Income Taxes

(Loss) income before (benefit from) provision for income taxes consists of the following:



	Fiscal Years Ended July 31,
	2016			2015	2014
U.S.	$	(7,666,000	)	33,425,000	36,885,000
Foreign	(526,000		)	578,000	1,622,000
	$	(8,192,000	)	34,003,000	38,507,000

The (benefit from) provision for income taxes included in the accompanying Consolidated Statements of Operations consists of the following:



	Fiscal Years Ended July 31,
	2016			2015		2014
Federal – current	$	2,297,000		12,367,000		11,629,000
Federal – deferred	(2,930,000		)	(2,342,000	)	(368,000	)

State and local – current	408,000			931,000		1,623,000
State and local – deferred	(310,000		)	(25,000	)	(33,000	)

Foreign – current	81,000			(173,000	)	506,000
Foreign – deferred	—			—		(1,000	)
(Benefit from) provision for income taxes	$	(454,000	)	10,758,000		13,356,000

The (benefit from) 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,
	2016					2015				2014
	Amount			Rate		Amount		Rate		Amount		Rate
Computed “expected” tax expense	$	(2,867,000	)	35.0	%	11,901,000		35.0	%	13,477,000		35.0	%
Increase (reduction) in income taxes resulting from:
State and local income taxes, net of Federal benefit	23,000			(0.3	)	720,000		2.1		1,172,000		3.1
Nondeductible stock-based compensation	68,000			(0.8	)	86,000		0.2		70,000		0.2
Domestic production activities deduction	(198,000		)	2.4		(1,030,000	)	(3.0	)	(912,000	)	(2.4	)
Research and experimentation credits	(1,106,000		)	13.5		(793,000	)	(2.3	)	(506,000	)	(1.3	)
Acquisition-related tax contingencies	1,962,000			(24.0	)	—		—		—		—
Nondeductible transaction costs	1,279,000			(15.6	)	—		—		—		—
Foreign income taxes	289,000			(3.5	)	(372,000	)	(1.1	)	(62,000	)	(0.2	)
Other	96,000			(1.2	)	246,000		0.7		117,000		0.3
(Benefit from) provision for income taxes	$	(454,000	)	5.5	%	10,758,000		31.6	%	13,356,000		34.7	%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at July 31, 2016 and 2015 are presented below.



	2016			2015
Deferred tax assets:
Inventory and warranty reserves	$	8,383,000		8,457,000
Compensation and commissions	5,842,000			1,712,000
Federal, state and foreign research and experimentation credits	16,364,000			4,223,000
Stock-based compensation	5,743,000			4,788,000
Acquisition-related contingent liabilities	12,929,000			—
Federal and state NOLs	25,760,000			—
Other	10,885,000			2,738,000
Less valuation allowance	(9,624,000		)	(4,442,000	)
Total deferred tax assets	76,282,000			17,476,000
Deferred tax liabilities:
Plant and equipment	(1,882,000		)	—
Intangibles	(84,198,000		)	(9,317,000	)
Total deferred tax liabilities	(86,080,000		)	(9,317,000	)
Net deferred tax (liabilities) assets	$	(9,798,000	)	8,159,000

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.

At July 31, 2016, we had approximately $64,938,000 of U.S. Federal net operating loss carryforwards reflected in deferred tax assets. Of the total loss carryforwards, approximately $3,806,000 is the remaining net operating loss carryforwards acquired with Xypoint by TCS in 2001, usable at the rate of $1,401,000 per year, and which will expire in 2021 if unused at that time. Additional U.S. Federal net operating loss carryforwards which were generated by TCS in 2013 and the period from January 1, 2016 through February 22, 2016 in the amount of approximately $59,673,000 usable at a rate of approximately $9,021,000 per year, will begin to expire in 2033. The remaining U.S. Federal net operating loss carryforwards generated in the current year of approximately $1,459,000 will expire in 2036.

At July 31, 2016, we had Federal alternative minimum tax credit carryforwards of approximately $2,288,000, which are available to offset future regular Federal taxes. We have Federal research and experimentation credits of approximately $9,475,000 that will begin to expire in 2019. We believe that it is more likely than not that the benefit from certain Federal research and experimentation credits will not be realized. In recognition of this risk, we have provided a valuation allowance of approximately $667,000 on the deferred tax assets relating to these credit carryforwards. The timing and manner in which we may utilize net operating loss carryforwards and tax credits in future tax years will be limited by the amounts and timing of future taxable income and by the application of the ownership change rules under Section 382 and 383 of the Internal Revenue Code.

We have state net operating loss carryforwards available of approximately $3,032,000 which expire through 2036, utilization of which will be limited in a manner similar to the Federal net operating loss carryforwards. We believe that it is more likely than not that the benefit from certain state net operating loss carryforwards will not be realized. In recognition of this risk, we have provided a valuation allowance of approximately $1,784,000 on the deferred tax assets relating to these state net operating loss carryforwards. We have state research and experimentation credits of approximately $5,777,000 expiring through 2036. We believe that it is more likely than not that the benefit from certain research and experimentation credits will not be realized. In recognition of this risk, we have provided a valuation allowance of approximately $5,511,000 on the deferred tax assets relating to these state credits.

At July 31, 2016 and 2015, our 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. Our foreign earnings and profits are insignificant and, as such, we have not recorded any deferred tax liability on unremitted foreign earnings.

We must generate approximately $204,900,000 of taxable income in the future to fully utilize our net deferred tax assets as of July 31, 2016. 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, at July 31, 2016, we had a hypothetical additional paid-in capital ("APIC") pool related to stock-based compensation of $16,937,000. 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 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, 2016 and 2015, total unrecognized tax benefits were $9,171,000 and $2,796,000, respectively, including interest of $63,000 and $68,000, respectively. At July 31, 2016, $2,992,000 of our unrecognized tax benefits were recorded as non-current income taxes payable in our Consolidated Balance Sheet. The remaining unrecognized tax benefits of $6,179,000 were presented as an offset to the associated non-current deferred tax assets in our Consolidated Balance Sheet. At July 31, 2015, $1,573,000 of our unrecognized tax benefits were recorded as non-current income taxes payable in our Consolidated Balance Sheet. The remaining unrecognized benefit of $1,223,000 was presented as an offset to the associated non-current deferred tax assets in our Consolidated Balance Sheet. Of the total unrecognized tax benefits, $8,261,000 and $2,138,000 at July 31, 2016 and 2015, 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. We do not expect that there will be any significant changes to our total unrecognized tax benefits within the next twelve months.

On August 1, 2015, we adopted FASB ASU No. 2015-17, "Balance Sheet Classification of Deferred Taxes" on a prospective basis. This FASB ASU requires that deferred tax assets and liabilities be classified as non-current in a statement of financial position. At July 31, 2016, this FASB ASU resulted in a reclassification of our net deferred tax assets and liabilities to the net non-current deferred tax liability in our Consolidated Balance Sheet. No prior periods were retrospectively adjusted.

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 2016, 2015 and 2014 (excluding interest):



	2016			2015		2014
Balance at beginning of period	$	2,728,000		2,703,000		2,873,000
Increase related to current period	2,487,000			410,000		374,000
Increase related to prior periods	4,490,000			144,000		20,000
Expiration of statute of limitations	(580,000		)	(468,000	)	(496,000	)
Decrease related to prior periods	(17,000		)	(61,000	)	(68,000	)
Balance at end of period	$	9,108,000		2,728,000		2,703,000

In the first quarter of fiscal 2017, we reached an effective settlement with the IRS relating to its audit of our Federal income tax return for fiscal 2014. Our Federal income tax returns for fiscal 2013 and 2015 are also subject to potential future IRS audit. None of our state income tax returns prior to fiscal 2012 are subject to audit. TCS's Federal income tax returns for calendar year 2013 through 2015 are subject to potential future IRS audit. None of TCS's state income tax returns prior to calendar year 2011 are subject to audit. Future tax assessments or settlements could have a material adverse effect on our consolidated results of operations and financial condition.