6. Income taxes

Deferred Tax Assets

The net deferred income tax assets at June 30, 2011, include net operating loss and alternative minimum tax carryforwards, capitalized research and development costs, research and development tax credits, non-qualified stock-based compensation expense, deferred warranty revenue, warranty and inventory reserves and accrued vacation, partially offset by accelerated depreciation expense. The Company’s total current and long term deferred tax assets balance at June 30, 2011, is $21.9 million.

In preparing the Company’s consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management considers all available positive and negative evidence, including its operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Management exercises significant judgment in determining its provisions for income taxes, its deferred tax assets and liabilities, and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred tax assets. Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business, as well as the generation of sufficient future taxable income. Management believes that, as of June 30, 2011, based on an evaluation and projections of future sales and profitability for fiscal 2011, no valuation allowance is necessary. However, such deferred tax assets could be reduced in the future if projections of future taxable income during the carryforward period are reduced.

The Company has completed research and development tax credit studies which identified approximately $5.9 million in tax credits for Federal, Arizona and California income tax purposes related to the 2003 through 2010 tax years, net of the federal benefit on the Arizona and California research and development tax credits. Management has made the determination that it is more likely than not that the full benefit of the research and development tax credit will not be sustained on examination and accordingly has established a cumulative liability for unrecognized tax benefits of $2.2 million as of June 30, 2011. In addition, management accrued approximately $106,000 for estimated uncertain tax positions related to certain state income tax liabilities. As of June 30, 2011, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease significantly within the next 12 months. Should the unrecognized tax benefits of $2.3 million be recognized, the Company’s effective tax rate would be favorably impacted.

The following presents a rollforward of our liability for unrecognized tax benefits as of June 30, 2011:


	Unrecognized
	Tax Benefits

Balance at January 1, 2011	$	2,281,840
Decrease in prior year tax positions		—
Increase in current year tax positions		(1,989	)
Decrease related to adjustment of previous estimates of activity		—
Decrease related to settlements with taxing authorities		—
Decrease related to lapse in statute of limitations		—

Balance at June 30, 2011	$	2,279,851

Effective Tax Rate

Our estimated full year effective tax rate, before discrete period adjustments, is approximately 48%, which is above the statutory rate due to the impact of non-deductible expenses for items such as Incentive Stock Option (“ISO”) expense, meals and entertainment and lobbying fees, which make our projected annual net income for tax purposes significantly higher than our book pre-tax income. The overall effective tax rate of 38.9% and 37.1% for the three and six months ended June 30, 2011, was below our estimated annual effective tax rate due to treating the litigation judgment expense, asset impairment expense and the lawsuit settlement proceeds as discrete items due to their significant and unusual nature and therefore taxeffecting them at the statutory rate.