Note 8. Income Taxes

The Company adjusts its effective tax rate each quarter based on its current estimated annual effective tax rate. The Company also records the tax impact of certain discrete items, unusual or infrequently occurring tax events and the effects of changes in tax laws or rates, in the interim period in which they occur. In addition, the Company evaluates its deferred tax assets quarterly to determine if a valuation allowance is required.

The Company considered whether a valuation allowance should be recorded against deferred tax assets based on the likelihood that the benefits of the deferred tax assets would or would not ultimately be realized in future periods. In making this assessment, significant weight was given to evidence that could be objectively verified such as recent operating results and less consideration was given to less objective indicators such as future earnings projections.

After consideration of positive and negative evidence, including the recent history of losses, the Company cannot conclude that it is more likely than not to generate future earnings sufficient to realize the Company’s deferred tax assets. Accordingly, the Company increased its valuation allowance by $3.1 million in the fiscal quarter ended September 30, 2011 to $63.5 million.

A summary of the income tax expense recorded for the three months ended September 30, 2011 and 2010 is as follows:


	Three Months Ended September 30,
	2011			2010
(In thousands)	(Unaudited)
Loss before taxes	$	(7,238	)	$	(9,512	)

Income tax benefit at federal statutory rate		(2,461	)		(3,234	)
State income taxes and credits		(280	)		(406	)
Dividends received deduction		(50	)		(416	)
Valuation allowance		3,082			4,365
Other permanent items		55			52

Income tax expense	$	346		$	361

As of September 30, 2011 and June 30, 2011 the Company had not recognized the following tax benefits in its consolidated financial statements:


	As of
	September 30, 2011		June 30, 2011
(In thousands)	(Unaudited)
Total unrecognized tax benefits*	$	3,902	$	3,902
Unrecognized benefits that, if recognized, would affect the Company’s effective tax rate, subject to the valuation allowance*	$	3,637	$	3,637

*	Excluding interest and penalties

The Internal Revenue Service completed an audit of the Company’s open tax years in December 2010. The Company is currently appealing the result of this audit. The State of California is currently conducting examinations of the Company’s tax returns for the years ended June 30, 2006 and 2007 and the Company is in settlement negotiations with the State of California regarding its audit of the Company’s June 30, 2002 to June 30, 2005 R&D tax credit claims. The Company believes it is reasonably possible that $3.6 million of its total unrecognized tax benefits could be released in the next twelve months upon the conclusion of these examinations.