NOTE 7-INCOME TAXES

The Company files income tax returns in the U.S. federal and various state and local jurisdictions and foreign jurisdictions. The components of the provision for income taxes are as follows (in thousands):

	Year Ended December 31,
	2011			2010			2009
Current:
Federal	$	(52	)	$	(154	)	$	(1,973	)
State		69			37			32
Foreign		208			235			338
		225			118			(1,603	)
Deferred:
Federal		(13	)		(45	)		9,686
State		13			45			871
Foreign		18			(116	)		(46	)
		18			(116	)		10,511
Provision for income taxes	$	243		$	2		$	8,908

The Company's deferred tax asset consists of the following (in thousands):

	December 31,
	2011			2010
Net operating loss	$	8,939		$	6,281
Stock-based compensation		6,374			5,644
Other accruals and reserves		3,374			3,385
Credits		2,062			1,488
Capital loss		312			558
Foreign		370			388
Accrued warranty		429			303
Depreciation and amortization		206			146
Other		(143	)		63
Net deferred tax asset before valuation allowance		21,923			18,256
Valuation allowance		(21,553	)		(17,868	)
Net deferred tax asset after valuation allowance	$	370		$	388

The Company's deferred tax asset balance is reported in the following captions in the Consolidated Balance Sheets (in thousands):

	December 31,
	2011			2010
Deferred tax asset (current portion)	$	55		$	63
Deferred tax asset, net of current portion		446			325
Accrued liabilities (current deferred tax liability)		(131	)		-
Net deferred tax asset after valuation allowance	$	370		$	388

The differences between the U.S. federal statutory income tax rate to the Company's effective tax are as follows:

	Year Ended December 31,
	2011			2010*		2009*
U.S. federal statutory income tax rate		35.00	%	35.00	%	35.00	%
State tax rate, net of federal benefit		2.56		2.81		(0.38	)
Benefit for research and development credit		6.02		2.97		1.05
Changes in unrecognized tax benefits		(0.02	)	2.59		0.71
Tax-exempt interest		0.19		0.98		5.42
Meals and entertainment		(0.88	)	(0.63	)	(0.76	)
Foreign income inclusion		(2.15	)	-		(0.32	)
Income tax refund		2.34		(1.13	)	11.00
Stock-based compensation		(9.64	)	(1.54	)	(8.91	)
Adjustment to beginning deferreds for state rate changes		4.30		(0.53	)	(0.47	)
Tax effect of other comprehensive income		(2.01	)	-		-
Valuation allowance		(37.54	)	(38.31	)	(142.18	)
Other		(0.65	)	(2.21	)	(1.73	)
Effective tax rate		(2.48	)%	0.00	%	(101.57	)%

*	Certain items have changed for classification purposes.

The Company recognizes deferred tax assets for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. The Company records a valuation allowance to reduce the deferred tax assets to their estimated realizable value, when it is more likely than not that it will not be able to generate sufficient future taxable income to realize the net carrying value. The Company reviews the deferred tax asset and valuation allowance on a quarterly basis, and considers whether positive and negative evidence exists to effect the realization of deferred tax assets. After considering both the positive and negative evidence as of September 30, 2009, the Company determined that it was not more-likely-than-not that it would realize the full value of its deferred tax assets. As a result, the Company established a valuation allowance of $10.2 million against the net deferred tax asset balance as of December 31, 2008. In addition, the Company recorded a valuation allowance against its deferred tax assets generated in 2009, 2010 and 2011, which resulted in a valuation allowance of $21.6 million as of December 31, 2011.

As of December 31, 2011, the Company had cumulative net operating loss carry-forwards for federal and state income tax reporting purposes of approximately $24.0 million and $9.6 million, respectively. The federal net operating loss carry-forwards expire through the year 2031 and the state net operating loss carry-forwards expire at various dates through the year 2031. Such net operating losses consist of excess tax benefits from employee stock option exercises and have not been recorded in the Company's deferred tax assets. The Company will record approximately $3.9 million as a credit to additional paid in capital as and when such excess tax benefits are ultimately realized.

As of December 31, 2011, the Company had research and development tax credits for federal and state income tax purposes of approximately $3.2 million and $3.6 million, respectively. The federal research and development tax credits expire through the year 2031. The state research and development credits can be carried forward indefinitely, except for $284,000, which will expire at various dates through the year 2020. The Company maintained a valuation allowance against these tax credits as of December 31, 2011. The Tax Reform Act of 1986 and similar state provisions limit the use of net operating loss carryforwards in certain situations where equity transactions result in a change of ownership as defined by Internal Revenue Code Section 382. In the event the Company should experience an ownership change, as defined, utilization of its federal and state net operating loss carryforwards could be limited.

Undistributed earnings of the Company's foreign subsidiaries net of foreign income inclusion of approximately $2.7 million at December 31, 2011, are considered to be indefinitely reinvested and, accordingly, no provision for federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to various foreign countries.

Uncertain Tax Positions

The Company establishes reserves for uncertain tax positions in accordance with the ASC. The subtopic prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Additionally, the subtopic provides guidance on derecognition, measurement, classification, interest and penalties, and transition of uncertain tax positions. The impact of an uncertain income tax position on income tax expense must be recognized at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company has provided taxes and related interest and penalties due for potential adjustments that may result from examinations of open U.S. Federal, state and foreign tax years. If the Company ultimately determines that payment of these amounts are not more-likely-than-not, the Company will reverse the liability and recognize a tax benefit during the period in which the Company makes the determination. The Company will record an additional charge in the Company's provision for taxes in the period in which the Company determines that the recorded tax liability is less than the Company expects the ultimate assessment to be. The Company's policy is to include interest and penalties related to gross unrecognized tax benefits within the provision for income taxes.

The following table summarizes the activity related to the Company's gross unrecognized tax benefits in December 31, 2009 to December 31, 2011 (in thousands):

	Year Ended December 31,
	2011			2010			2009
Balance at beginning of year	$	555		$	787		$	1,640
Increases related to prior year tax positions		-			-			88
Decreases related to prior year tax positions		-			(29	)		(857	)
Increases related to current year tax positions		44			24			29
Decreases related to lapsing of statute of limitations		(16	)		(227	)		(113	)
Balance at end of year	$	583		$	555		$	787

The Company's total unrecognized tax benefits that, if recognized, would affect its effective tax rate were approximately $400,000 and $405,000 as of December 31, 2011 and 2010, respectively. The Company had accrued approximately $79,000 and $71,000 for payment of interest as of December 31, 2011 and 2010, respectively. Interest included in the provision for income taxes was not significant in all the periods presented. The Company has not accrued any penalties related to its uncertain tax positions as it believes that it is more likely than not that there will not be any assessment of penalties. The Company expects that the amount of unrecognized tax benefits will not change within the next 12 months.

The Company files U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2004 through 2011 tax years generally remain subject to examination by U.S., federal and most state tax authorities due to the Company's net operating loss and credit carryforwards. For significant foreign jurisdictions, the 2006 through 2011 tax years generally remain subject to examination by their respective tax authorities.