Note 16. Income Taxes

The Company’s loss before income tax provision (benefit) was subject to taxes in the following jurisdictions for the following periods (in thousands):


	Year Ended December 31,
	2011			2010			2009
United States	$	(105,841	)	$	(46,365	)	$	(46,967	)
Foreign		15,580			10,803			17,364

	$	(90,261	)	$	(35,562	)	$	(29,603	)

The expense (benefit) for income taxes is comprised of (in thousands):


	Year Ended December 31,
	2011		2010			2009
Current tax provision (benefit):
Federal	$	19,908	$	(18,494	)	$	(23,311	)
State		580		361			790
Foreign		4,964		5,743			5,329

		25,452		(12,390	)		(17,192	)

Deferred tax expense (benefit):
Federal		43,948		117			4,752
State		10,987		(2,988	)		(1,655	)
Foreign		1,172		(1,497	)		(248	)

		56,107		(4,368	)		2,849

Income tax provision (benefit)	$	81,559	$	(16,758	)	$	(14,343	)

During 2011, 2010 and 2009, tax benefits related to the exercise or vesting of stock-based awards were $0, $492,000 and $1,028,000, respectively. Such benefits were recorded as a reduction of income taxes payable with a corresponding increase in additional paid-in capital or a decrease to deferred tax assets in connection with compensation cost previously recognized in income.

Deferred tax assets and liabilities are classified as current or noncurrent according to the classification of the related asset or liability. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2011 and 2010 are as follows (in thousands):


	December 31,
	2011			2010
Deferred tax assets:
Reserves and allowances not currently deductible for tax purposes	$	14,161		$	18,113
Basis difference related to fixed assets		7,891			15,083
Compensation and benefits		3,932			4,550
Basis difference for inventory valuation		2,252			3,549
Compensatory stock options and rights		9,927			9,932
Deferred revenue and other		2,151			1,330
Operating loss carryforwards		66,332			4,766
Tax credit carryforwards		9,402			8,124
Correlative effects of global income allocations		424			—
Basis difference related to intangible assets with a definite life		2,725			1,519

Total deferred tax assets		119,197			66,966
Valuation allowance for deferred tax assets		(110,844	)		(1,704	)

Deferred tax assets, net of valuation allowance	$	8,353		$	65,262

Deferred tax liabilities:
State taxes, net of federal income tax benefit		(1,472	)		(3,744	)
Prepaid expenses		(2,582	)		(2,086	)
Other		(108	)		(138	)
Basis difference related to intangible assets with an indefinite life		(34,313	)		(33,397	)

Total deferred tax liabilities		(38,475	)		(39,365	)

Net deferred tax assets	$	(30,122	)	$	25,897

Net deferred tax assets are shown on the accompanying consolidated balance sheets as follows:
Current deferred tax assets	$	4,029		$	23,514
Non-current deferred tax assets		1,386			3,786
Current deferred tax liabilities		(4,108	)		(27	)
Non-current deferred tax liabilities		(31,429	)		(1,376	)

Net deferred tax assets (liabilities)	$	(30,122	)	$	25,897

The current year change in net deferred taxes of $56,019,000 is comprised of a net deferred expense of $57,291,000 recorded through current income tax expense for the year ended December 31, 2011, offset by $88,000 of foreign currency translation adjustments and a net deferred benefit of $1,184,000 related to reserves for uncertain tax positions in accordance with ASC Topic 740-25-6.

Deferred tax assets and liabilities result from temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are anticipated to be in effect at the time the differences are expected to reverse. The realization of the deferred tax assets, including the loss and credit carry forwards listed above, is subject to the Company generating sufficient taxable income during the periods in which the temporary differences become realizable. In accordance with the applicable accounting rules, the Company maintains a valuation allowance for a deferred tax asset when it deemed it to be more likely than not that some or all of the deferred tax asset will not be realized. In evaluating whether a valuation allowance is required under such rules, the Company considers all available positive and negative evidence, including prior operating results, the nature and reason for any losses, its forecast of future taxable income, and the dates on which any deferred tax assets are expected to expire. These assumptions require a significant amount of judgment, including estimates of future taxable income. These estimates are based on the Company’s best judgment at the time made based on current and projected circumstances and conditions.

At December 31, 2011, the Company had deferred tax assets of $119,197,000. Approximately $115,296,000 of the deferred tax assets pertain to the Company’s U.S. business and $3,901,000 pertain to foreign jurisdictions. In evaluating the likelihood that these deferred tax assets will be realized, the Company considered the Company’s taxable loss in the United States in each of the past three years, the reasons for such loss, the Company’s projected financial forecast for the U.S business, and the dates on which the deferred tax assets are expected to expire. When evaluated in light of the applicable standards, this evidence suggests that the Company should establish a valuation allowance. As a result, in 2011, the Company recorded a $52,455,000 increase to income tax expense in order to establish a valuation allowance against its U.S. deferred tax assets and discontinued recognizing income tax benefits related to its U.S. net operating losses. If sufficient positive evidence arises in the future, such as a sustained return to profitability, any existing valuation allowance could be reversed as appropriate, decreasing income tax expense in the period that such conclusion is reached. The Company has concluded that with respect to non-U.S. entities, there is sufficient positive evidence to conclude that realization of its deferred tax assets is deemed to be more likely than not under applicable accounting rules, and no allowances have been established.

The non-cash charge to establish a valuation allowance does not have any impact on the Company’s consolidated cash flows, nor does such an allowance preclude the Company from using loss carry forwards or other deferred tax assets in the future, except as described below. Until the Company re-establishes a pattern of continuing profitability, in accordance with the applicable accounting guidance, U.S. income tax expense or benefit related to the recognition of deferred tax assets in the consolidated statement of operations for future periods will be offset by decreases or increases in the valuation allowance with no net effect on the consolidated statement of operations.

As a result of the establishment of the valuation allowance against its U.S. deferred tax assets, the Company does not recognize a tax benefit on taxable losses generated in the U.S. Furthermore, income taxes related to intercompany profits generated from sales in the U.S. to the Company’s foreign subsidiaries that would typically impact the statement of operations in periods with no valuation allowance are no longer deferred and amounts previously accumulated as prepaid tax expense are charged to the provision for income taxes in the statement of operations. The reversal of the prepaid tax asset is included in the determination of the annual estimated effective tax rate resulting in $21,634,000 of tax expense for the year ended 2011.

The Company has federal and state income tax credit carryforwards of $5,166,000 and $6,363,000 respectively, which will expire at various dates beginning in 2020. Such credit carryforward expire as follows:


U.S. foreign tax credit	3,579,000	2020 - 2021
U.S. research tax credit	1,587,000	2030 - 2031
State investment tax credits	555,000	Do not expire
State research tax credits	5,808,000	Do not expire

The Company has recorded a deferred tax asset reflecting the benefit of operating loss carryforwards. The net operating losses expire as follows:


U.S. loss carryforwards	$	159,917,000	2031
State loss carryforwards	$	121,919,000	2012 - 2034
Foreign loss carryforwards	$	1,174,000	2019

Although the Company has set up a valuation allowance against the majority of its U.S. federal and state deferred tax assets, which include net operating loss carry forwards (“NOLs”) and other losses, such allowance does not preclude the Company from using the deferred tax assets in the future. However, the Company’s ability to utilize the losses to offset future taxable income may be deferred or limited significantly if the Company were to experience an “ownership change” as defined in section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general, an ownership change will occur if there is a cumulative increase in ownership of the Company’s stock by “5-percent shareholders” (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. The determination of whether an ownership change has occurred for purposes of Section 382 is complex and requires significant judgment. The extent to which the Company’s ability to utilize the losses is limited as a result of such an ownership change depends on many variables, including the value of the Company’s stock at the time of the ownership change. Although the Company’s ownership has changed significantly during the three-year period ended December 31, 2011 (due in significant part to the Company’s June 2009 preferred stock offering), the Company does not believe there has been a cumulative increase in ownership in excess of 50 percentage points during that period. The Company continues to monitor changes in ownership. If such a cumulative increase did occur in any three year period and the Company was limited in the amount of losses it could use to offset taxable income, the Company’s results of operations and cash flows would be adversely impacted.

A reconciliation of the effective tax rate on income or loss and the statutory tax rate is as follows:


	Year Ended December 31,
	2011			2010			2009
Statutory U.S. tax rate		35.0	%		35.0	%		35.0	%
State income taxes, net of U.S. tax benefit		(0.8	)%		1.5	%		1.4	%
Federal and State tax credits, net of U.S. tax benefit		—			2.6	%		5.4	%
Expenses with no tax benefit		0.2	%		(2.4	)%		(3.4	)%
Domestic manufacturing tax benefits		—			—			(0.7	)%
Effect of foreign rate changes		(0.5	)%		—			—
Amortization of intangibles with an indefinite life		(1.0	)%		—			—
Release of prepaid taxes on intercompany profit		(24.0	)%		—			—
Change in deferred tax valuation allowance		(98.6	)%		2.2	%		(0.8	)%
Reversal of previously accrued taxes		—			1.4	%		1.5	%
Accrual for interest and income taxes related to uncertain tax positions		(0.6	)%		5.2	%		7.7	%
Other		(0.1	)%		1.6	%		2.4	%

Effective tax rate		(90.4	)%		47.1	%		48.5	%

In 2011, 2010 and 2009, the tax rate benefited from net favorable adjustments to previously estimated tax liabilities in the amount of $2,000, $515,000 and $457,000, respectively. The most significant favorable adjustments in each year related to adjustments resulting from the finalization of the Company’s prior year U.S. and state income tax returns as well as agreements reached with the Internal Revenue Service (“IRS”) and other major jurisdictions on certain issues necessitating a reassessment of the Company’s tax exposures for all open tax years, with no individual year being significantly affected.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):


	2011			2010			2009
Balance at January 1	$	9,121		$	15,831		$	16,525
Additions based on tax positions related to the current year		830			1,825			1,364
Additions for tax positions of prior years		370			110			866
Reductions for tax positions of prior years		(39	)		(1,832	)		(70	)
Settlement of tax audits		—			(4,157	)		(1,842	)
Reductions due to lapsed statute of limitations		(407	)		(2,656	)		(1,012	)

Balance at December 31	$	9,875		$	9,121		$	15,831

As of December 31, 2011, the liability for income taxes associated with uncertain tax benefits was $9,875,000 and can be reduced by $4,310,000 of offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments which was recorded as a long-term income tax receivable, as well as $1,089,000 of tax benefits associated with state income taxes and other timing adjustments which are recorded as deferred income taxes pursuant to ASC Topic 740-25-6. The net amount of $4,476,000, if recognized, would affect the Company’s financial statements and favorably affect the Company’s effective income tax rate.

The Company does expect changes in the amount of unrecognized tax benefits in the next twelve months; however, the Company does not expect the changes to have a material impact on its results of operations or its financial position.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense. For the years ended December 31, 2011, 2010 and 2009, the Company recognized tax expense of approximately $242,000, and a net benefit of approximately $490,000 and $190,000, respectively, related to interest and penalties in the provision for income taxes. As of December 31, 2011 and 2010, the Company had accrued $890,000 and $648,000, respectively, (before income tax benefit) in long-term liabilities for the payment of interest and penalties.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in its major jurisdictions as follows:


Major Tax Jurisdiction	Years No Longer Subject to Audit
U.S. federal		2007 and prior
California (U.S.)		2006 and prior
Canada		2006 and prior
Japan		2007 and prior
Korea		2008 and prior
United Kingdom		2007 and prior

As of December 31, 2011, the Company did not provide for United States income taxes or foreign withholding taxes on a cumulative total of $97,551,000 of undistributed earnings from certain non-U.S. subsidiaries that will be permanently reinvested outside the United States. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against the Company’s U.S. tax liability, if any. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. Should the Company repatriate foreign earnings, the Company would have to adjust the income tax provision in the period management determined that the Company would repatriate earnings.

Subsequent to the issuance of the consolidated financial statements for the year ended December 31, 2010, the Company identified that it had understated its long-term deferred tax liabilities by approximately $8,967,000 in its consolidated financial statements as of December 31, 2010 and in certain prior periods. This understatement relates to the tax treatment of certain intangible assets, certain depreciable assets, deductible stock options and deferred revenue related to gift cards, all of which relate to periods prior to 2008. Accordingly, the Company recorded a prior period adjustment as of December 31, 2008, which resulted in a decrease to retained earnings of $9,428,000 and an increase to additional paid-in capital of $461,000, with corresponding decreases of $879,000 and $8,088,000 to short-term and long-term deferred tax assets. These corrections do not impact the Company’s consolidated statements of operations previously reported in the Company’s consolidated financial statements for each of the three years in the period ended December 31, 2010. The Company does not believe the foregoing corrections are material to such financial statements. The effects of these corrections on the Company’s December 31, 2010 consolidated financial statements are summarized as follows (in thousands):


	December 31, 2010
	As Previously Reported		As Corrected
Deferred tax assets, net (current)	$	24,393	$	23,514
Deferred tax assets, net (non-current)	$	11,874	$	3,786
Additional paid-in capital	$	263,774	$	264,235
Retained earnings	$	442,405	$	432,977