NOTE 11 — Income Taxes

The provision for income taxes consisted of the following for the fiscal periods identified below (in thousands):



	Fiscal 2013			Fiscal 2012			Transition Period
Current:
Federal tax expense (benefit)	$	107		$	(127	)	$	(84	)
State tax expense (benefit)	(112		)	184			(289		)
Current tax expense (benefit)	(5		)	57			(373		)
Deferred tax expense (benefit)	—			40			(14		)
Income tax provision (benefit)	$	(5	)	$	97		$	(387	)

The following presents a reconciliation of income tax computed at the U.S. statutory rate to the effective income tax rate for the fiscal periods ended:



	February 1, 2014		February 2, 2013		January 28, 2012
Federal income tax (benefit) at statutory rate	35.0	%	(35.0	)%	(35.0	)%
State income tax (benefit), net of federal	0.4		0.5		(0.4	)
Change in valuation allowance	(33.7	)	34.8		35.0
Reserve for unrecognized tax benefits	(2.4	)	(0.5	)	—
Tax exempt interest income	—		(0.1	)	(0.1	)
Officer compensation expense	—		0.3		—
Other	0.6		0.6		—
Effective income tax rate	(0.1	)%	0.6	%	(0.5	)%

Significant components of the Company's deferred income tax assets and liabilities are as follows (in thousands):



	February 1, 2014			February 2, 2013
Deferred tax assets:
Accrued vacation compensation	$	402		$	435
Accrued Friendship Rewards loyalty liability	1,301			1,255
Accrued incentives	1,434			—
Merchandise inventories	1,351			1,287
Deferred rent obligations	3,418			4,585
Stock-based compensation expense	2,303			1,482
Net operating loss carryforwards	26,857			31,491
Contribution carryforwards	202			1,431
Tax credit carryforwards	984			722
Depreciation and amortization	2,651			1,647
Other accrued liabilities	1,767			2,286
Total deferred tax assets	42,670			46,621
Less: Valuation allowance	(42,223		)	(46,164		)
Net deferred tax assets	447			457
Deferred tax liabilities:
Other	(447		)	(457		)
Total deferred tax liabilities	(447		)	(457		)
Net deferred tax assets (liabilities)	$	—		$	—

Deferred income tax assets represent potential future income tax benefits. Realization of these assets is ultimately dependent upon future taxable income. The Company has incurred a net cumulative loss as measured by the results of the current year and the prior two years. ASC 740 “Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more likely than not that some or all of the recorded deferred tax assets will not be realized in a future period. Forming a conclusion that a valuation allowance is not needed is difficult when negative evidence such as cumulative losses exists. As a result of management's evaluation, there was insufficient positive evidence to overcome the negative evidence related to the Company's cumulative losses. Accordingly, a non-cash provision of $10.6 million in fiscal 2011 was recognized to establish a valuation allowance against deferred tax assets. The decrease in the valuation allowance of approximately $3.9 million from February 2, 2013 to February 1, 2014 primarily relates to utilization of net operating losses as well as timing differences resulting from merchandise inventories, depreciation and deferred lease incentives, stock compensation, and accrued bonus. The valuation allowance does not have any impact on cash and does not prevent the Company from using the deferred tax assets in the future when profits are realized.

As of February 1, 2014, the Company has federal and state net operating loss carryforwards which will reduce future taxable income. Approximately $25.1 million in net federal tax benefits are available from these federal loss carryforwards of approximately $71.8 million, and an additional $1.0 million is available in net tax credit carryforwards. Included in the federal net operating loss is approximately $1.8 million of loss generated by deductions related to equity-based compensation, the tax effect of which will be recorded to additional paid in capital when utilized. The state loss carryforwards will result in net state tax benefits of approximately $2.3 million. The federal net operating loss carryovers will expire in November 2031 and beyond. The Company has analyzed equity ownership changes and determined our net operating losses will not be limited under IRC Section 382. The state net operating loss carryforwards will expire in November 2014 and beyond. Additionally, the Company has charitable contribution carryforwards that will expire in 2014 and beyond.

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



Balance at February 26, 2011	$	1,304
Additions based on tax positions related to the current year	27
Additions for tax positions of previous years	241
Reductions for tax positions of previous years	(72		)
Reductions for tax positions of previous years due to lapse of applicable statute of limitations	(488		)
Settlements	(156		)
Balance at January 28, 2012	856
Additions based on tax positions related to the current year	283
Reductions for tax positions of previous years	(39		)
Reductions for tax positions of previous years due to lapse of applicable statute of limitations	(107		)
Balance at February 2, 2013	993
Additions based on tax positions related to the current year	152
Reductions for tax positions of previous years	(152		)
Reductions for tax positions of previous years due to lapse of applicable statute of limitations	(236		)
Balance at February 1, 2014	$	757

The Company's liability for unrecognized tax benefits is recorded within other non-current liabilities. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of February 1, 2014 and February 2, 2013 were $0.5 million and $0.7 million, respectively.

Interest and penalties related to unrecognized tax benefits of approximately $47 thousand, $42 thousand and $0.2 million were recognized as components of income tax expense in fiscal 2013, fiscal 2012 and the transition period, respectively. At February 1, 2014 and February 2, 2013, approximately $0.1 million and $0.3 million, respectively, was accrued for the potential payment of interest and penalties.

The Company and its subsidiaries are subject to U.S. federal income taxes and the income tax obligations of various state and local jurisdictions. Fiscal 2011 is currently under exam by the Internal Revenue Service. The transition period, fiscal 2012 and fiscal 2013 remain subject to examination by the Internal Revenue Service. With few exceptions, the Company is not subject to state income tax examination by tax authorities for taxable years prior to fiscal 2009. As of February 1, 2014, the Company had no other ongoing audits in various jurisdictions and does not expect the liability for unrecognized tax benefits to significantly increase or decrease in the next twelve months.