Income Taxes

Income before provision for income taxes consists of the following:



	Fiscal Years Ended July 31,
	2014		2013		2012
U.S.	$	36,885,000	28,930,000		44,930,000
Foreign	1,622,000		(1,437,000	)	(890,000	)
	$	38,507,000	27,493,000		44,040,000

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



	Fiscal Years Ended July 31,
	2014			2013	2012
Federal – current	$	11,629,000		7,129,000	14,389,000
Federal – deferred	(368,000		)	385,000	(4,194,000	)
State and local – current	1,623,000			1,393,000	2,045,000
State and local – deferred	(33,000		)	35,000	(380,000	)

Foreign – current	506,000			48,000	(240,000	)
Foreign – deferred	(1,000		)	695,000	4,000
	$	13,356,000		9,685,000	11,624,000

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,
	2014					2013				2012
	Amount			Rate		Amount		Rate		Amount		Rate
Computed “expected” tax expense	$	13,477,000		35.0	%	9,623,000		35.0	%	15,414,000		35.0	%
Increase (reduction) in income taxes resulting from:
State and local income taxes, net of Federal benefit	1,172,000			3.1		782,000		2.8		995,000		2.3
Nondeductible stock-based compensation	70,000			0.2		71,000		0.3		86,000		0.2
Domestic production activities deduction	(912,000		)	(2.4	)	(1,344,000	)	(4.9	)	(1,436,000	)	(3.3	)
Research and experimentation credits	(506,000		)	(1.3	)	(888,000	)	(3.2	)	(241,000	)	(0.5	)
Change in the beginning of the year valuation allowance for deferred tax assets	—			—		693,000		2.5		—		—
Audit settlements	—			—		(141,000	)	(0.5	)	(2,841,000	)	(6.5	)
Foreign income taxes	(62,000		)	(0.2	)	640,000		2.3		99,000		0.2
Other	117,000			0.3		249,000		0.9		(452,000	)	(1.0	)
	$	13,356,000		34.7	%	9,685,000		35.2	%	11,624,000		26.4	%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at July 31, 2014 and 2013 are presented below.



	2014			2013
Deferred tax assets:
Allowance for doubtful accounts receivable	$	193,000		217,000
Inventory and warranty reserves	8,125,000			7,559,000
Compensation and commissions	1,716,000			1,705,000
State and foreign research and experimentation credits	3,383,000			2,736,000
Stock-based compensation	4,859,000			8,068,000
Other	2,520,000			2,478,000
Less valuation allowance	(2,958,000		)	(2,225,000	)
Total deferred tax assets	17,838,000			20,538,000
Deferred tax liabilities:
Plant and equipment	(486,000		)	(1,424,000	)
Intangibles	(10,322,000		)	(10,187,000	)
Total deferred tax liabilities	(10,808,000		)	(11,611,000	)
Net deferred tax assets	$	7,030,000		8,927,000

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, 2014 and 2013, our net deferred tax assets include approximately $484,000 of deferred tax assets relating to foreign research and experimentation credits which are principally recorded as other assets in our Consolidated Balance Sheet. As of July 31, 2014 and 2013, our state and foreign deferred tax assets relating to research and experimentation credits have been offset by a valuation allowance as they may not be utilized in a future period.

We must generate approximately $57,000,000 of taxable income in the future to fully utilize our gross deferred tax assets as of July 31, 2014. 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, 2014, we had a hypothetical additional paid-in capital (“APIC”) pool related to stock-based compensation of approximately $17,574,000. 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, 2014 and 2013, total unrecognized tax benefits, all of which were recorded as non-current income taxes payable in our Consolidated Balance Sheets, were $2,743,000 and $2,963,000, respectively, including interest of $40,000 and $90,000, respectively. Of these amounts, $2,152,000 and $2,348,000, 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.

Our policy is to recognize interest and penalties relating to uncertain tax positions in income tax expense. The following table summarizes the activity related to our unrecognized tax benefits for fiscal years 2014 and 2013:



	2014			2013
Balance at beginning of period	$	2,873,000		2,529,000
Increase related to current period	374,000			585,000
Increase related to prior periods	20,000			175,000
Expiration of statute of limitations	(496,000		)	(207,000	)
Decrease related to prior periods	(68,000		)	(209,000	)
Balance at end of period	$	2,703,000		2,873,000

Our federal income tax returns for fiscal 2011 through 2014 are subject to potential future IRS audit. Future tax assessments or settlements could have a material adverse effect on our consolidated results of operations and financial condition.