Income Taxes

12 Months Ended

Dec. 31, 2018

20. Income Tax

Income tax from continuing operations was a benefit of approximately $3.7 million and $0.6 million for the years ended December 31, 2018 and 2017, respectively. The effective tax rate on continuing operations was 46.1% for the year ended December 31, 2018 compared with 23.1% for the same period in 2017. The difference between the Company’s effective tax rate year over year was primarily attributable to lower pre-tax income at certain individual subsidiaries in 2018 versus the impact of certain provisions of U.S tax reform in 2017.

On December 22, 2017, tax reform legislation known as the Tax Cuts and Jobs Act (the Tax Act) was signed into law. A majority of the provisions of the Tax Act are effective January 1, 2018. The Tax Act makes broad and complex changes to the U.S. Internal Revenue Code which include, but are not limited to: (1) the reduction of the corporate income tax rate from 35% to 21%; (2) the implementation of a modified territorial tax system with a one-time transition tax on previously unremitted earnings of foreign subsidiaries; (3) a new provision designed to tax global intangible low-taxed income (GILTI); (4) the deduction for foreign-derived intangible income (FDII); (5) a new limitation on deductible interest expense; and (6) limitations on the deductibility of certain executive compensation. In response to the Tax Act, the SEC issued Staff Accounting Bulletin No. 118 (SAB 118), which provided companies with a one-year measurement period to complete the accounting for the tax effects of the Tax Act. The end of the measurement period for purposes of SAB 118 was December 22, 2018. The Company has completed the analysis in accordance with guidance available as of the date of this filing and has recorded the impact as explained below.

At December 31, 2017, the impact of the remeasurement of deferred tax assets and liabilities from 35% to 21% was an expense of $3.2 million which was fully offset by a change in the valuation allowance. The 2017 U.S. tax impact of the one-time transition tax on the mandatory deemed repatriation of foreign earnings was an expense of $3.0 million. This impact was fully offset with net operating loss carryforwards for which a full valuation allowance had been recorded. As a result, no tax expense was recorded. In finalizing its analysis in 2018 the Company recorded an immaterial amount of adjustments to the original provisional amounts. With respect to GILTI, the Company has adopted a policy to account for this provision as a period cost.

For the year ended December 31, 2018, an income tax benefit of $0.4 million was recorded for discontinued operations. For the year ended December 31, 2017, income tax benefit for discontinued operations was $0.6 million.

Income tax expense attributable to income from continued operations for years ended December 31, 2018 and 2017 consisted of:

		Year Ended December 31,
		2018		2017
		(in thousands)
Current income tax (benefit) expense:
Federal and state	$	(191)	$	253
Foreign		279		297
		88		550
Deferred income tax (benefit) expense):
Federal and state		(3,552)		(1,730)
Foreign		(212)		575
		(3,764)		(1,155)
Total income tax benefit from continuing operations	$	(3,676)	$	(605)

The total benefit from income taxes included in the statement of operations is as follows:

		Year Ended December 31,
		2018		2017
		(in thousands)

Continuing operations	$	(3,676)	$	(605)
Discontinued operations		(441)		(617)
Total income tax benefit	$	(4,117)	$	(1,222)

Income tax benefit for the years ended December 31, 2018 and 2017 differed from the amount computed by applying the U.S. federal income tax rate of 21% and 34%, respectively, to pre-tax continuing operations income as a result of the following:

		Year Ended December 31,
		2018		2017
		(in thousands)
Computed "expected" income tax benefit	$	(1,674)	$	(892)
Increase (decrease) in income taxes resulting from:
Permanent differences, net		(117)		(118)
Foreign tax rate differential		(11)		23
State income taxes, net of federal income tax benefit		(121)		(103)
Non-deductible stock compensation expense		(329)		174
Acquisition costs		438		-
Impact of U.S. rate change		-		3,159
Tax credits		(242)		(14)
Change in reserve for uncertain tax position		203		(58)
Impact of change to prior year tax accruals		100		72
Impact of adoption of ASU 2016-09		-		(486)
U.S tax on foreign dividends		-		3,149
Foreign withholding taxes		-		38
Conversion of U.S foreign tax credits from credit to deduction		-		648
Change in valuation allowance allocated to income
tax benefit		(1,850)		(6,152)
Other		(73)		(45)
Total income tax benefit	$	(3,676)	$	(605)

Certain prior year amounts in the above table have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the Company’s consolidated financial statements.

Income tax (benefit) expense is based on the following pre-tax income from continuing operations for the years ended December 31, 2018 and 2017:

		Year Ended December 31,
		2018		2017
		(in thousands)
Domestic	$	(9,034)	$	(3,662)
Foreign		1,059		1,041
Total	$	(7,975)	$	(2,621)

The tax effects of temporary differences that give rise to significant components of the deferred tax assets and deferred tax liabilities at December 31, 2018 and 2017 are as follows:

		December 31,
		2018		2017
		(in thousands)
Deferred income tax assets:
Accounts receivable	$	57	$	93
Inventory		1,147		891
Operating loss and credit carryforwards		20,095		8,287
Accrued expenses		1,692		-
Pension liabilities		110		151
Contingent consideration		-		2,273
Stock compensation		999		1,667
Other assets		172		122
Total gross deferred assets		24,272		13,484
Less: valuation allowance		(13,899)		(11,447)
Deferred tax assets	$	10,373	$	2,037

Deferred income tax liabilities:
Indefinite-lived intangible assets	$	1,975	$	3,166
Definite-lived intangible assets		10,221		2,383
Property, plant and equipment		204		-
Other accrued liabilities		63		270
Total deferred tax liabilities		12,463		5,819
Deferred income tax liability, net	$	(2,090)	$	(3,782)

Deferred income tax assets and liabilities by classification on the consolidated balance sheets were as follows:

		December 31,
		2018		2017
		(in thousands)

Deferred income tax assets	$	211	$	182
Deferred income tax liabilities		(2,301)		(2,653)
Long term liabilities held for sale		-		(1,311)
Deferred income tax liability, net	$	(2,090)	$	(3,782)

As of December 31, 2018 and 2017, the Company maintained a total valuation allowance of $13.9 million and $11.4 million, respectively, which relates to foreign, federal, and state deferred tax assets in both years. The valuation allowance is based on estimates of taxable income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. The movement in the valuation allowance is primarily due to the finalization of purchase accounting for the DSI acquisition and its impact on the valuation allowance related to certain U.S. deferred tax assets.

The Company adopted the provisions of ASU 2016-09, Improvements to Employee Share-based Payment Accounting, on January 1, 2017. Upon adoption, the company recorded previously unrecognized excess tax benefits from the exercise of employee stock options as an increase in its deferred tax asset for net operating losses of approximately $0.5 million. The tax benefit of this increased deferred tax asset is fully offset by an increase in the valuation allowance. Following adoption, excess tax benefits or tax deficit is reflected as income tax benefit or expense in the year the tax impact is generated. Prior to the adoption of ASU 2016-09, these excess tax benefits could only be recognized when the related tax deduction reduces income taxes payable and the benefit would be reflected as a credit to additional paid-in capital if realized.

At December 31, 2018, the Company had federal net operating loss carryforwards of $27.2 million, a portion of which ($21.9 million) expires between 2019 and 2037; the remainder have an unlimited carryforward period. The Company’s state net operating loss carryforwards of $17.5 million expire between 2019 and 2037. The Company has foreign tax credits of $0.2 million which begin to expire in 2020, as well as $8.6 million of research and development tax credit carryforwards which begin to expire in 2020. Approximately $1.0 million of the research and development tax credit carryforwards are offset by a reserve for uncertain tax positions. The Company had $0.8 million of alternative minimum tax credit carryforwards which are not subject to expiration and become refundable under the Tax Act beginning in 2018. In addition, the Company had a total of $3.8 million of state investment tax credit carryforwards, research and development tax credit carryforwards, and EZ credit carryforwards, which begin to expire in 2019. The Internal Revenue Code (IRC) limits the amounts of net operating loss carryforwards or credits that a company may use in any one year in the event of a change in ownership under IRC Sections 382 or 383. As a result of the DSI acquisition as well as acquisitions in prior years, certain losses and carryforwards would be subject to such limitation. The Company has provided a full or partial valuation allowance for the portion of state NOLs and federal and state credit carryforwards the Company expects to expire before use.

As of December 31, 2018 and December 31, 2017, cash and cash equivalents held by the Company’s foreign subsidiaries was $3.2 million and $4.8 million, respectively. As of December 31, 2017, the Company changed its indefinite reinvestment assertion to provide that all foreign cash balances above the level required for local operating expenses would be repatriated to the U.S. in tax years after 2017. The Company maintains this modified assertion at December 31, 2018. As a result of the 2017 Tax Act, post-2017 dividends from qualifying Controlled Foreign Corporations are no longer taxed in the U.S. However, any dividends to the U.S. must still be assessed for withholding tax liability as well as state income tax liability. As a result of the Company’s assertion, the Company determined the potential state income tax liability related to available cash balances at foreign subsidiaries to be immaterial in 2018 and 2017. In addition, an accrued withholding tax liability of $38 thousand was recorded as of both December 31, 2018 and December 31, 2017, related to amounts determined to be available for repatriation.

At December 31, 2018 and 2017 the amount of unrecognized tax benefits that would affect the Company’s effective tax rate are shown in the table below:

		(in thousands)
Balance at December 31, 2016	$	406
Decreases based on tax positions of prior years		(53)
Settlements		(30)
Balance at December 31, 2017		323
Release due to expiration of statute of limitations		(94)
Additions based on tax positions of prior years		242
Additions based on tax positions of acquired entities		1,389
Balance at December 31, 2018	$	1,860

In 2017, a German income tax audit was settled for $30 thousand. In 2018, the Company recorded a reserve of $0.2 million related to upcoming audits. Additionally, reserves of $1.4 million were recorded to purchase accounting based on tax positions of acquired entities, including $0.8 million for credits and $0.5 million related to state income tax issues.

The Company anticipates that the total unrecognized tax benefits will be reduced within the next 12 months by approximately $0.5 million due to the expected settlement of certain positions of acquired entities. The Company classifies interest and penalties related to unrecognized tax benefits as a component of income tax expense. At December 31, 2018 and at December 31, 2017, the Company had accrued interest and penalties of $0.1 million and $15 thousand respectively. During 2018 and 2017, the Company recognized a net expense of $31 thousand and $5 thousand, respectively, for interest and penalties in its total tax provision.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to income tax examinations by tax authorities in foreign jurisdictions for years before 2014. In the U.S., the Company's net operating loss and tax credit carryforward amounts remain subject to federal and state examination for tax years starting in 2000 as a result of tax losses incurred in prior years. There are currently no pending federal or state tax examinations. The Company is subject to audits by various taxing jurisdictions. At December 31, 2018, the Company received notice of income tax examinations to begin in 2019 at foreign subsidiaries for which reserves have been recorded.