Note 11 — Income Taxes

STAAR is subject to income taxes in the U.S. and numerous foreign jurisdictions. In evaluating STAAR’s ability to recover the deferred tax assets within a jurisdiction from which they arise, management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of recent operations. In projecting future taxable income, STAAR begins with historical results and incorporates assumptions including overall current and projected business and industry conditions, the amount of future federal, state, and foreign pretax operating income, the reversal of temporary differences and the successful implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates STAAR uses to manage the underlying businesses. In evaluating the objective evidence that historical results provide, STAAR considers three years of cumulative operating results. Valuation allowances, or reductions to deferred tax assets, are recognized if, based on the weight of all the available evidence, it is more likely than not that some portion or all of the deferred tax asset may not be realized.

STAAR Surgical Company acquired its remaining ownership interest in STAAR Japan in 2008. Based on management's assessment of all available evidence at the time, including STAAR Japan’s history of cumulative losses, STAAR concluded it was more likely than not that the net deferred tax assets would not be realized, and accordingly, a full valuation allowance was established. As of December 28, 2012, STAAR Japan’s valuation allowance was approximately $1.0 million.

During 2011 and 2012, STAAR was engaged in a global restructuring strategy to consolidate global manufacturing into the U.S. to reduce costs, improve gross profit, enable use of $122.5 million in net operating loss carryforwards in the U.S., and reduce income taxes in foreign jurisdictions. At the time, STAAR manufactured its products in three facilities one of each located in the U.S., Switzerland and Japan. Since that time, STAAR has developed and begun implementing a plan to consolidate its manufacturing into a single site at its Monrovia, California location, to be completed by the middle of 2014. During 2013, STAAR completed the transfer of the manufacturing operations in Japan to the U.S.

An important change in connection with this global restructuring strategy was the conversion of STAAR Japan from a traditional principal manufacturer with unlimited manufacturing and inventory risk to a limited-risk distributor, or LRD. As an LRD, STAAR Japan has no risks of manufacturing and very limited risk of maintaining inventory. This conversion was accomplished by contractually shifting these risks from STAAR Japan to STAAR AG, another wholly owned subsidiary of STAAR, as part of this global restructuring strategy.

STAAR Japan, although legally converted to an LRD at the end of 2012, continued to sell off its on-hand inventory from the end of 2012 through the first six months of 2013; consequently, it retained that inventory risk and functioned substantively as a principal entrepreneur during that period. Beginning in the third quarter of 2013, STAAR Japan began to operate as an LRD, both legally and economically, for STAAR AG. STAAR AG contractually assumed full principal manufacturing responsibility for its LRD (STAAR Japan), thereby allowing STAAR Japan to completely transfer the risks of being a principal manufacturer to STAAR AG. As a result of this change to an LRD, in the normal course of business, STAAR Japan no longer bears the risks of manufacturing its inventory and operates as a limited-risk distributor for STAAR AG. STAAR AG has engaged STAAR U.S. as its contract manufacturer for all of STAAR AG’s territory, including for Japan and China. Also, beginning in the third quarter of 2013, STAAR AG began selling inventory to STAAR Japan in order for STAAR Japan to market and distribute the products in its territory, principally in Japan and China, as an LRD. As a limited-risk distributor, STAAR Japan is contractually guaranteed to earn a fixed return on its net sales. The rate of return is consistent with what a limited-risk distributor would earn in a distribution agreement of similar risks and responsibilities with an unrelated party as determined by formal transfer price studies conducted by STAAR in connection with its global manufacturing consolidation strategy.

As a result of this change from a principal manufacturer to a limited-risk distributor with a guaranteed return, STAAR Japan has achieved a three-year cumulative pretax income in the third quarter of 2013, as measured from the beginning of the fourth quarter of 2010 through the end of the third quarter of 2013. Based on these results and management’s consideration of all available positive and negative evidence, including the projected pretax income that STAAR Japan is contractually guaranteed to earn as an LRD, management concluded that, at September 27, 2013, it is more likely than not that STAAR Japan’s deferred tax assets would be realized. Accordingly, STAAR Japan fully released its remaining valuation allowance against net deferred tax assets based on the weight of positive evidence that existed at September 27, 2013. This release amounted to approximately $433,000 of income tax benefit recorded in the consolidated financial statements for the three and nine months ended September 27, 2013 (as translated using the Japanese Yen exchange rate on September 27, 2013). The valuation allowance as of December 28, 2012 of $1.0 million was reduced to $433,000 primarily due to the utilization of STAAR Japan’s net operating loss carryover during the nine months ended September 27, 2013.