NOTE 3: Provision (Benefit) for Income Taxes

The components of the provision (benefit) for income taxes for fiscal 2011, 2010, and 2009 are as follows (in thousands):


	Fiscal 2011			Fiscal 2010			Fiscal 2009
Current:
Federal	$	532		$	239		$	(24	)
State		484			192			273

		1,016			431			249

Deferred:
Federal		7,880			8,801			7,315
State		1,725			1,194			1,117
Change in valuation allowance		(642	)		(457	)		(8,432	)
Valuation allowance release		—			—			(64,753	)

		8,963			9,538			(64,753	)

	$	9,979		$	9,969		$	(64,504	)

Reconciliations of the provision (benefit) for income taxes to the amount of the provision (benefit) that would result from applying the federal statutory rate of 35% to income before provision (benefit) for income taxes for fiscal 2011, 2010, and 2009 are as follows:


	Fiscal 2011			Fiscal 2010			Fiscal 2009
Provision for income taxes at federal statutory rate		35.0	%		35.0	%		35.0	%
State income taxes, net of federal income tax benefit		5.4			3.8			4.7
Charitable contributions		—			4.6			—
Nondeductible interest on secured convertible notes		—			4.6			1.4
Other nondeductible expenses		0.2			0.7			0.5
Valuation allowance		(2.0	)		(3.0	)		(327.7	)
Other		1.2			(1.5	)		(2.6	)

Effective tax rate		39.8	%		44.2	%		(288.7	)%

The major components of the Company's net deferred income tax assets at January 28, 2012, and January 29, 2011, are as follows (in thousands):


	January 28, 2012			January 29, 2011
Deferred rent	$	6,142		$	5,776
Merchandise inventories		1,703			1,640
Difference between book and tax bases of fixed assets		5,355			4,892
State income taxes		(2,131	)		(2,763	)
Supplemental employee retirement plan		897			954
Net operating loss and other tax attribute carryforwards		23,553			35,422
Deferred revenue		5,055			4,301
Stock-based compensation		1,955			1,788
Other		1,384			1,536

		43,913			53,546
Valuation allowance		—			(642	)

Net deferred income tax assets	$	43,913		$	52,904

As a result of the Company's historical operating losses and future projected results, management concluded in fiscal 2004 that it was more likely than not that the Company would not realize its net deferred tax assets. As a result, the Company established a valuation allowance for 100% of its net deferred income tax assets in fiscal 2004. The Company discontinued recording income tax benefits in the consolidated statements of operations from fiscal 2004 through fiscal 2008. At the end of fiscal 2009, the Company determined, based upon the balance of positive and negative evidence, that it was more likely than not that substantially all of the net deferred tax assets will be realized in the future, and the Company reversed $64.7 million of valuation allowance on its deferred tax assets, all of which was recorded to the provision (benefit) for income taxes on the consolidated statement of operations.

During fiscal 2010, the Company implemented a change in tax method, upon filing its 2009 federal income tax return, which resulted in the reduction of deferred tax assets related to its charitable contribution carry forwards of $0.5 million. This decrease was recorded as a deferred income tax charge and increased the Company's effective income tax rate for the year.

The Company's effective income tax rate for fiscal 2011 was approximately 39.8%. Due to its expected utilization of federal and state NOL carry forwards during fiscal 2011, the Company incurred cash payable for income taxes for the fiscal year of approximately 4.9% of pre-tax income, representing the portion of federal and state alternative minimum taxes and state regular income taxes that cannot be offset by NOLs. The difference between the effective income tax rate and the anticipated cash income taxes is recorded as a non-cash provision for deferred income taxes.

As of January 28, 2012, the Company had federal NOL carryforwards of $65.7 million, of which $14.6 million relates to benefits from stock-based compensation. The Company's federal NOL carryforwards begin to expire in 2023. The NOL carryforwards are subject to annual utilization limitations as of January 28, 2012. As of January 28, 2012, the Company also had net federal charitable contribution carryforwards remaining of $0.6 million, alternative minimum tax credits of $2.9 million, which do not expire, and remaining state NOLs of $48.2 million, which are also subject to annual utilization limitations, of which $14.6 million relates to benefits from stock-based compensation.

On an ongoing basis, the Company projects taxable income in future years and establishes a valuation allowance related to the deferred tax assets it anticipates will not be utilized. As of January 28, 2012, the Company has no valuation allowance.

The Company uses the with-or-without method to determine when it will recognize and realize excess tax benefits from stock-based compensation. Under this method, the Company will recognize and realize these excess tax benefits only after it realizes the tax benefits of NOLs from operations.

Section 382 of the Internal Revenue Code ("Section 382") contains provisions that may limit the availability of federal NOL carryforwards to be used to offset taxable income in any given year upon the occurrence of certain events, including significant changes in ownership interests of the Company's common stock. Under Section 382, an ownership change that triggers potential limitations on NOL carryforwards occurs when there has been a greater than 50% change in ownership interest by shareholders owning 5% or more of a company over a period of three years or less. Based on its analyses, the Company had ownership changes in April 2005 and December 2006, which resulted in Section 382 limitations applying to federal NOLs generated prior to those dates, which were approximately $150.6 million.

As a result of those ownership changes, of the Company's $65.7 million of remaining federal NOL carryforwards, the Company may utilize up to $60.9 million to offset taxable income in fiscal 2012 and 2013. The Section 382 limitation is currently under examination by the Internal Revenue Service. Pending the examination results, the NOL utilization could be further limited. The Company may also experience additional ownership changes in the future, which could further limit the amount of federal NOL carryforwards annually available and increase future cash income tax payments. As of January 28, 2012, there have been no ownership changes since 2006.

In addition, the Company may determine that varying state laws with respect to NOL carryforward utilization may result in lower limits, or an inability to utilize loss carryforwards in some states altogether, which could result in the Company incurring additional state income taxes. During fiscal 2008, the State of California passed legislation that suspended the Company's ability to utilize NOL carryforwards to offset taxable income in fiscal 2008 and 2009. In late 2010, the State of California extended such legislation that further suspended use of NOL carryforwards to fiscal 2010 and 2011. As a result, the Company incurred regular state income taxes in California and an increased effective tax rate in fiscal 2008 through 2011.

The Company may also generate income in future periods on a federal alternative minimum tax basis, which would result in alternative minimum taxes payable on a portion of such income.

The Company applies a tax position in a tax return to be recognized in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. These provisions also require that a change in judgment that results in subsequent recognition, derecognition, or change in a measurement of a tax position taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs. These provisions require expanded disclosures, including identification of tax positions for which it is reasonably possible that total amounts of unrecognized tax benefits will significantly change in the next 12 months, a description of tax years that remain subject to examination by major tax jurisdiction, a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of each annual reporting period, the total amount of unrecognized tax benefits or expenses that, if recognized, would affect the effective tax rate, and the total amounts of interest and penalties recognized in the statements of operations and financial position.

The adoption of these provisions had no effect on the Company's consolidated financial statements. At January 28, 2012, the Company had no material unrecognized tax benefits or expenses that, if recognized, would affect the Company's effective income tax rate in future periods. The Company is currently unaware of any issues under review that could result in significant payments, accruals, or material deviations from its recognized tax positions.

The Company recognizes interest and penalties accrued related to unrecognized tax benefits and penalties within its provision for income taxes. The Company had no such interest and penalties accrued at January 28, 2012. Prior to its adoption of these provisions, the Company recognized such interest and penalties, which were immaterial in prior periods, within general and administrative expenses.

The major jurisdictions in which the Company files income tax returns include the United States federal jurisdiction as well as various state jurisdictions within the United States. The Company's fiscal 2008 and thereafter tax returns are subject to examination by the United States federal jurisdiction, and, generally, fiscal 2007 and thereafter tax returns are subject to examination by various state tax authorities. The Company's fiscal 2008 and 2009 income tax returns are currently under examination by the Internal Revenue Service. The Section 382 limitation of the NOL utilization and various other areas are being examined. The Company is also under various state income tax audits. The Company does not expect that the results of the examinations will have a material impact on its financial condition or statement of operations at January 28, 2012.