14. Income Taxes

Income Tax Expense

Income before income taxes consists of the following (in thousands):


		2011		2010		2009
Domestic	$	11,238	$	6,936	$	14,158
Foreign		228		341		196
Income before income taxes	$	11,466	$	7,277	$	14,354

Income tax expense consists of the following (in thousands):


		2011		2010			2009
Current:
Federal	$	2,634	$	4,415		$	225
State		103		255			114
Foreign		84		46			82
		2,821		4,716			421
Deferred:
Federal		1,087		(1,560	)		5,022
State		183		158			255
Foreign		4		19			(23	)
		1,274		(1,383	)		5,254
Income tax expense	$	4,095	$	3,333		$	5,675

The Company's income tax expense in 2011, 2010, and 2009 included the Company's federal, state, and foreign tax obligations. The Company's effective income tax rate was approximately 36%, 46% and 40% for the years ended December 31, 2011, 2010, and 2009, respectively. The Company's effective income tax rate for the year ended December 31, 2011 was impacted by the discrete and favorable effect of deductions taken on the Company's 2010 federal tax returns, which were filed in the third quarter of 2011. This favorable effect was largely offset by the unfavorable tax treatment, recognized in the second quarter of 2011, of certain acquisition related expenses, which the Company incurred related to its acquisition of Cardiogenesis.

The income tax expense amounts differ from the amounts computed by applying the U.S. federal statutory income tax rate of 35% to pretax income as a result of the following (in thousands):


		2011			2010			2009
Tax expense at statutory rate	$	4,013		$	2,547		$	5,024
Increase (reduction) in income taxes resulting from:
Non-deductible transaction costs		540			-			-
State income taxes, net of federal benefit		250			347			321
Equity compensation		149			334			334
Non-deductible entertainment expenses		142			129			129
Foreign income taxes		3			28			26
Domestic production activities deduction		(727	)		-			-
Research and development credit		(314	)		(187	)		(68	)
Other		39			135			(91	)
	$	4,095		$	3,333		$	5,675

Deferred Taxes

The tax effects of temporary differences which give rise to deferred tax assets and liabilities at December 31 are as follows (in thousands):


		2011			2010
Deferred tax assets:
Allowance for bad debts	$	151		$	110
Deferred preservation costs and inventory reserves		699			1,401
Investment in equity securities		802			832
Property		2,380			2,197
Intangible assets		-			440
Accrued expenses		2,859			2,812
Loss carryforwards		11,842			2,942
Credit carryforwards		4,124			4,527
Stock compensation		1,636			1,455
Other		717			716
Less valuation allowance		(2,395	)		(1,771	)
Total deferred tax assets		22,815			15,661

Deferred tax liabilities:
Prepaid items		(348	)		(377	)
Intangible assets		(3,935	)		-
Other		(20	)		(6	)
Total deferred tax liabilities		(4,303	)		(383	)

Total net deferred tax assets	$	18,512		$	15,278

As of December 31, 2011 the Company maintained a total of $2.4 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $18.5 million. As of December 31, 2010 the Company maintained a total of $1.8 million in valuation allowances against deferred tax assets, related to state net operating loss carryforwards, and a net deferred tax asset of $15.3 million.

The increase in the Company's net deferred tax assets is primarily due to the acquisition of Cardiogenesis in the second quarter of 2011, as Cardiogenesis had significant deferred tax assets, primarily due to its net operating loss carryforwards. The Company believes that the realizability of its acquired net operating loss carryforwards will be limited in future periods due to a change in control of its subsidiary Cardiogenesis, as mandated by Section 382 of the Internal Revenue Code of 1986, as amended. The Company believes that its acquisition of Cardiogenesis constitutes a change in control. The deferred tax assets recorded on the Company's Consolidated Balance Sheets do not include amounts that it expects will not be realizable due to this change in control. A portion of the acquired net operating loss carryforwards is related to state income taxes and can only be used by the Company's subsidiary Cardiogenesis. Due to Cardiogenesis' history of losses when operated as a stand-alone company, management believes it is more likely than not that these deferred tax assets will not be realized.

Therefore, the Company recorded a valuation allowance against these state net operating loss carryforwards. See also Note 4 above for a further discussion of the Company's acquisition of Cardiogenesis.

As of December 31, 2011 the Company had approximately $2.9 million of tax-effected state net operating loss carryforwards that will began to expire in 2012, $887,000 in research and development tax credit carryforwards that will begin to expire in 2022, and $180,000 in credits from the state of Texas that will fully expire by 2027. Additionally, at December 31, 2011 the Company had $3.1 million in alternative minimum tax credit carryforwards that do not expire.

Uncertain Tax Positions

A reconciliation of the beginning and ending balances of the Company's uncertain tax position liability, excluding interest and penalties, is as follows (in thousands):


		2011			2010			2009
Beginning balance	$	1,822		$	1,742		$	1,799
Decreases related to prior year tax positions		(112	)		(19	)		(183	)
Increases related to current year tax positions		78			99			136
Settlements		-			-			(10	)
Ending balance	$	1,788		$	1,822		$	1,742

A reconciliation of the beginning and ending balances of the Company's liability for interest and penalties on uncertain tax positions is as follows (in thousands):


		2011			2010		2009
Beginning balance	$	391		$	342	$	431
Accrual of interest and penalties		65			49		83
Decreases related to prior year tax positions		(38	)		-		(172	)
Ending balance	$	418		$	391	$	342

As of December 31, 2011 the Company's total uncertain tax liability including interest and penalties of $2.2 million was recorded as a reduction to deferred tax assets of $309,000 and a non-current liability of $1.9 million on the Company's Consolidated Balance Sheet. As of December 31, 2010 the Company's total uncertain tax liability including interest and penalties of $2.2 million was recorded as a reduction to deferred tax assets of $850,000 and a non-current liability of $1.4 million on the Company's Consolidated Balance Sheet.

Other

The Company's tax years 2008 through 2011 generally remain open to examination by the major taxing jurisdictions to which the Company is subject. However, certain returns from years prior to 2008 in which net operating losses and tax credits have arisen are still open for examination by the tax authorities.