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 Company's loss before provision for income taxes consisted of the following (in thousands):

	Year Ended December 31,
	2012			2011			2010
U.S.	$	(6,767	)	$	(10,458	)	$	(11,114	)
Foreign		437			640			598
Loss before income taxes	$	(6,330	)	$	(9,818	)	$	(10,516	)

The components of the provision for income taxes are as follows (in thousands):

	Year Ended December 31,
	2012			2011			2010
Current:
Federal	$	(13	)	$	(52	)	$	(154	)
State		(56	)		69			37
Foreign		366			208			235
		297			225			118
Deferred:
Federal		(12	)		(13	)		(45	)
State		—			13			45
Foreign		(67	)		18			(116	)
		(79	)		18			(116	)
Provision for income taxes	$	218		$	243		$	2

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

	December 31,
	2012			2011(1)
Net operating loss	$	9,409		$	8,660
Stock-based compensation		6,560			6,374
Other accruals and reserves		3,259			3,374
Credits		2,261			2,062
Capital loss		796			312
Foreign		436			370
Accrued warranty		466			429
Depreciation and amortization		180			206
Other		(31	)		(143	)
Net deferred tax asset before valuation allowance		23,336			21,644
Valuation allowance		(22,906	)		(21,274	)
Net deferred tax asset after valuation allowance	$	430		$	370

(1) The Company revised the 2011 tax footnote to reduce deferred tax assets by approximately $280,000 related to future tax benefits for net operating losses that were not properly recorded in the previous period. This reduction in deferred taxes was offset by a corresponding reduction in the valuation allowance, and as such had no impact to the Consolidated Financial Statements, earnings per share, statement of cash flows, or statement of equity for any period presented.

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

	December 31,
	2012			2011
Deferred tax asset (current portion)	$	40		$	55
Deferred tax asset, net of current portion		553			446
Accrued liabilities (current deferred tax liability)		(163	)		(131	)
Net deferred tax asset after valuation allowance	$	430		$	370

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

	Year Ended December 31,
	2012			2011	*	2010	*
U.S. federal statutory income tax rate		35.00	%	35.00	%	35.00	%
State tax rate, net of federal benefit		3.28		2.56		2.81
Benefit for research and development credit		3.40		6.02		2.97
Changes in unrecognized tax benefits		1.06		(0.02	)	2.59
Foreign income inclusion		(0.05	)	(2.15	)	—
Income tax refund		1.07		2.34		(1.13	)
Stock-based compensation		(16.95	)	(9.64	)	(1.54	)
Tax effect of other comprehensive income		0.28		(2.01	)	—
Valuation allowance		(25.51	)	(34.70	)	(38.31	)
Other		(5.03	)	.12		(2.39	)
Effective tax rate		(3.45	)%	(2.48	)%	0.00	%

*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 has recorded a full valuation allowance against its U.S. federal and state deferred tax assets due to its history of operating losses.

As of December 31, 2012, the Company had cumulative net operating loss carry-forwards for federal and state income tax reporting purposes of approximately $25.5 million and $9.2 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 2032. Included in the net operating loss carryforwards are approximately $4.0 million of excess tax benefits from employee stock option exercises, for which the Company has not recorded a deferred tax asset. When such excess tax benefits are ultimately realized, the Company will record the deferred tax asset and the credit to additional paid in capital.

As of December 31, 2012, the Company had research and development tax credits for federal and state income tax purposes of approximately $3.2 million and $4.0 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, 2012.

The Tax Reform Act of 1986 and similar state provisions limit the use of net operating loss and research and development credit carry-forwards 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 carry-forwards and credits could be limited and may expire unutilized.

Undistributed earnings of the Company's foreign subsidiaries net of foreign income inclusion of approximately $2.9 million at December 31, 2012, are considered to be indefinitely reinvested and, accordingly, no provision for federal and state income taxes has been provided thereon. Depending on the timing and nature of the distribution, if the total undistributed earnings of foreign subsidiaries were remitted while the Company is able to utilize its net operating losses, it is likely there would be no material additional tax resulting from the distribution.

Uncertain Tax Positions

The Company establishes reserves for uncertain tax positions based on 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 Company files U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2004 through 2012 tax years generally remain subject to examination by U.S., federal and California state tax authorities due to the Company's net operating loss and credit carryforwards. For significant foreign jurisdictions, the 2007 through 2012 tax years generally remain subject to examination by their respective tax authorities.

The following table summarizes the activity related to the Company's gross unrecognized tax benefits in December 31, 2010 to December 31, 2012 (in thousands):

	Year Ended December 31,
	2012			2011			2010
Balance at beginning of year	$	583		$	555		$	787
Increases related to prior year tax positions		—			—			—
Decreases related to prior year tax positions		—			—			(29	)
Increases related to current year tax positions		29			44			24
Decreases related to lapsing of statute of limitations		(76	)		(16	)		(227	)
Balance at end of year	$	536		$	583		$	555

The Company's total unrecognized tax benefits that, if recognized, would affect its effective tax rate were approximately $325,000 and $400,000 as of December 31, 2012 and 2011, respectively. The Company had accrued approximately $86,000 and $79,000 for payment of interest as of December 31, 2012 and 2011, 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 materially change within the next 12 months.