NOTE 12—INCOME TAXES

The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.

As of March 31, 2013, the Company had net operating loss (“NOL”) carryforwards for federal and state purposes of approximately $69.5 million and $45.3 million, respectively, which begin to expire in 2013. The utilization of NOL and credit carryforwards may be limited under the provisions of the Internal Revenue Code (“IRC”) Section 382 and similar state provisions. IRC Section 382 generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income where a corporation has undergone significant changes in stock ownership. During the year ended December 31, 2006, the Company completed an analysis to determine the potential applicability of any annual limitations imposed by IRC Section 382. Based on the analysis, management determined that there was no significant IRC Section 382 limitation. As of March 31, 2013, the Company had research and development tax credit carryforwards for federal and state purposes of approximately $954,000 and $516,000, respectively, which will begin to expire in 2018 for federal purposes and will carryforward indefinitely for state purposes. An updated analysis may be required at the time the Company begins utilizing any of its net operating losses to determine if there is an IRC Section 382 limitation.

Accounting for uncertainty in income taxes prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company has elected to classify interest and penalties as a component of its income tax provision. For the three months ended March 31, 2013 and 2012, the Company recorded an increase of $0 and $1,000, respectively, with respect to the liability for unrecognized tax benefits, including related estimates of penalties and interest.

During the three months ended March 31, 2013, the Company reversed certain deferred tax liabilities associated with international operations and research and development credits resulting in a tax benefit of approximately $214,000.

During the three months ended March 31, 2013, the Company recorded an income tax benefit of $158,000 based on its projected annual effective tax rate of 4.9% for the year ending December 31, 2013. The effective tax rate differs from the statutory tax rate of 34% primarily due to the existence of valuation allowances against net deferred tax assets and current liabilities resulting from the estimated state income tax liabilities and federal alternative minimum tax liability.

Recently enacted tax laws may also affect the tax provision on the Company’s financial statements. The state of California requires the use of a single sales factor apportionment formula for tax years beginning on or after January 1, 2013. The Company’s state deferred tax assets will be revalued to account for the change in the tax law during the quarter ending June 30, 2013. The Company records a full valuation allowance against the state deferred tax assets therefore the California apportionment mandate is not expected to have a material impact on the Company’s consolidated financial statements.