NOTE 12. Income Taxes

Income before income taxes consisted of the following for the fiscal years ended June 30, 2013, 2012 and 2011:


	Year Ended June 30,
(Amounts in thousands)	2013			2012		2011
Domestic (loss) income	$	(17,164	)	$	16,964	$	5,887
Foreign income		64,815			56,548		43,739
Total income before income taxes	$	47,651		$	73,512	$	49,626

The components of the provision for income taxes for the fiscal years ended June 30, 2013, 2012 and 2011, are as follows:


	Year Ended June 30,
(Amounts in thousands)	2013			2012		2011
Current income taxes
Federal	$	-		$	-	$	(493	)
State		116			148		557
Foreign		7,879			7,182		6,454
Total current provision	$	7,995		$	7,330	$	6,518
Deferred income taxes
Federal	$	(980	)	$	7,591	$	2,200
State		(471	)		815		1,025
Foreign		396			357		(1,106	)
Total deferred provision	$	(1,055	)	$	8,763	$	2,119
Total	$	6,940		$	16,093	$	8,637

The total income tax provision differs from the amount obtained by applying the statutory federal income tax rate to income before income taxes as follows:


							Year Ended June 30,
	2013					2012					2011
(Amounts in thousands, except percentages)		Amount		Rate			Amount		Rate			Amount		Rate
Income tax provision at statutory rates	$	16,678		35.0	%	$	25,729		35.0	%	$	17,369		35.0	%
State taxes, net of federal benefits		(559	)	(1.2	)		526		0.7			714		1.5
Tax on foreign earnings at different rates from statutory rates		(8,792	)	(18.4	)		(9,590	)	(13.0	)		(8,664	)	(17.5	)
Research and development and foreign tax credits		(1,050	)	(2.2	)		(579	)	(0.8	)		(1,291	)	(2.6	)
Change in U.S. and foreign valuation allowance		31		0.1			10		-			(292	)	(0.6	)
Other		632		1.3			(3	)	-			801		1.6
Total	$	6,940		14.6	%	$	16,093		21.9	%	$	8,637		17.4	%

The total income tax provision for the year ended June 30, 2013 in the above table includes out-of-period adjustments of $0.9 million, included in Other, to correct an error related to deferred taxes. Income tax expense increased and net income decreased by $0.9 million. The Company did not adjust the prior periods as it concluded that such adjustments were not material to the current or prior period consolidated financial statements.

On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law by the President of the United States. Under the provisions of the American Taxpayer Relief Act of 2012, the research and development tax credit that had expired December 31, 2011, was reinstated retroactively to January 1, 2012, and is now scheduled to expire on December 31, 2013. The impact of the extension of such tax credit resulted in a net tax benefit of approximately $0.5 million for the fiscal year ending June 30, 2013, of which $0.2 million was recorded as a discrete item.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes plus operating loss carryforwards. The tax effects of significant items comprising the Company's net deferred tax assets and liabilities are as follows:


	As of June 30,
(Amounts in thousands)		2013			2012
Deferred tax assets
Accrued expenses	$	13,319		$	16,734
Accounts receivable		-			652
Stock-based compensation		4,177			4,873
Net operating loss carryforwards		33,276			25,115
Inventory		7,963			6,860
Contingent liabilities		8,866			10,850
Research and development tax incentives, foreign tax credits, alternative minimum tax
and other tax credits		12,027			10,581
Other		6,913			5,447
Gross deferred tax assets	$	86,541		$	81,112


Accounts receivable	$	(805	)	$	-
Property, plant and equipment		(6,029	)		(6,847	)
Intangible assets		(49,403	)		(50,081	)
Other		(4,781	)		(3,962	)
Gross deferred tax liabilities		(61,018	)		(60,890	)
Valuation allowances		(356	)		(325	)
Total net deferred tax assets	$	25,167		$	19,897

The following table represents the classification of the Company's net deferred tax assets and liabilities:


		As of June 30,
(Amounts in thousands)		2013			2012
Current net deferred tax assets	$	31,085		$	37,669
Non-current net deferred tax liabilities		(5,918	)		(17,772	)
Total net deferred tax assets	$	25,167		$	19,897

At June 30, 2013, the Company's consolidated balance sheet includes deferred tax assets of $32.6 million from net operating losses, comprised of $24.0 million and $7.8 million of U.S. federal and state net operating losses, respectively, and $0.8 million of foreign net operating losses. The need for a valuation allowance against domestic deferred tax assets was considered. The Company is in a domestic cumulative taxable loss position for the three-year period ended June 30, 2013, which is considered significant evidence indicating that the Company may not be able to realize some portion or all of these deferred taxes in the future. However, the Company believes, based on the weight of all available evidence, that it is more likely than not that it will generate sufficient domestic taxable income to realize the domestic net operating loss carryforwards before they expire. This conclusion considers available evidence, both positive and negative, including the Company's past operating results and forecast of future taxable income. In determining future taxable income, assumptions utilized include the anticipated amount of pre-tax domestic operating income and enacted tax rates. The Company concluded that the positive evidence supporting the realizability of the domestic deferred tax assets was sufficient, without having to assume the use of potentially available feasible and prudent tax planning strategies. The assumptions utilized in forecasting pre-tax income are based on historical data and expected business cycles. The most recent domestic losses were generated in fiscal years 2008, 2009, and 2013. The losses in fiscal years 2008 and 2009 were mainly attributable to expenses associated with the original Liz Claiborne license agreement and charges related to the Company's Global Efficiency Re-engineering initiative ("Initiative"), and are not considered to be reflective of the core historical earnings of the business. In fiscal 2009, the retail and consumer markets were severely impacted by one of the worst holiday seasons in recent history. The markets have begun to recover, and the Company believes this positive recovery trend will continue and that it will generate pre-tax profits as markets improve. For the year ended June 30, 2013, domestic pre-tax book loss was $17 million, which included $29.3 million of inventory-related costs associated with the 2012 Acquisitions and non-recurring product changeover costs and product discontinuation charges related to the repositioning of the Elizabeth Arden brand. Additionally, the Company has a strong domestic earnings history, including domestic pre-tax book income in fiscal years 2005 through 2007 and 2010 through 2012 ranging from $7.6 million to $28.8 million and $0.2 million to $21.9 million, respectively. These earnings were based on a consistent business model of selling fragrance, skin care and cosmetic products with strong brand recognition. The Company also anticipates that improved pre-tax operating income will continue to result from improved gross margins due to its ongoing strategic and operating initiatives.

At June 30, 2013, the Company had U. S. federal operating loss carryforwards of $105.0 million that will begin to expire on June 30, 2024. The Company had state and local net operating loss carryforwards of $125.9 million that will expire as follows: approximately $2.4 million at June 30, 2014, $18.5 million during the period from 2015 to 2019, and $104.8 million in 2020 and thereafter. An equivalent amount of federal and state taxable income would need to be generated in order to fully realize the U. S. federal and state net deferred tax assets before their expiration. In contrast to the U.S. Internal Revenue Code, many U.S. states do not allow the carryback of a net operating loss in any significant amount or have suspended the utilization of net operating losses for a specific period of time. As a result, in these states the Company's net operating loss carryforwards are significantly higher than the federal net operating loss carryforward. To the extent that the Company does not generate sufficient state taxable income within the statutory carryforward periods to utilize the loss carryforwards in these states, the loss carryforwards will expire unused. The state and local net operating loss carryforwards have an effective tax rate of approximately 5.0%. The Company believes that, based on its projections of future taxable income in its domestic jurisdictions, it will realize these net operating losses before they expire.

At June 30, 2013, the Company had foreign net operating loss carryforwards of approximately $3.8 million that will begin to expire in fiscal year 2014. The Company's ability to use foreign net operating loss carryforwards is dependent on generating sufficient future taxable income prior to their expiration. As a result, an equivalent amount of foreign taxable income would need to be generated in order to fully realize the foreign net operating loss carryforwards. However, due to the uncertainty of achieving sufficient profits to utilize foreign net operating loss carryforwards in certain jurisdictions, and the near-term expiration of certain foreign net operating loss carryforwards, as of June 30, 2013, the Company has recorded a valuation allowance of approximately $0.4 million related to these foreign net operating loss carryforwards.

In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management approved forecasts. This process requires significant judgment by management about matters that are by their nature uncertain. If future events differ significantly from the Company's current forecasts, a valuation allowance may need to be established, which could have a material adverse effect on its results of operations and financial condition. The Company will continue to monitor and update its assumptions and forecasts of future taxable income and assess the need for a valuation allowance.

The Company has not provided for taxes on approximately $334 million of undistributed earnings of foreign subsidiaries, as these earnings are deemed to be permanently reinvested. If in the future these earnings are repatriated to the United States, or if the Company determines such earnings will be remitted in the foreseeable future, additional tax provisions may be required. Due to complexities in the tax laws and the assumptions that would have to be made, it is not practicable to estimate the amounts of income tax provisions that may be required.

Deferred tax assets relating to tax benefits of employee stock option awards have been reduced to reflect stock option exercises during the year ended June 30, 2013. Some exercises resulted in tax deductions in excess of previously recorded benefits based on the option value at the time of grant ("windfalls"). Although the additional tax benefit for the windfalls is reflected in net operating loss carryforwards, the additional tax benefit associated with the windfalls is not recognized for financial statement purposes until the deduction reduces taxes payable. Accordingly, windfall gross tax benefits of $29.2 million are not reflected in deferred tax assets. The deferred tax assets will be recognized with an offset to additional paid-in capital as the windfall reduces current taxes payable.

At June 30, 2013, the total amount of gross unrecognized tax benefits was $11.8 million. These unrecognized tax benefits could favorably affect the effective tax rate in a future period, if and to the extent recognized. Other than with respect to the Internal Revenue Service ("IRS") audit for fiscal years ending June 30, 2008 ("Fiscal 2008") and June 30, 2009 ("Fiscal 2009"), the Company does not expect changes in the amount of unrecognized tax benefits to have a significant impact on its results of operations over the next 12 months.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits as of June 30, 2013, 2012 and 2011 was as follows:


	Year Ended June 30,
(Amounts in thousands)	2013		2012		2011

Beginning balance	$	7,335	$	4,837	$	5,817
Additions based on tax positions related to the current year		3,518		2,428		92
Additions for tax positions of prior years		949		70		27
Reductions for tax positions of prior years		-		-		(138	)
Reductions due to closure of foreign tax audits		-		-		(932	)
Gross balance		11,802		7,335		4,866
Interest and penalties		-		-		(29	)
Ending balance	$	11,802	$	7,335	$	4,837

The Company and its domestic subsidiaries file income tax returns with federal, state and local tax authorities within the United States. The Company also files tax returns for its international affiliates in various foreign jurisdictions. The statute of limitations for the Company's U.S. federal tax returns remains open for the year ended June 30, 2008 and subsequent fiscal years. The IRS began an examination of the Company's U.S. federal tax returns for Fiscal 2008 and Fiscal 2009 during fiscal year 2011 and, in May 2013 issued an IRS Letter 950 ("30-day Letter") for Fiscal 2008 and Fiscal 2009 relating to transfer pricing matters. In the 30-day Letter, the IRS proposed adjustments that would increase the Company's U.S. taxable income for Fiscal 2008 and Fiscal 2009 by approximately $29.1 million, which could be material to the Company's consolidated statements of operations in the period in which resolved unless resolved favorably by the Company. The Company disagrees with the proposed adjustments and has filed a protest commencing the appeals process and intends to vigorously contest them and pursue its available remedies. While any IRS examination contains an element of uncertainty, based on current facts and circumstances, the Company believes the ultimate outcome at IRS appeals or any judicial process, if necessary, will not have a material adverse effect on the Company's financial condition, business or prospects. In addition, if the examination is not resolved favorably, the Company has $105 million of U.S. federal operating loss carryforwards as of June 30, 2013, of which $60 million would be available to offset any cash flow impact. It is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits, but it is not possible to determine either the magnitude or range of any increase or decrease at this time. The year ended June 30, 2004 and subsequent fiscal years remain subject to examination for various state tax jurisdictions. In addition, the Company has subsidiaries in various foreign jurisdictions that have statutes of limitations generally ranging from one to five years. The year ended June 30, 2008 and subsequent fiscal years remain subject to examination for various foreign jurisdictions.

The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and related penalties in the provision for income taxes in the consolidated statement of operations, which is consistent with the recognition of these items in prior reporting periods.