Income Taxes

U.S Tax Reform Impact

December 22, 2017,

the U.S. Government enacted the reconciled tax reform bill, commonly known as the Tax Cuts and Jobs Act of

2017

(the “TCJA”), which became effective on

January 1, 2018.

The TCJA makes broad changes to the U.S. tax code including, but

not

limited to, reducing the Company’s federal statutory tax rate from

35%,

to an average rate of

29.35%

for the fiscal year ended

May 27, 2018,

and then

21%

for fiscal years thereafter; requiring companies to pay a

one

-time transition tax on certain unrepatriated earnings of foreign subsidiaries; generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations' creating a global intangibles low-taxed income inclusion (GILTI) and the base erosion anti-abuse tax (BEAT), a new minimum tax. The TCJA also enhances and extends through

2026

the option to claim accelerated depreciation deductions on qualified property; however, the domestic manufacturing deduction, from which the Company has historically benefitted, has been eliminated.

December 22, 2017,

SAB

118

was issued to address the application of GAAP in situations when a registrant does

not

have the necessary information available, prepared, or analyzed in reasonable detail to complete its accounting for certain income tax effects of the TCJA. Pursuant to SAB

118,

as of

May 27, 2018,

the Company had

not

yet completed its accounting for the tax effects of the enactment of the TCJA. The Company’s provision for income taxes for the year ended

May 27, 2018

is based in part on its best estimate of the effects of the transition tax and existing deferred tax balances with its understanding of the TCJA and guidance available as of the date of this filing. For the amounts which were reasonably estimable, we recognized a provisional remeasurement of

$16.2

million of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. The provisional amount related to the

one

-time transition tax on the mandatory deemed repatriation of foreign earnings was an expense of

$1.8

million. We are still analyzing certain aspects of the TCJA and refining the estimate of the expected reversal of our deferred tax balance. This can potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts.

The (benefit) provision for income taxes from continuing operations consisted of the following (in thousands):

	Year Ended
	May 27, 2018			May 28, 2017		May 29, 2016
Current:
Federal	$	(2,854	)	$	1,388	$	2,085
State		60			39		(96	)
Foreign		83			82		83
Total		(2,711	)		1,509		2,072

Deferred:
Federal		(7,122	)		2,270		(9,165	)
State		470			261		(611	)
Total		(6,652	)		2,531		(9,776	)
Income tax (benefit) expense	$	(9,363	)	$	4,040	$	(7,704	)

The actual provision for income taxes from continuing operations differs from the statutory U.S. federal income tax rate as follows (in thousands):

	Year Ended
	May 27, 2018			May 28, 2017			May 29, 2016
Tax at U.S. statutory rate (1)	$	4,784		$	4,922		$	(6,963	)
State income taxes, net of federal benefit		439			307			(518	)
Tax reform		(14,350	)		—			—
Change in valuation allowance		(176	)		85			6
Tax credit carryforwards		(777	)		(834	)		(156	)
Other compensation-related activity		566			(365	)		173
Domestic manufacturing deduction		—			(243	)		(307	)
Other		151			168			61
Income tax (benefit) expense	$	(9,363	)	$	4,040		$	(7,704	)

(

) Statutory rate was

29.35%

for fiscal year

2018

and

35%

for fiscal years

2017

and

2016.

The decrease in the income tax expense for fiscal year

2018

was primarily due to the TCJA such as the statutory rate change for federal and state, and

one

-time transition tax on the repatriation of foreign earnings. Additionally, the effective tax rate for fiscal year

2018

decreased from expense of

29%

to a benefit of

64%

in comparison to fiscal year

2017.

Significant components of deferred tax assets and liabilities reported in the accompanying consolidated balance sheets consisted of the following (in thousands):

	Year Ended
	May 27, 2018			May 28, 2017
Deferred tax assets:
Accruals and reserves	$	1,421		$	3,242
Net operating loss carryforwards		1,955			2,766
Stock-based compensation		1,247			2,032
Research and AMT credit carryforwards		2,032			1,050
Other		427			661
Gross deferred tax assets		7,082			9,751
Valuation allowance		(1,337	)		(1,325	)
Net deferred tax assets		5,745			8,426

Deferred tax liabilities:
Basis difference in investment in non-public company		(3,722	)		(11,495	)
Goodwill and other indefinite life intangibles		(8,201	)		(11,119	)
Depreciation and amortization		(11,307	)		(10,393	)
Deferred tax liabilities		(23,230	)		(33,007	)

Net deferred tax liabilities	$	(17,485	)	$	(24,581	)

The effective tax rates for fiscal year

2018

differ from the blended statutory federal income tax rate of

29.35%

as a result of several factors, including change in ending federal and state deferred blended rate,

one

-time transition tax due to the repatriation of foreign earnings, the change in valuation allowance, limitation of deductibility of executive compensation, and the benefit of federal and state research and development credits. The effective tax rates for fiscal year

2017

differ from the statutory federal income tax rate of

35%

as a result of several factors, including non-deductible stock-based compensation expense, disqualified dispositions of incentive stock options, excess equity compensation benefits from the adoption of ASU

2016

09,

domestic manufacturing deduction, the benefit of federal and state research and development credits, the change in valuation allowance, all of which is partially offset by state taxes. The effective tax rates for fiscal year

2016

differ from the statutory federal income tax rate of

35%

as a result of several factors, including state taxes, non-deductible stock-based compensation expense, disqualified dispositions of incentive stock options, domestic manufacturing deduction,

162m

limitation, the benefit of federal and state research and development credits and the change in valuation allowance.

During the fiscal year ended

May 27,

2018,

excess tax deficits related to stock-based compensation of

$38,000

were reflected in the consolidated statements of income (loss) as a component of income tax expense as a result of the adoption of ASU

2016

09,

specifically related to the prospective application of excess tax deficits and tax deficiencies related to stock-based compensation.

The Company elected to early adopt the new guidance of ASU

2016

09,

Compensation – Stock Compensation (Topic

718

)

Improvements to Employee Share-Based Payments Accounting

, in the quarter beginning

May 30, 2016.

Accordingly the primary effects of the adoption are as follows: (

) using a modified retrospective application, the Company recorded unrecognized excess tax benefits of

$549,000

as a cumulative-effect adjustment, which increased retained earnings, and reduced deferred taxes by the same, (

) using a modified retrospective application, the Company has elected to recognize forfeitures as they occur and recorded a

$200,000

increase to additional paid in capital, a

$126,000

reduction to retained earnings, and a

$74,000

reduction to deferred taxes to reflect the incremental stock-based compensation expense, net of the related tax impacts, that would have been recognized in prior years under the modified guidance, and (

)

$150,000

and

$463,000

in excess tax benefits from stock-based compensation was reclassified from cash flows from financing activities to cash flows from operating activities for the fiscal years ended

May 29, 2016

and

May 31, 2015,

respectively, in the Consolidated Statements of Cash Flows.

As of

May 27, 2018,

the Company had federal, Indiana, and other state net operating loss carryforwards of approximately

$7.1

million,

$5.6

million, and

$3.1

million, respectively. These losses expire in different periods through

2032,

not

utilized. The Company acquired additional net operating losses through the acquisition of GreenLine. Utilization of these acquired net operating losses in a specific year is limited due to the “change in ownership” provision of the Internal Revenue Code of

1986

and similar state provisions. The net operating losses presented above for federal and state purposes are net of any such limitation.

The Company has federal, California, and Minnesota research and development tax credit carryforwards of approximately

$0.4

million,

$1.5

million, and

$0.7

million, respectively. The research and development tax credit carryforwards have an unlimited carryforward period for state purposes and a

-year carryforward for federal purposes.

Valuation allowances are reviewed each period on a tax jurisdiction by jurisdiction basis to analyze whether there is sufficient positive or negative evidence to support a change in judgment about the realizability of the related deferred tax assets. Based on this analysis and considering all positive and negative evidence, the Company determined that a valuation allowance of

$1.3

million should be recorded as a result of uncertainty around the utilization of certain state net operating losses and a book impairment loss on the Company's investment in Aesthetic Sciences as it is more likely than

not

that a portion of the deferred tax asset will

not

be realized in the foreseeable future. The valuation allowance increased by an immaterial amount from the prior year primarily due to uncertainty around the utilization of certain state net operating losses and credits.

The accounting for uncertainty in income taxes recognized in an enterprise’s financial statements prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and the derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition.

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

	As of
	May 27, 2018			May 28, 2017			May 29, 2016
Unrecognized tax benefits – beginning of the period	$	537		$	842		$	987
Gross increases – tax positions in prior period		21			11			1
Gross decreases – tax positions in prior period		—			(90	)		(223	)
Gross increases – current-period tax positions		116			93			77
Settlements		(95	)		—			—
Lapse of statute of limitations		(100	)		(319	)		—
Unrecognized tax benefits – end of the period	$	479		$	537		$	842

As of

May 27, 2018,

the total amount of net unrecognized tax benefits is

$479,000,

of which,

$372,000,

if recognized, would change the effective tax rate. The Company accrues interest and penalties related to unrecognized tax benefits in its provision for income taxes. The total amount of penalties and interest is

not

material as of

May 27, 2018.

Additionally, the Company expects its unrecognized tax benefits to decrease by approximately

$25,000

within the next

months.

Due to tax attribute carryforwards, the Company is subject to examination for tax years

2015

forward for U.S. tax purposes. The Company was also subject to examination in various state jurisdictions for tax years

2012

forward,

none

of which were individually material.