NOTE 6 — INCOME TAXES:

Income Tax Issues Concerning Overseas Income

On April 15, 2013 and June 5, 2013, the Company received correspondence from the IRS including a (i) Form 5701 and Form 886-A regarding Adjusted Sales Income (collectively referred to as “NOPA 1”) and (ii) Form 5701 and Form 886-A regarding Adjusted Subpart F-Foreign Base Company Sales Income (collectively referred to as “NOPA 2”).

With respect to NOPA 1, the IRS is (i) challenging the position of the Company with respect to the way the Company’s controlled foreign corporation in Macao (the “Macao CFC”) recorded its product sales during Fiscal 2010 and Fiscal 2011 and (ii) asserting that an upward adjustment to the Company’s Fiscal 2010 and Fiscal 2011 taxable income of $4,981,520 and $5,680,182, respectively, is required.

With respect to NOPA 2, the IRS is challenging the position of the Company with respect to the fact that the Company considered the service fee paid by the Company to the Macao CFC to be non-taxable in the US. The IRS has taken the position that the service fee paid to the Macao CFC by the Company constitutes foreign base company sales income (“FBCSI”). The IRS asserts that the service fee earned by the Macao CFC in connection with its sale of products to the Company should be taxable to the Company as FBCSI. As a result, the IRS determined that an upward adjustment to the Company’s Fiscal 2010 and Fiscal 2011 taxable income of $1,553,984 and $1,143,162, respectively, is required.

The Company has evaluated the determinations made by the IRS as set forth in each of NOPA 1 and NOPA 2 in order to decide (a) how it will proceed and (b) the potential impact on the Company’s financial condition and operations. Furthermore, although NOPA 1 and NOPA 2 represent potential adjustments to Fiscal 2010 and Fiscal 2011 only, the Company believes it is likely that the IRS will take the position that the same type of adjustments should be made for each of the Company’s subsequent fiscal years. The assessment and payment of such additional taxes, penalties and interest would have a material adverse effect on the Company’s financial condition and results of operations.

With respect to NOPA 1, the Company is disputing the proposed adjustment with the IRS. In the event that the Company is not successful in its dispute, the Company estimates that it could be liable for a maximum in taxes, penalties and interest of approximately $14.9 million pertaining to NOPA 1, in the aggregate, for its Fiscal 2010, Fiscal 2011, Fiscal 2012, Fiscal 2013 and Fiscal 2014 periods. However, because the Company’s current assessment is that its appeal of NOPA 1 is more likely than not to be successful, the Company has not recorded any liability to its March 31, 2014 or March 31, 2013 balance sheets related to NOPA 1.

With respect to NOPA 2, the Company agrees in principle with the IRS’ position that the service fee paid to the Macao CFC by the Company would be treated as FBCSI and taxable to the Company but the Company does not agree with the adjustment to the Company’s taxable income as calculated by the IRS. However, the Company has estimated as approximately $1.1 million the amount of taxes, penalties and interest for which it would be liable for its Fiscal 2010, Fiscal 2011, Fiscal 2012 and Fiscal 2013 periods using the adjustments to taxable income as proposed by the IRS, and such amount was recorded by the Company as tax expense during Fiscal 2013. In addition, the Company began at this time to prospectively recognize the service fee, net of related expenses, paid to the Macao CFC as FBCSI taxable income to the Company. During Fiscal 2014, the Company remitted approximately $0.9 million of this estimated liability to the IRS, and plans to remit the balance of $0.2 million upon final agreement of this amount due with the IRS.

The Company’s provision for income tax (benefit) expense for Fiscal 2014 and Fiscal 2013 was as follows:


	2014			2013
	(In thousands)
Current:
Federal	$	(450	)	$	1,353
Foreign, state and other		(484	)		215
Prior year federal and state with penalty & interest		0			881
Deferred:
Federal		(467	)		947
Foreign, state and other		(68	)		270

Provision for income tax (benefit) expense	$	(1,469	)	$	3,666

The Company files a consolidated federal return and certain state and local income tax returns.

The difference between the effective rate reflected in the provision for income taxes and the amounts determined by applying the statutory federal rate of 34% to earnings before income taxes for Fiscal March 2014 and Fiscal 2013 is analyzed below:


	2014			2013
	(In thousands)
Statutory provision	$	(52	)	$	3,283
Foreign subsidiary		(1,009	)		(2,626	)
State taxes		(529	)		366
Permanent differences		304			716
Prior year taxes		0			897
True up AMT Credit		0			898
True up to prior year taxes		(158	)		56
Valuation allowance		(234	)		0
Expiration of Stock Options and Warrants		209			0
Other, net		0			76

Provision for income tax (benefit) expense	$	(1,469	)	$	3,666

As of March 31, 2014 and March 31, 2013, the significant components of the Company’s deferred tax assets and liabilities were as follows:


	2014		2013
	(In thousands)
Deferred tax assets:
Current:
Accounts receivable reserves	$	842	$	881
Inventory reserves		401		401
Accruals		151		237
Stock warrants		0		166

Total current deferred tax assets		1,394		1,685

Non-current:
Property, plant, and equipment		669		1,169
Net operating loss and credit carry forwards		1,084		107
Stock compensation		0		79

Total non-current deferred tax assets - gross		1,753		1,355
Valuation allowances		0		(234	)

Total non-current deferred tax assets		1,753		1,121


Total deferred tax assets		3,147		2,806

Deferred tax liabilities:
Non-current:
Capital lease expense		0		194

Total deferred tax liabilities		0		194


Net deferred tax assets	$	3,147	$	2,612

The Company has $2.4 million of U.S. federal net operating loss carry forwards (“NOLs”) as of March 31, 2014 that expire in 2034.

The Company has $3.7 million of state NOLs as of March 31, 2014 as follows (in millions $):


Loss Year (Fiscal)	Included in DTA		Expiration Year (Fiscal)
2008	$	1.3 million		2018
2014	$	2.4 million		2034

The tax benefits related to these state net operating loss carry forwards and future deductible temporary differences are recorded to the extent management believes it is more likely than not that such benefits will be realized.

Income of foreign subsidiaries before taxes was $2,966,000 for the fiscal year ended March 31, 2014 as compared to a loss before taxes of $80,000 for the fiscal year ended March 31, 2013, respectively.

No provision was made for U.S. or additional foreign taxes on undistributed earnings of foreign subsidiaries. Such earnings have been and will be reinvested but could become subject to additional tax if they were remitted as dividends, or were loaned to the Company or a domestic affiliate, or if the Company should sell its stock in the foreign subsidiaries. It is not practicable to determine the amount of additional tax, if any, that might be payable on undistributed foreign earnings.

A reconciliation of the Company’s changes in uncertain tax positions from April 1, 2013 to March 31, 2014 is as follows:


	In 000’s
Total amount of unrecognized tax benefits as of April 1, 2013	$	121
Gross increases in unrecognized tax benefits as a result of tax positions taken during a prior period		—
Gross decreases in unrecognized tax benefits as a result of tax positions taken during a prior period		—
Gross increases in unrecognized tax benefits as a result of tax positions taken during the current period		—
Gross decreases in unrecognized tax benefits as a result of tax positions taken during the current period		—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities		—
Reductions to unrecognized tax benefits as a result of lapse of statute of limitations		(121	)

Total amount of unrecognized tax benefits as of March 31, 2014		—