5. Income Taxes

The Company has a domestic net operating loss (NOL) and tax credit carryforwards of approximately $13.0 million and $5.9 million, respectively, as of October 1, 2011. In accordance with ASC 740, Income Taxes, management assessed the Company's recent operating results and estimated future taxable income. Based on the Company's increased profitability and estimated future repatriation from foreign subsidiaries, the Company determined it is more likely than not that the NOL's and a majority of the tax credits would be fully utilized prior to their expiration. The Company has a valuation allowance of approximately $0.7 million related to certain of the research and development tax credits at October 1, 2011 and July 2, 2011.

The Company expects to repatriate a portion of its foreign earnings based on increased sales growth driving additional capital requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company expects to repatriate approximately $8 million in the future. As such, earnings are recognized in the United States, and the Company would be subject to U.S. federal income taxes and potential withholding taxes in foreign jurisdictions. Both the domestic tax and estimated withholding tax have been recorded as part of deferred taxes as of October 1, 2011. Included in tax credits is $2.7 million related to foreign tax credits that can be used to offset future domestic income tax. All other unremitted foreign earnings are expected to remain permanently reinvested in planned fixed assets purchases in foreign locations.

The Company has a wholly owned foreign subsidiary in Mexico that utilizes certain tax credits related to production assets that currently offset all of the income tax liabilities under general Mexican income tax law. However, the Company is subject to a Mexican business flat tax called Impuesto Empresarial a Tasa Unica (IETU). The Company anticipates that it will be taxable under IETU for the foreseeable future based on projected assets used in its operations. The effect of IETU and an associated presidential decree has been included in the effective tax rate for the quarter ending October 1, 2011.

The Company is required to pay taxes in China on its statutory foreign profits. Its subsidiary in China did not have statutory profits during the quarter ended October 1, 2011. However, the Company anticipates generating future taxable income in China and also anticipates utilizing the reminder of its Chinese NOL's. Accordingly, there is no valuation allowance related to the Chinese NOL.

The Company's effective tax rate differs from the federal tax rate as follows (in thousands):


	October 1, 2011			October 2, 2010
Federal income tax provision at statutory rate	$	514		$	868
Foreign earnings taxed at lower rates		(45	)		(39	)
Effect of foreign currency rate changes		(258	)		—
Change in valuation allowance		—			61
Other		54			(80	)

Income tax provision	$	265		$	810

ASC 740 requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. During the fourth quarter of the year ended July 2, 2011, the Company recorded an unrecognized tax benefit of approximately $0.8 million which is related to certain R&D tax credits generated in 2010 and prior years. No additional unrecognized tax benefits were recognized during the quarter ending October 1, 2011. The Company is finalizing the R&D credit study which was begun in the prior fiscal year. At this time, it is anticipated that additional gross credits and additional unrecognized tax benefit may be recorded in the future. However, at this time, management is not able to accurately estimate these amounts. Accordingly, no additional tax benefit or uncertain tax position has been recognized during the first quarter.

The July 2, 2011 balance sheet in the accompanying financial statements includes two reclassifications that were not reflected in the July 2, 2011 Form 10-K. The reclassifications decreased the short term deferred tax asset by approximately $0.6 million with a corresponding decrease in the current portion of the deferred tax liability. There was also a reclassification to decrease the long term portion of the deferred tax asset by approximately $3.6 million with a corresponding decrease in the deferred tax liability. These balance sheet reclassifications related to the netting of the deferred tax accounts within the same tax jurisdiction and did not impact the Company's working capital, cash flows or income statement accounts and were not material to the July 2, 2011 consolidated financial statements.