increases for tax positions related to prior years		4,961			4,915			560
Reductions for tax positions related to prior years		(1,444	)		(5,365	)		(2,073	)
Settlements		(592	)		(1,720	)		(65	)
Lapse of statute of limitations		(199	)		(489	)		(1,492	)
Gross unrecognized income tax benefits at end of year	$	11,843		$	8,312		$	4,872

        During 2010, Headwaters recognized approximately $0.2 million of interest and penalties and during 2011, Headwaters released approximately $3.4 million of liabilities for interest and penalties. During 2012, Headwaters released approximately $0.4 million of liabilities for interest and penalties and as of September 30, 2012, approximately $2.4 million was accrued for the payment of interest and penalties. Changes to the estimated liability for unrecognized income tax benefits during 2011 were primarily the result of settlement of the IRS audit for the years 2005 through 2008. Changes to the estimated liability for unrecognized income tax benefits during 2012 were primarily the result of a tentative agreement reached with the IRS regarding its audit of 2009 and the expiration of statute of limitation time periods. As of September 30, 2012, approximately $3.9 million of unrecognized income tax benefits would affect the 2012 effective tax rate if released into income, due to the impact of the valuation allowance.

        The calculation of tax liabilities involves uncertainties in the application of complex tax regulations in multiple tax jurisdictions and Headwaters currently has open tax years subject to examination by the IRS or other taxing authorities for the years 2009 through 2011. Headwaters recognizes potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to which, additional taxes and interest will be due. If events occur (or do not occur) as expected and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer required to be recorded in the consolidated financial statements. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. It is reasonably possible that approximately $1.5 million to $3.0 million of Headwaters' unrecognized income tax benefits will be released within the next 12 months, depending on the timing of ongoing examinations, the expiration of statute of limitation time periods and other factors.