(10) Income Taxes

Income before provision for income taxes consists of the following:



	Fiscal Years Ended July 31,
	2012			2011		2010
U.S.	$	44,930,000		102,159,000		97,217,000
Foreign	(890,000		)	(355,000	)	85,000
	$	44,040,000		101,804,000		97,302,000

The provision for income taxes included in the accompanying consolidated statements of operations consists of the following:



	Fiscal Years Ended July 31,
	2012			2011		2010
Federal – current	$	14,389,000		29,735,000		39,448,000
Federal – deferred	(4,194,000		)	683,000		(7,180,000	)
State and local – current	2,045,000			3,683,000		5,448,000
State and local – deferred	(380,000		)	62,000		(651,000	)

Foreign – current	(240,000		)	(270,000	)	(406,000	)
Foreign – deferred	4,000			16,000		13,000
	$	11,624,000		33,909,000		36,672,000

The provision for income taxes differed from the amounts computed by applying the U.S. Federal income tax rate as a result of the following:



	Fiscal Years Ended July 31,
	2012					2011				2010
	Amount			Rate		Amount		Rate		Amount		Rate
Computed “expected” tax expense	$	15,414,000		35.0	%	35,632,000		35.0	%	34,056,000		35.0	%
Increase (reduction) in income taxes resulting from:
State and local income taxes, net of Federal benefit	995,000			2.3		2,614,000		2.6		3,118,000		3.2
Impairment of goodwill	—			—		—		—		1,666,000		1.7
Nondeductible stock-based compensation	86,000			0.2		94,000		0.1		167,000		0.2
Domestic production activities deduction	(1,436,000		)	(3.3	)	(2,893,000	)	(2.9	)	(2,086,000	)	(2.2	)
Research and experimentation credits	(241,000		)	(0.5	)	(1,255,000	)	(1.3	)	(137,000	)	(0.1	)
Change in the beginning of the year valuation allowance for deferred tax assets	—			—		—		—		(50,000	)	(0.1	)
Audit settlements	(2,841,000		)	(6.5	)	20,000		0.1		(302,000	)	(0.3	)
Foreign income taxes	99,000			0.2		151,000		0.2		9,000		0.1
Other	(452,000		)	(1.0	)	(454,000	)	(0.5	)	231,000		0.2
	$	11,624,000		26.4	%	33,909,000		33.3	%	36,672,000		37.7	%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at July 31, 2012 and 2011 are presented below.



	2012			2011
Deferred tax assets:
Allowance for doubtful accounts receivable	$	576,000		436,000
Inventory and warranty reserves	7,684,000			6,998,000
Compensation and commissions	1,890,000			1,273,000
State research and experimentation credits	1,691,000			1,449,000
Stock-based compensation	10,133,000			10,606,000
Net operating losses	101,000			663,000
Other	4,922,000			4,970,000
Less valuation allowance	(1,162,000		)	(1,162,000	)
Total deferred tax assets	25,835,000			25,233,000
Deferred tax liabilities:
Plant and equipment	(2,137,000		)	(3,261,000	)
Intangibles	(11,077,000		)	(12,544,000	)
Total deferred tax liabilities	(13,214,000		)	(15,805,000	)
Net deferred tax assets	$	12,621,000		9,428,000

We provide for income taxes under the provisions of FASB ASC 740, “Income Taxes.” FASB ASC 740 requires an asset and liability based approach in accounting for income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of them will not be realized. If management determines that it is more likely than not that some or all of its deferred tax assets will not be realized, a valuation allowance will be recorded against such deferred tax assets.

As of July 31, 2012 and 2011, our deferred tax assets have been offset by a valuation allowance primarily related to state research and experimentation credits which may not be utilized in future periods. As of July 31, 2012, we had a deferred tax asset relating to state net operating losses of approximately $101,000, which will expire from fiscal year 2029 through fiscal year 2030. We believe that it is more likely than not that we will realize these net operating losses before their expiration.

We must generate approximately $73,000,000 of taxable income in the future to fully utilize our gross deferred tax assets as of July 31, 2012. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. In addition, as of July 31, 2012, we had a hypothetical additional paid-in capital (“APIC”) pool related to stock-based compensation of approximately $22,786,000. To the extent that previously issued and outstanding stock-based awards either expire unexercised or are exercised for an intrinsic value less than the original fair-market value recorded at the time of issuance, the difference between the related deferred tax asset amount originally recorded and the actual tax benefit would be recorded against the hypothetical APIC pool. Once this hypothetical APIC pool is reduced to zero, future shortfalls would be recorded as income tax expense in the period of stock-based award expiration or exercise.

At July 31, 2012 and 2011, the total unrecognized tax benefits, excluding interest, were $2,529,000 and $6,763,000, respectively. Of these amounts, $1,990,000 and $5,719,000, respectively, net of the reversal of the federal benefit recognized as a deferred tax asset relating to state reserves, would positively impact our effective tax rate, if recognized. Unrecognized tax benefits result from income tax positions taken or expected to be taken on our income tax returns for which a tax benefit has not been recorded in our financial statements. Of the total unrecognized tax benefits, $2,624,000 and $3,811,000, including interest, were recorded as non-current income taxes payable in our Consolidated Balance Sheets at July 31, 2012 and 2011, respectively.

Our policy is to recognize interest and penalties relating to uncertain tax positions in income tax expense. At July 31, 2012 and 2011, interest accrued relating to income taxes was $60,000 and $545,000, respectively, net of the related income tax benefit. The following table summarizes the activity related to our unrecognized tax benefits for fiscal years 2012 and 2011:



	2012			2011
Balance as of July 31	$	6,763,000		7,056,000
Increase related to fiscal 2012	432,000			639,000
Increase related to prior periods	417,000			601,000
Expiration of statute of limitations	(1,401,000		)	(1,087,000	)
Decrease related to prior periods	(3,309,000		)	(446,000	)
Settlements with taxing authorities	(373,000		)	—
Balance as of July 31	$	2,529,000		6,763,000

In August 2011, we reached an effective settlement with the IRS relating to its audit of our federal income tax returns for fiscal 2007, 2008 and 2009. Although adjustments relating to the settlement of our prior year completed audits were immaterial, a resulting tax assessment or settlement for other potential later periods, or for other tax jurisdictions, could have a material adverse effect on our consolidated results of operations and financial condition. Our federal income tax returns for fiscal 2010, 2011 and 2012 are subject to potential future IRS audit.