6. INCOME TAXES

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


	2012		2011		2010
	(in thousands)

Domestic	$	1,253	$	257	$	399
Foreign		(169)		(90)		18

Total	$	1,084	$	167	$	417

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


	2012		2011		2010
	(in thousands)
Current:
Federal	$	4	$	-	$	-
State		21		11		17
Foreign		25		25		26
		50		36		43

Deferred:
Federal		(391)		(185)		390
State		(3)		(1)		(168)
Change in valuation allowance		394		185		(228)
		-		(1)		(6)

Total provision	$	50	$	35	$	37

At September 30, 2012, the Company had U.S. federal tax loss carryforwards of approximately $6.9 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 $1.7 million in state tax loss carryforwards, which also expire at various dates through 2031. These loss carryforwards are available to reduce future federal, state and foreign taxable income but are subject to review and possible adjustment by the appropriate taxing authorities. The loss carryforwards, which may be utilized in any future period, may be subject to limitations based upon changes in the ownership of the Company’s stock. An alternative minimum tax credit of approximately $154,000 is available to offset future regular federal taxes. Research and development credits of approximately $778,000 expire beginning in 2019. In addition, the Company has the following net operating loss carryforwards: United Kingdom losses of $7.4 million with no expiration date, Australia losses of $3.7 million with no expiration date and Germany losses of $691,000 with no expiration date.

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


	2012		2011		2010
	(in thousands)
Deferred tax liabilities:
Prepaid expenses	$	(47)	$	(91)	$	(37)
Acquired intangibles		-		(40)		(43)
		(47)		(131)		(80)
Deferred tax assets:
Net operating loss carryforwards		5,493		5,146		4,793
Research and development credits		778		624		571
Alternative minimum tax credits		154		164		164
Accounts and notes receivable reserves		105		27		48
Depreciation and amortization		1,446		1,241		1,412
Deferred rent		-		-		21
Other		(300)		165		122
		7,676		7,367		7,131

Total		7,629		7,236		7,051

Valuation allowance		(7,629)		(7,236)		(7,051)

Deferred tax liability, net	$	-	$	-	$	-

The valuation allowance relates to the Company’s U.S. and foreign net operating losses and other deferred tax assets and is recorded based upon the uncertainty surrounding their realizability, as these assets can only be realized via profitable operations in the respective tax jurisdictions. The Company records a deferred tax asset or liability based on the difference between the financial statement and tax basis of assets and liabilities, as measured by enacted tax rates assumed to be in effect when these differences reverse. In evaluating the Company’s ability to recover its deferred tax assets, the Company considers all available positive and negative evidence including its past operating results, the existence of cumulative income in the most recent fiscal years, changes in the business in which the Company operates and its forecast of future taxable income. In determining future taxable income, the Company is responsible for assumptions utilized including the amount of federal, state and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies.

These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates that the Company is using to manage the underlying business. Despite having net income for book purposes, the Company has experienced cumulative tax losses on a three year running basis covering the years ended September 30, 2012, 2011 and 2010. Accordingly, as of September 30, 2012, the Company determined that it is more likely than not that the deferred tax assets will not be realized and a full valuation allowance has been recorded.

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, 2012, 2011 and 2010 (in thousands):


	2012		2011		2010

Provision at federal statutory rate	$	369	$	57	$	142
State, net of federal impact		14		7		(99)
Foreign income taxes		25		25		26
Valuation allowance increase (decrease)		394		185		(228)
Return to provision adjustments		(256)		(181)		147
Foreign deferred tax asset rate change and true-up		(369)		-		-
Other		(127)		(58)		49

Provision for income taxes	$	50	$	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, 2011 and 2012, the Company increased its tax liability by $25,000, resulting in a cumulative tax liability of $200,000 at September 30, 2012. 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 and 2012, the Company released portions of its reserve for uncertain tax positions and recorded benefits of $2,000 and $9,000, respectively.

As of October 1, 2010, the Company had approximately $826,000 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, 2011 and 2012 was as follows (in thousands):


Balance at October 1, 2010	$	826
Additions for prior year tax positions		24
Balance at September 30, 2011		850
Additions for prior year tax positions		16
Balance at September 30, 2012	$	866

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, Singapore, 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, 2009 through September 30, 2011 are generally still open to examination in the jurisdictions listed above.