5. INCOME TAXES

Income from operations before income taxes consists of the following for the years ended September 30:


		2011			2010
		(in thousands)

Domestic	$		257		$	399
Foreign			(90	)		18

Total	$		167		$	417

The provision for income taxes consisted of the following for the years ended September 30:


		2011			2010
		(in thousands)
Current:
Federal	$	-		$	-
State		11			17
Foreign		25			26
		36			43
Deferred:
Federal		(185	)		390
State		(1	)		(168	)
Change in valuation allowance		185			(228	)
		(1	)		(6	)

Total provision	$	35		$	37

At September 30, 2011, the Company had U.S. federal tax loss carryforwards of approximately $7.1 million, expiring at various dates through 2031, including $182,000 resulting from the Mergence acquisition during 2004 which are subject to additional annual limitations as a result of the changes in Mergence's ownership, and had approximately $1.4 million in state tax loss carryforwards, which also expire at various dates through 2031. An alternative minimum tax credit of approximately $164,000 is available to offset future regular federal taxes. Research and development credits of approximately $624,000 expire beginning in 2011. In addition, the Company has the following net operating loss carryforwards: United Kingdom losses of $7.5 million with no expiration date, Australia losses of $3.6 million with no expiration date and Germany losses of $98,000 with no expiration date.

The components of the Company's net deferred tax assets are as follows at September 30:


		2011			2010
		(in thousands)
Deferred taxliabilities:
Prepaid expenses		(91	)		(37	)
Acquired intangibles		(40	)		(43	)
		(131	)		(80	)
Deferred taxassets:
Net operating loss carryforwards		5,146			4,793
Research and development credits		624			571
Accounts and notes receivable reserves		27			48
Alternative minimum tax credits		164			164
Depreciation and amortization		1,241			1,412
Deferred rent		-			21
Other		165			122
		7,367			7,131

Total		7,236			7,051

Valuation allowance		(7,236	)		(7,051	)

Deferred taxliability, net	$	-		$	-

For financial reporting purposes, the Company had profitable income from domestic operations in 2011 and 2010 but incurred losses from domestic operations in previous years. The Company had domestic taxable losses in both 2011 and 2010 as the Company's subsidiaries in the United Kingdom are treated as branches on the domestic tax returns and, accordingly, any losses at such subsidiaries are recorded on the domestic income tax returns. Prior to the results of the last two years, the Company had generally experienced significant losses from operations, both domestically and internationally, over several prior years. The Company has also had a history of certain state net operating loss carryforwards expiring. Approximately $3.7 million of state net operating loss carryforwards expired in fiscal 2010. No state net operating loss carryforwards expired in fiscal 2011. Accordingly, management does not believe the deferred tax assets are more likely than not to be realized and a full valuation allowance has been provided.

The following table reconciles the Company's tax provision based on its effective tax rate to its tax provision based on the federal statutory rate of 34% for the years ended September 30, 2011 and 2010 (in thousands):


		2011			2010

Provision at federal statutory rate	$	57		$	142
State, net of federal impact		7			(99	)
Foreign income taxes		25			26
Valuation allowance increase (decrease)		185			(228	)
Return to provision adjustments		(181	)		147
Other		(58	)		49

Provision for income taxes	$	35		$	37

Provision for Uncertain Tax Positions

The Company applies the accounting requirements for uncertain tax positions which provide a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.

In accordance with these requirements, the Company first determines whether a tax authority would "more likely than not" sustain its tax position if it were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, the Company measures the amount of tax benefit based on the largest amount of tax benefit that the Company has a greater than 50% chance of realizing in a final settlement with the relevant authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard, or are resolved through negotiation or litigation with the taxing authority, or upon expiration of the statute of limitations.

At October 1, 2009, the Company had a cumulative tax liability of $125,000 related to foreign tax exposure. During each of the fiscal years ended September 30, 2010 and 2011, the Company increased its tax liability by $25,000, resulting in a cumulative tax liability of $175,000 at September 30, 2011. These amounts have been recorded as an increase to other long-term liabilities on the Company's consolidated balance sheets. The Company does not expect its tax liability to change significantly during the next twelve months. The Company's policy is to recognize interest and penalties related to uncertain tax positions as a component of income tax expense in its consolidated statements of operations. To date, the Company has not accrued any amounts for interest and penalties associated with this liability as such amounts have been de minimis. Also in fiscal 2010, the Company recorded additional uncertain tax positions of approximately $9,000 which were recorded as a reduction of the Company's deferred tax asset and a corresponding reduction to its valuation allowance. During fiscal 2011, the Company released a portion of its reserve for uncertain tax positions and recorded a benefit of $2,000 for the year.

As of October 1, 2009, the Company had approximately $793,000 of total gross unrecognized tax benefits (before consideration of any valuation allowance). These unrecognized tax benefits represent differences between tax positions taken by the Company in its various consolidated and separate worldwide tax returns and the benefits recognized and measured for uncertain tax positions. This amount also represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. The change in the unrecognized tax benefits in fiscal years ended September 30, 2010 and 2011 was as follows (in thousands):


Balance at October 1, 2009	$	793
Additions for prior year tax positions		33
Balance at September 30, 2010		826
Additions for prior year tax positions		24
Balance at September 30, 2011	$	850

In the normal course of business, the Company is subject to examination by taxing authorities throughout the world, including such jurisdictions as the United Kingdom, Germany, Australia, and the United States, and as a result, files numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The fiscal years ended September 30, 2008 through September 30, 2010 are generally still open to examination in the jurisdictions listed above.