5. Income Taxes

The Company has a domestic net operating loss (NOL) and tax credit carryforwards of approximately $10.4 million and $7.7 million, respectively, as of December 31, 2011. In accordance with ASC 740, Income Taxes, management assesses the Company's recent operating results and estimated future taxable income. Based on the Company's continued and increased profitability and estimated future repatriation from foreign subsidiaries, the Company believes it is more likely than not that the NOL's and a majority of the tax credits will be fully utilized prior to their expiration. The Company has a valuation allowance of approximately $0.9 million related to certain research and development tax credits at December 31, 2011 because it is anticipated that those credits will expire prior to utilization.

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 currently expects to repatriate approximately $8.8 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 December 31, 2011. 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 December 31, 2011.

The Company is required to pay taxes in China on its statutory foreign profits. Its subsidiary in China had statutory profits during the quarter ended December 31, 2011 and it is anticipated that the Chinese subsidiary will utilize the remainder of its NOL carryforward during the fiscal year ending June 30, 2012. 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):


	Three Months Ended
	December 31, 2011			January 1, 2011
Federal income tax expense at statutory rate	$	927		$	558
Foreign earnings taxed at lower rates		(229	)		(551	)
Effect of foreign currency rate changes		106			—
Recognition of tax credits		(1,469	)		—
Change in valuation allowance		183			(13	)
Other		(21	)		(87	)

Income tax provision	$	(503	)	$	(93	)


	Six Months Ended
	December 31, 2011			January 1, 2011
Federal income tax expense at statutory rate	$	1,441		$	1,425
Foreign earnings taxed at lower rates		(274	)		(542	)
Effect of foreign currency rate changes		(151	)		—
Recognition of tax credits		(1,469	)		—
Change in valuation allowance		183			(13	)
Other		32			(167	)

Income tax provision	$	(238	)	$	703

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. In the fourth quarter of 2011, a second and distinct unit of account was identified for potential additional R&D credits and the Company initiated a study to analyze the relevant case law and the specific facts and circumstances in this area. During the quarter ended December 31, 2011, the Company recognized an additional $4.0 million of additional tax credits based upon the updated results of this study. For the additional R&D tax credits recorded in December 2011, the Company also recorded $2.0 million of additional unrecognized tax benefits based upon its assessment under ASC 740. The Company accounted for these credits and the related net unrecognized tax benefits as a change in estimate and as a discrete item in December 2011.

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.