Note 8—Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands):

	December 31, 2011			January 1, 2011

Deferred tax assets:
Reserves and allowances	$	1,995		$	1,844
State taxes, net of federal income tax benefit		—			1
Depreciation and amortization		682			375
Other accruals		331			316
Compensatory stock options and rights		2,150			1,949
Other		25			48
Tax credit carryforwards		1,949			1,296
Operating loss carryforward		12,306			11,513
Foreign operating loss carryforward		1,031			878

Total deferred tax assets		20,469			18,220

Deferred tax liabilities:
Prepaid expenses		(199	)		(203	)

Total deferred tax liabilities		(199	)		(203	)

Subtotal		20,270			18,017

Valuation allowance		(20,270	)		(18,017	)

	$	—		$	—

The Company evaluates whether a valuation allowance should be established against its deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. In making such judgments, significant weight is given to evidence that can be objectively verified. As of December 31, 2011 and January 1, 2011, a valuation allowance of $20.3 million and $18.0 million, respectively, has been provided based on the Company's assessment that it is more likely than not, that sufficient taxable income will not be generated to realize the tax benefits of the temporary differences. The valuation allowance increased by approximately $2.3 million and $5.9 million during the years ended December 31, 2011 and January 1, 2011, respectively, primarily related to the increase in the net operating loss carryforward.

At December 31, 2011, the Company has approximately $32.3 million of federal net operating loss ("NOL") carryforwards which begin to expire in year 2029, and approximately $24.2 million of state net operating loss carryforwards which begin to expire in year 2017, and Federal and state tax credit carryforwards of approximately $0.9 million and $1.0 million, respectively at December 31, 2011. Federal tax credit carryforwards begin to expire in 2026 and state tax credits carry forward indefinitely. In addition, the Company has approximately $7.6 million of operating loss carryforwards in the PRC that begin to expire in 2012.

The deferred tax asset at December 31, 2011 does not include approximately $1.4 million and $1.6 million of excess tax benefits from employee stock option exercises that are a component of the federal and state net operating loss carryover, respectively. The Company's stockholders' equity balance will be increased if and when such excess tax benefits are ultimately realized.

For financial reporting purposes, loss before benefit of income taxes includes the following components (in thousands):

	Year Ended

	December 31, 2011			January 1, 2011
United States	$	(4,207	)	$	(13,827	)
Foreign		(1,445	)		(2,002	)

	$	(5,652	)	$	(15,829	)

The Company's income tax benefit consists of the following (in thousands):

	Year Ended

	December 31, 2011			January 1, 2011
Current:
Federal	$	(55	)	$	(728	)
State		2			14

Total current		(53	)		(714	)

Deferred:
Federal		(1,516	)		(4,209	)
State		(582	)		(894	)
Foreign		(157	)		(801	)
Change in valuation allowance		2,255			5,904

Total deferred		—			—

Income tax benefit	$	(53	)	$	(714	)

During 2010, the Company carried back approximately $1.7 million of gross net operating losses under the Worker, Homeownership, and Business Act and received a federal income tax refund of approximately $0.7 million. During 2011, the Company reduced its unrecognized tax benefits by approximately $0.1 million as a result of a lapse in a federal statute of limitations.

A reconciliation of income taxes computed by applying the statutory U.S. income tax rate to the Company's loss before income taxes to the income tax benefit is as follows:

	Year Ended

	December 31, 2011			January 1, 2011
U.S. federal statutory tax		35	%		35	%
Valuation allowance		(25	)		(26	)
Loss from foreign subsidiary		(9	)		(4	)

Effective income tax benefit rate		1	%		5	%

Unrecognized Tax Benefits

The following table summarizes the activity related to the Company's unrecognized tax benefits (in thousands):


Balance at January 2, 2010	$	77
Reversal of liability for expiration of statute of limitations		—
Accrual of potential interest related to unrecognized tax benefits		—

Balance at January 1, 2011		77
Reversal of liability for expiration of statute of limitations		(55	)
Accrual of potential interest related to unrecognized tax benefits		—

Balance at December 31, 2011	$	22

Unrecognized tax benefits of tax positions, if recognized, would affect the Company's annual effective tax rate.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. Interest and penalty accruals were insignificant at December 31 and January 1, 2011.

The Company files tax returns with federal, state and foreign jurisdictions. The Company is no longer subject to IRS or state examinations for periods prior to 2007 although certain carryforward attributes that were generated prior to 2007 may still be adjusted by the IRS.

Tax Holidays

In 2008, the Company began operating under tax holidays in the PRC, which are effective from January 2008 through December 2012. Since the Company operated at a loss in the PRC in 2011 and 2010, it did not realize any benefit to its consolidated results of operations attributable to the tax holidays.