JTH - 10.31.2014 10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  
FORM 10-Q
 
ý      Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended October 31, 2014
 
OR
 
o         Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from             to             .
 
Commission File Number 001-35588
 
Liberty Tax, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
27-3561876
(State of incorporation)
 
(IRS employer identification no.)
 
1716 Corporate Landing Parkway
Virginia Beach, Virginia 23454
(Address of principal executive offices)
 (757) 493-8855
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
 
Accelerated filer x
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No ý
 
The number of shares outstanding of the registrant’s Class A common stock as of December 1, 2014 was 11,783,139.

The number of shares outstanding of the registrant's Class B common stock as of December 1, 2014 was 900,000.



LIBERTY TAX, INC.
 
Form 10-Q for the Period Ended October 31, 2014
 
Table of Contents
 
 
 
Page
 
 
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I 

ITEM 1
FINANCIAL STATEMENTS 

3


LIBERTY TAX, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
October 31, 2014 (unaudited), October 31, 2013 (unaudited), and April 30, 2014
(In thousands, except share data)
 
 
October 31, 2014
 
October 31, 2013
 
April 30, 2014
Assets
 
 

 
 
 
 

Current assets:
 
 

 
 
 
 

Cash and cash equivalents
 
$
4,605

 
$
2,607

 
$
46,080

Receivables:
 
 

 
 
 
 

Trade accounts
 
28,407

 
20,749

 
43,122

Notes
 
41,114

 
52,074

 
27,715

Interest, net
 
2,493

 
3,180

 
415

Allowance for doubtful accounts
 
(5,437
)
 
(4,948
)
 
(5,596
)
Total receivables, net
 
66,577

 
71,055

 
65,656

Available-for-sale securities
 
—

 
4,606

 
—

Assets held for sale
 
5,398

 
—

 
4,413

Income taxes receivable
 
20,647

 
11,759

 
—

Deferred income tax asset
 
4,013

 
2,875

 
4,058

Other current assets
 
3,789

 
2,926

 
5,325

Total current assets
 
105,029

 
95,828

 
125,532

Property, equipment, and software, net of accumulated depreciation of $24,936, $20,355, and $22,311, respectively
 
41,635

 
36,470

 
38,343

Notes receivable, excluding current portion, net of allowance for doubtful accounts
 
22,294

 
16,793

 
15,824

Goodwill
 
2,978

 
7,194

 
2,997

Other intangible assets, net of accumulated amortization
 
12,134

 
16,316

 
14,295

Other assets
 
2,553

 
2,160

 
1,772

Total assets
 
$
186,623

 
$
174,761

 
$
198,763

Liabilities and Stockholders’ Equity
 
 

 
 
 
 

Current liabilities:
 
 

 
 
 
 

Current installments of long-term debt
 
$
1,965

 
$
6,485

 
$
6,797

Accounts payable and accrued expenses
 
11,798

 
7,851

 
15,023

Due to ADs
 
8,010

 
8,315

 
18,236

Income taxes payable
 
—

 
—

 
9,676

Deferred revenue - short-term portion
 
7,224

 
6,693

 
6,051

Total current liabilities
 
28,997

 
29,344

 
55,783

Long-term debt, excluding current installments
 
22,119

 
22,987

 
21,691

Revolving credit facility
 
51,711

 
38,459

 
—

Deferred revenue - long-term portion
 
8,368

 
8,092

 
8,059

Deferred income tax liability
 
5,158

 
2,106

 
3,045

Total liabilities
 
116,353

 
100,988

 
88,578

Commitments and contingencies
 
 

 
 
 
 

Stockholders’ equity:
 
 

 
 
 
 

Class A preferred stock, $0.01 par value per share, 190,000 shares authorized, 0 shares issued and outstanding
 
—

 
—

 
—

Special voting preferred stock, $0.01 par value per share, 10 shares authorized, issued and outstanding
 
—

 
—

 
—

Class A common stock, $0.01 par value per share, 21,200,000 shares authorized, 11,704,797, 12,037,721, and 12,409,208 shares issued and outstanding, respectively
 
117

 
120

 
124

Class B common stock, $0.01 par value per share, 1,000,000 shares authorized, 900,000 shares issued and outstanding
 
9

 
9

 
9

Exchangeable shares, $0.01 par value per share, 100,000 shares issued and outstanding
 
1

 
1

 
1

Additional paid-in capital
 
1,365

 
7,818

 
9,411

Accumulated other comprehensive income (loss), net of taxes
 
(103
)
 
1,639

 
66

Retained earnings
 
68,881

 
64,186

 
100,574

Total stockholders’ equity
 
70,270

 
73,773

 
110,185

Total liabilities and stockholders’ equity
 
$
186,623

 
$
174,761

 
$
198,763


See accompanying notes to condensed consolidated financial statements.

4


LIBERTY TAX, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three and six months ended October 31, 2014 and 2013 (unaudited)
(In thousands, except per share data)
 
 
 
Three Months Ended October 31,
 
Six Months Ended October 31,
 
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 

 
 

 
 

 
 

Franchise fees
 
$
1,324

 
$
886

 
$
2,028

 
$
1,925

AD fees
 
1,649

 
1,880

 
3,474

 
3,683

Royalties and advertising fees
 
1,199

 
1,180

 
2,893

 
2,629

Financial products
 
200

 
169

 
657

 
618

Interest income
 
1,784

 
2,200

 
3,978

 
4,434

Tax preparation fees, net of discounts
 
391

 
242

 
906

 
628

Other revenue
 
1,187

 
760

 
1,637

 
1,465

Total revenues
 
7,734

 
7,317

 
15,573

 
15,382

Operating expenses:
 
 

 
 

 
 

 
 

Employee compensation and benefits
 
9,665

 
8,196

 
18,080

 
14,285

Selling, general, and administrative expenses
 
10,353

 
7,744

 
17,878

 
14,010

AD expense
 
924

 
705

 
1,665

 
1,533

Advertising expense
 
2,979

 
2,507

 
5,861

 
5,191

Depreciation, amortization, and impairment charges
 
2,029

 
1,745

 
4,328

 
3,323

Total operating expenses
 
25,950

 
20,897

 
47,812

 
38,342

Loss from operations
 
(18,216
)
 
(13,580
)
 
(32,239
)
 
(22,960
)
Other income (expense):
 
 
 
 
 
 
 
 
Foreign currency transaction loss
 
(9
)
 
(5
)
 
(10
)
 
(12
)
Gain on sale of available-for-sale securities
 
—

 
188

 
—

 
188

Interest expense
 
(566
)
 
(357
)
 
(867
)
 
(602
)
Loss before income taxes
 
(18,791
)
 
(13,754
)
 
(33,116
)

(23,386
)
Income tax benefit
 
(7,463
)
 
(5,276
)
 
(13,144
)
 
(8,981
)
Net loss
 
$
(11,328
)
 
$
(8,478
)
 
$
(19,972
)
 
$
(14,405
)
Net loss per share of Class A and Class B common stock:
 


 


 


 


Basic and diluted
 
$
(0.89
)
 
$
(0.66
)
 
$
(1.56
)
 
$
(1.12
)

See accompanying notes to condensed consolidated financial statements.

5


LIBERTY TAX, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Loss
Three and six months ended October 31, 2014 and 2013 (unaudited)
(In thousands)
 
 
 
Three Months Ended October 31,
 
Six Months Ended October 31,
 
 
2014
 
2013
 
2014
 
2013
Net loss
 
$
(11,328
)
 
$
(8,478
)
 
$
(19,972
)
 
$
(14,405
)
Unrealized gain on available-for-sale securities, net of taxes of $-, $397, $-, and $540, respectively
 
—

 
645

 
—

 
877

Reclassified gain on sale of available-for-sale securities included in income, net of taxes of $-, $72, $-, and $72, respectively
 
—

 
(116
)
 
—

 
(116
)
Foreign currency translation adjustment
 
(287
)
 
(176
)
 
(169
)
 
(316
)
Comprehensive loss
 
$
(11,615
)
 
$
(8,125
)
 
$
(20,141
)
 
$
(13,960
)

 See accompanying notes to condensed consolidated financial statements.

6


LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Six months ended October 31, 2014 and 2013 (unaudited)
(In thousands)
 
 
 
2014
 
2013
Cash flows from operating activities:
 
 

 
 

Net loss
 
$
(19,972
)
 
$
(14,405
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 

 
 

Provision for doubtful accounts
 
3,208

 
3,430

Depreciation, amortization, and impairment charges
 
4,328

 
3,323

Stock-based compensation expense related to equity classified awards
 
1,508

 
741

Stock-based compensation income related to liability classified awards
 
—

 
(872
)
Gain on bargain purchases and sales of Company-owned offices
 
(287
)
 
(518
)
Deferred tax expense
 
2,158

 
2,598

Gain on sale of available-for-sale securities
 
—

 
(188
)
Changes in accrued income taxes
 
(30,322
)
 
(17,654
)
Changes in other assets and liabilities
 
(1,051
)
 
(4,336
)
Net cash used in operating activities
 
(40,430
)
 
(27,881
)
Cash flows from investing activities:
 
 

 
 

Issuance of operating loans to franchisees
 
(20,577
)
 
(17,420
)
Payments received on operating loans to franchisees
 
1,770

 
1,230

Purchases of Company-owned offices and AD rights
 
(2,701
)
 
(4,436
)
Proceeds from sale of Company-owned offices and AD rights
 
3,300

 
205

Proceeds from sale of available-for-sale securities
 
—

 
456

Purchases of property, equipment, and software
 
(7,129
)
 
(5,463
)
Net cash used in investing activities
 
(25,337
)
 
(25,428
)
Cash flows from financing activities:
 
 

 
 

Proceeds from the exercise of stock options
 
8,145

 
2,998

Repurchase of common stock
 
(33,699
)
 
(2,495
)
Repayment of amounts due to former ADs
 
(4,211
)
 
(1,439
)
Repayment of other long-term debt
 
(928
)
 
(979
)
Borrowings under revolving credit facility
 
52,874

 
43,104

Repayments under revolving credit facility
 
(1,163
)
 
(4,645
)
Payment for debt issue costs
 
(917
)
 
—

Tax benefit of stock option exercises
 
4,273

 
416

Net cash provided by financing activities
 
24,374

 
36,960

Effect of exchange rate changes on cash, net
 
(82
)
 
(57
)
Net decrease in cash and cash equivalents
 
(41,475
)
 
(16,406
)
Cash and cash equivalents at beginning of period
 
46,080

 
19,013

Cash and cash equivalents at end of period
 
$
4,605

 
$
2,607


  See accompanying notes to condensed consolidated financial statements.






7


LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Six months ended October 31, 2014 and 2013 (unaudited)
(In thousands)
 
 
 
2014
 
2013
Supplemental disclosures of cash flow information:
 
 

 
 

Cash paid for interest, net of capitalized interest of $78 and $250, respectively
 
$
578

 
$
455

Cash paid for taxes, net of refunds
 
10,748

 
6,143

Accrued capitalized software costs included in accounts payable
 
237

 
224

During the six months ended October 31, 2014 and 2013, the Company acquired certain assets from franchisees and ADs as follows:
 
 

 
 

Fair value of assets purchased
 
$
6,477

 
$
10,770

Receivables applied, net of amounts due ADs and related deferred revenue
 
(2,877
)
 
(1,184
)
Bargain purchase gains
 
(163
)
 
(434
)
Notes and accounts payable issued
 
(736
)
 
(4,716
)
Cash paid to franchisees and ADs
 
$
2,701

 
$
4,436

During the six months ended October 31, 2014 and 2013, the Company sold certain assets to franchisees and ADs as follows:
 
 

 
 

Book value of assets sold
 
$
6,430

 
$
1,872

Loss on sale - loss recognized
 
(15
)
 
(39
)
Gain on sale - revenue deferred
 
1,945

 
—

Notes received
 
(5,060
)
 
(1,628
)
Cash received from franchisees and ADs
 
$
3,300

 
$
205


See accompanying notes to condensed consolidated financial statements.

8


LIBERTY TAX, INC. AND SUBSIDIARIES
 
Notes to Condensed Consolidated Financial Statements
 
October 31, 2014 and 2013 (Unaudited)
 
(1) Organization and Significant Accounting Policies
 
Description of Business
 
Liberty Tax, Inc. (the "Company") was incorporated in Delaware in September 2010 as a holding company engaged through its subsidiaries as a franchisor and operator of a system of income tax preparation offices located in the United States and Canada. In July 2014, the corporate name was changed to Liberty Tax, Inc. from JTH Holding, Inc. The Company’s principal operations are conducted through JTH Tax, Inc. (d/b/a Liberty Tax Service), the Company’s largest subsidiary. Through this system of income tax preparation offices, the Company also facilitates refund-based tax settlement financial products, such as instant cash advances, refund transfer products, and personal income tax refund discounting. The Company also offers online tax preparation services.

The Company’s operating revenues are seasonal in nature with peak revenues occurring in the months of January through April.  Therefore, results for interim periods are not indicative of results to be expected for the full year.
 
Unless specifically noted otherwise, as used throughout these consolidated financial statements, the term “Company” or “Liberty” refers to the consolidated entities of Liberty Tax, Inc.
 
Basis of Presentation
 
The consolidated financial statements include the accounts of Liberty Tax, Inc. and its wholly-owned subsidiaries. Assets and liabilities of the Company’s Canadian operations have been translated into U.S. dollars using the exchange rate in effect at the end of the period. Revenues and expenses have been translated using the average exchange rates in effect each month of the period. Transaction gains and losses are recognized when incurred. The Company consolidates any variable interest entities of which it is the primary beneficiary. When the Company does not have a controlling interest in an entity, but exerts significant influence over the entity, the Company applies the equity method of accounting. All intercompany balances and transactions have been eliminated in consolidation.
 
The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information.  The condensed consolidated financial statements, including these notes, are unaudited and exclude some of the disclosures only required in annual financial statements.  Consolidated balance sheet data as of April 30, 2014 was derived from the Company’s April 30, 2014 Annual Report on Form 10-K.
 
In the opinion of management, all adjustments necessary for a fair presentation of such financial statements in accordance with GAAP have been recorded.  These adjustments consisted only of normal recurring items.  The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s financial statements and notes thereto included in its April 30, 2014 Annual Report on Form 10-K.
 
Office Count

The Company and its franchisees operated 4,438 offices in the U.S. and Canada during the 2014 tax season. The Company will report this information for the 2015 tax season in the quarterly report on Form 10-Q for the quarter ended January 31, 2015, once all offices have been opened for the 2015 tax season.

Use of Estimates
 
Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period, to prepare these condensed consolidated financial statements and accompanying notes in conformity with GAAP. Actual results could differ from those estimates.



9



Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360). This update changes the criteria for reporting discontinued operations for all public and nonpublic entities as well as requiring new disclosures about discontinued operations and disposals of components of an entity that do not qualify for discontinued operations reporting. Public business entities should apply the amendments in this update prospectively to all disposals of components of an entity and all business or nonprofit activities that, on acquisition, are classified as held-for-sale that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. The adoption of the new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on May 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
 
Foreign Operations
 
Canadian operations contributed $371 thousand and $1.2 million in revenues for the three and six months ended October 31, 2014, respectively and $286 thousand and $806 thousand in revenues for the three and six months ended October 31, 2013, respectively.
 
(2) Accounts and Notes Receivable
 
The Company provides financing to franchisees and area developers ("ADs") for the purchase of franchises, areas, Company-owned offices, and for working capital and equipment needs. The franchise-related notes generally are payable over five years and the working capital and equipment notes generally are due within one year. Most notes bear interest at 12%.  Activity related to notes receivable for the six months ended October 31, 2014 and 2013 and for the fiscal year ended April 30, 2014 was as follows:

 
 
Six Months Ended 
 October 31, 2014
 
Six Months Ended 
 October 31, 2013
 
Year Ended
April 30, 2014
 
 
(In thousands)
Balance at beginning of period
 
$
84,494

 
$
89,340

 
$
89,340

Increases in notes:
 
 
 
 
 
 
Sales of franchises and areas
 
5,045

 
2,898

 
8,032

Sales of certain assets to franchisees and ADs
 
9,158

 
1,628

 
11,714

Franchisee to franchisee note assumptions and refinancing
 
5,198

 
3,889

 
9,421

Working capital and equipment loans to franchisees
 
20,577

 
17,420

 
76,012

Refinancing of accounts receivable
 
—

 
7,182

 
7,176

Decreases in notes:
 
 
 
 
 
 
Repayment of notes
 
(6,734
)
 
(3,877
)
 
(95,469
)
Notes canceled
 
(9,330
)
 
(10,052
)
 
(21,325
)
Foreign currency adjustment
 
(75
)
 
(161
)
 
(407
)
Balance at end of period
 
108,333

 
108,267

 
84,494

Unrecognized revenue portion of notes receivable
 
(43,217
)
 
(38,300
)
 
(39,701
)
Notes receivable, net of unrecognized revenue
 
$
65,116

 
$
69,967

 
$
44,793





10


Notes receivable, net of unrecognized revenue, are presented in the consolidated balance sheets as follows:

 
 
Six Months Ended 
 October 31, 2014
 
Six Months Ended 
 October 31, 2013
 
Year Ended
April 30, 2014
 
 
(In thousands)
Notes receivable, current portion
 
$
41,114

 
$
52,074

 
$
27,715

Notes receivable, excluding current portion, net of allowance for doubtful accounts
 
22,294

 
16,793

 
15,824

Non-current allowance for doubtful accounts
 
1,708

 
1,100

 
1,254

Notes receivable, net of unrecognized revenue
 
$
65,116

 
$
69,967

 
$
44,793

 
Most of the notes receivable are due from the Company's franchisees and ADs and are collateralized by the underlying franchise and, when the franchise or AD is an entity, are guaranteed by the owners of the respective entity. The debtors' ability to repay the notes is dependent upon both the performance of the tax preparation industry as a whole and the individual franchisees' or ADs' areas.
The previous practice of refinancing accounts receivable resulted from a franchisee electing to deliver to the Company a promissory note for past-due royalties and advertising fees that had previously been recorded as accounts receivable in the consolidated financial statements. Effective October 1, 2013, the Company reduced the interest rate on its past due accounts receivable from 18% to 12% and ceased its practice of refinancing accounts receivable into notes receivable.
Notes canceled are comprised of the cancellation of existing unpaid notes of selling franchisees in franchisee to franchisee sales that include the assumption of debt by the acquiring franchisee and any unpaid notes receivable from a franchisee or AD related to specific territories or clusters of territories that the Company reacquires or terminates. In the latter transactions, the cancellation of notes is part of the consideration paid by the Company, and any excess of the consideration paid over the fair value of assets acquired is written off to the allowance for doubtful accounts. The adequacy of the allowance for doubtful accounts is assessed and adjusted as deemed necessary on a quarterly basis.
Unrecognized revenue relates to the financed portion of franchise fees and AD fees and, in the case of sales of Company-owned offices, the financed portion of gains related to these sales in each case where revenue has not yet been recognized. For franchise fees and gains related to the sale of Company-owned offices, revenue is recorded as note payments are received by the Company. Payments on AD fee notes receivable generate a corresponding increase in deferred revenue, which is amortized into revenue over the life of the AD contract, historically 10 years. The Company recently changed the term of new and renewal AD contracts to 6 years and the revenue for these contracts will be recognized over that period, subject to the receipt of cash.
Accounts and notes receivable include royalties billed that relate to territories operated by franchisees located in AD territories and a portion of those accounts and notes are payable to the AD. The Company has recorded amounts payable to ADs for their share of these receivables of $8.0 million, $8.3 million, and $18.2 million at October 31, 2014, October 31, 2013, and April 30, 2014, respectively.
At October 31, 2014, the Company had unfunded lending commitments for working capital loans to franchisees and area developers of $14.2 million.

Allowance for Doubtful Accounts
Management believes that the recorded allowance is adequate based upon its consideration of the estimated value of the franchises and AD areas supporting the receivables. Any adverse change in the tax preparation industry or the individual franchisees' or ADs' areas could affect the Company's estimate of the allowance.







11


Activity in the allowance for doubtful accounts for the three and six months ended October 31, 2014 and 2013 was as follows: 
 
 
Three Months Ended October 31,
 
Six Months Ended October 31,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In thousands)
Balance at beginning of period
 
$
7,105

 
$
6,420

 
$
6,850

 
$
6,684

Provision for doubtful accounts
 
1,752

 
1,868

 
3,208

 
3,430

Write-offs
 
(1,681
)
 
(2,216
)
 
(2,893
)
 
(4,028
)
Foreign currency adjustment
 
(31
)
 
(24
)
 
(20
)
 
(38
)
Balance at end of period
 
$
7,145

 
$
6,048

 
$
7,145

 
$
6,048

The allocation of the allowance for doubtful accounts between current and non-current as of October 31, 2014, October 31, 2013, and April 30, 2014 was as follows:
 
 
October 31, 2014
 
October 31, 2013
 
April 30, 2014
 
 
(In thousands)
Current
 
$
5,437

 
$
4,948

 
$
5,596

Non-current
 
1,708

 
1,100

 
1,254

Total allowance for doubtful accounts
 
$
7,145

 
$
6,048

 
$
6,850


Management considers specific accounts and notes receivable to be impaired if the net amounts due exceed the fair value of the underlying franchise and estimates an allowance for doubtful accounts based on that excess. While not specifically identifiable as of the balance sheet date, our experience also indicates that a portion of our other accounts and notes receivable are also impaired, as management does not expect to collect all principal and interest due under the current contractual terms. Net amounts due include contractually obligated accounts and notes receivable plus accrued interest, net of unrecognized revenue, reduced by the allowance for uncollected interest, amounts due ADs, related deferred revenue, and amounts owed to the franchisee by the Company. In establishing the fair value of the underlying franchise, management considers recent sales between franchisees, net fees of open offices earned during the most recently completed tax season, and the number of unopened offices.

12


The allowance for doubtful accounts at October 31, 2014, October 31, 2013, and April 30, 2014 was allocated as follows:
 
 
October 31, 2014
 
October 31, 2013
 
April 30, 2014
 
 
(In thousands)
Impaired:
 
 

 
 
 
 

Accounts receivable
 
$
4,408

 
$
4,588

 
$
6,083

Notes receivable, including interest, net of unrecognized revenue
 
6,946

 
8,478

 
9,221

Less allowance for uncollected interest, amounts due ADs, related deferred revenue, and amounts due franchisees
 
(2,056
)
 
(2,017
)
 
(2,592
)
Net accounts and notes receivable
 
$
9,298

 
$
11,049

 
$
12,712

 
 
 
 
 
 
 
Allowance for doubtful accounts for impaired notes and accounts receivable
 
$
4,342

 
$
5,255

 
$
6,131

 
 
 
 
 
 
 
Non-impaired:
 
 

 
 
 
 

Accounts receivable
 
$
26,682

 
$
18,577

 
$
38,965

Notes receivable, including interest, net of unrecognized revenue
 
61,596

 
66,195

 
37,050

Less allowance for uncollected interest, amounts due ADs, related deferred revenue, and amounts due franchisees
 
(10,339
)
 
(11,574
)
 
(19,381
)
Net accounts and notes receivable
 
$
77,939

 
$
73,198

 
$
56,634

 
 
 
 
 
 
 
Allowance for doubtful accounts for non-impaired notes and accounts receivable
 
$
2,803

 
$
793

 
$
719

 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
Accounts receivable
 
$
31,090

 
$
23,165

 
$
45,048

Notes receivable, including interest, net of unrecognized revenue
 
68,542

 
74,673

 
46,271

Total accounts and notes receivable
 
99,632

 
97,838

 
91,319

Less allowance for uncollected interest, amounts due ADs, related deferred revenue, and amounts due franchisees
 
(12,395
)
 
(13,591
)
 
(21,973
)
Total net accounts and notes receivable
 
$
87,237

 
$
84,247

 
$
69,346

 
 
 
 
 
 
 
Total allowance for doubtful accounts
 
$
7,145

 
$
6,048

 
$
6,850


The Company’s average investment in impaired notes receivable during the six months ended October 31, 2014 and 2013 was $8.0 million and $8.9 million, respectively.
 
Analysis of Past Due Receivables
The breakdown of accounts and notes receivable past due at October 31, 2014 was as follows:
 
 
Total
Past Due
 
Current
 
Total Receivables
 
Allowance for Uncollected Interest
 
Net Receivables
 
 
(In thousands)
Accounts receivable
 
$
29,081

 
$
2,009

 
$
31,090

 
$
(2,683
)
 
$
28,407

Notes and interest receivable, plus non-current allowance for doubtful accounts
 
8,742

 
59,800

 
68,542

 
(933
)
 
67,609

Total accounts, notes and interest receivable
 
$
37,823

 
$
61,809

 
$
99,632

 
$
(3,616
)
 
$
96,016

 
Accounts receivable are considered to be past due if unpaid 30 days after billing and notes receivable are considered past due if unpaid 90 days after the due date, at which time the notes are put on nonaccrual status. The Company’s investment in notes receivable on nonaccrual status at October 31, 2014, October 31, 2013, and April 30, 2014 was $7.8 million, $6.6

13


million, and $10.8 million, respectively. Payments received on notes in nonaccrual status are applied to interest income first until the note is current and then to the principal note balance. Nonaccrual notes that are paid current are moved back into accrual status during the next annual review.

(3) Investments
 
During fiscal 2013, the Company purchased corporate equity securities, as a strategic investment in a business partner, for $3.0 million and classified them as available for sale.  At October 31, 2013, the fair value of this investment was $4.6 million and the unrealized gain, net of tax, was $1.1 million. Securities with a basis of $268 thousand were sold at a gain of $188 thousand during the second quarter of fiscal 2014. There were no such investments at October 31, 2014 or April 30, 2014.
 
(4) Goodwill and Intangible Assets 
At the end of the fourth quarter of fiscal 2014, assets acquired from U.S. franchisees were transferred out of goodwill and intangible assets and classified as assets held for sale. Changes in the carrying amount of goodwill for the six months ended October 31, 2014 and 2013 were as follows:
 
 
October 31, 2014
 
October 31, 2013
 
 
(In thousands)
Balance at beginning of period
 
$
2,997

 
$
5,685

Acquisitions of assets from franchisees
 
—

 
2,763

Disposals and foreign currency changes, net
 
(19
)
 
(1,164
)
Impairments
 
—

 
(90
)
Balance at end of period
 
$
2,978

 
$
7,194

Components of intangible assets were as follows as of October 31, 2014, October 31, 2013, and April 30, 2014:
 
 
October 31, 2014
 
 
Weighted average amortization period
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
 
 
(In thousands)
Amortizable intangible assets:
 
 
 
 
 
 
 
 
Customer lists acquired from unrelated third parties
 
6 years
 
$
4,816

 
$
(1,717
)
 
$
3,099

Assets acquired from franchisees:
 
 
 
 
 
 
 
 
Customer lists
 
5 years
 
513

 
(461
)
 
52

Reacquired rights
 
5 years
 
454

 
(408
)
 
46

AD rights
 
10 years
 
12,266

 
(3,329
)
 
8,937

Total intangible assets
 
 
 
$
18,049

 
$
(5,915
)
 
$
12,134


 
 
October 31, 2013
 
 
Weighted average amortization period
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
 
 
(In thousands)
Amortizable intangible assets:
 
 
 
 
 
 
 
 
Customer lists acquired from unrelated third parties
 
7 years
 
$
1,603

 
$
(427
)
 
$
1,176

Assets acquired from franchisees:
 
 
 
 
 
 
 
 
Customer lists
 
4 years
 
2,576

 
(722
)
 
1,854

Reacquired rights
 
2 years
 
2,203

 
(1,280
)
 
923

AD rights
 
10 years
 
15,261

 
(2,898
)
 
12,363

Total intangible assets
 
 
 
$
21,643

 
$
(5,327
)
 
$
16,316



14


 
 
April 30, 2014
 
 
Weighted average amortization period
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
 
 
(In thousands)
Amortizable intangible assets:
 
 
 
 
 
 
 
 
Customer lists acquired from unrelated third parties
 
6 years
 
$
4,816

 
$
(995
)
 
$
3,821

Assets acquired from franchisees:
 
 
 
 
 
 
 
 
Customer lists
 
4 years
 
551

 
(387
)
 
164

Reacquired rights
 
2 years
 
481

 
(338
)
 
143

AD rights
 
10 years
 
13,641

 
(3,474
)
 
10,167

Total intangible assets
 
 
 
$
19,489

 
$
(5,194
)
 
$
14,295

During the six months ended October 31, 2014 and 2013, the Company acquired the assets of various franchisees for $213 thousand and $5.2 million, respectively. During the first six months of fiscal 2014, both U.S. and Canadian franchise acquisitions were recorded as intangible assets, however, during the first six months of fiscal 2015, U.S. franchise acquisitions were recorded as assets held for sale, while Canadian franchise acquisitions continued to be recorded as intangible assets. These acquisitions were accounted for as business combinations, with all value allocated to intangible assets. The purchase price of assets acquired from franchisees and recorded as customer lists, reacquired rights, and goodwill during the six months ended October 31, 2014 and 2013 was allocated as follows:
 
 
Six Months Ended October 31,
 
 
2014
 
2013
 
 
(In thousands)
Customer lists and reacquired rights
 
$
213

 
$
2,418

Goodwill
 
—

 
2,763

Purchase price of assets acquired from franchisees, not held for sale
 
$
213

 
$
5,181


(5) Assets Held For Sale
At the end of the fourth quarter of fiscal 2014, assets acquired from U.S. franchisees were classified as assets held for sale. During the six months ended October 31, 2014, the Company acquired $4.2 million in assets from U.S. franchisees. These acquisitions were accounted for as business combinations, with the value allocated to customer lists and reacquired rights of $2.1 million and goodwill of $2.1 million prior to being reclassified to assets held for sale.  The acquired businesses are operated as Company-owned offices until a buyer is located and a new franchise agreement is entered into.

Changes in the carrying amount of assets held for sale for the six months ended October 31, 2014 were as follows:
 
 
Six Months Ended 
 October 31, 2014
 
 
(In thousands)
Balance at beginning of period
 
$
4,413

Acquisitions of assets from franchisees
 
4,175

Dispositions
 
(3,190
)
Balance at end of period
 
$
5,398


(6) Debt
 
In October 2014, the Company amended its credit facility. The amended credit facility consists of a $21.2 million term loan and a revolving credit facility that currently allows borrowing of up to $203.8 million with an accordion feature that permits the Company to request an increase in availability of up to an additional $50.0 million. Outstanding borrowings accrue interest at one-month London Interbank Offered Rate (LIBOR) plus a margin ranging from 1.50% to 2.25% depending on the Company’s leverage ratio. At October 31, 2014, the interest rate was 1.78%, and the average interest rate paid during the six months ended October 31, 2014 was also 1.78%. The indebtedness is collateralized by substantially all the assets of the Company and both loans mature on April 30, 2019 (except as to the commitments of one lender under the revolving credit facility, which mature on September 30, 2017).  The credit facility contains certain financial covenants that the Company must

15


meet, including leverage and fixed-charge coverage ratios as well as minimum net worth requirements.  The Company was in compliance with the financial covenants at October 31, 2014. 
Debt at October 31, 2014, October 31, 2013, and April 30, 2014 consisted of the following:
 
 
October 31, 2014
 
October 31, 2013
 
April 30, 2014
 
 
(In thousands)
Credit Facility:
 
 

 
 
 
 

Revolver
 
$
51,711

 
$
38,459

 
$
—

Term loan
 
20,984

 
22,813

 
21,875

 
 
72,695

 
61,272

 
21,875

Amounts due to former ADs and mortgages
 
3,100

 
6,659

 
6,613

 
 
75,795

 
67,931

 
28,488

Less: current portion
 
(1,965
)
 
(6,485
)
 
(6,797
)
Long-term debt
 
$
73,830

 
$
61,446

 
$
21,691

 
(7) Income Taxes
 
The Company computes its provision for or benefit from income taxes by applying the estimated annual effective tax rate to income or loss from recurring operations and adjusting the effects of any discrete income tax items specific to the period, if applicable.

(8) Stockholders’ Equity

Stockholders' Equity Activity
During the six months ended October 31, 2014 and 2013, activity in stockholders’ equity was as follows:
 
 
Six Months Ended 
 October 31, 2014
 
Six Months Ended 
 October 31, 2013
 
 
(In thousands)
Class A common shares issued from the exercise of stock options
 
503

 
200

Proceeds from exercise of stock options
 
$
8,145

 
$
2,998

Class A common shares repurchased
 
1,210

 
137

Payments for repurchased shares
 
$
33,699

 
$
2,495

Tax benefit of stock option exercises
 
$
4,273

 
$
416


Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income at October 31, 2014, October 31, 2013, and April 30, 2014 were as follows:
 
 
October 31, 2014
 
October 31, 2013
 
April 30, 2014
 
 
(In thousands)
Foreign currency adjustment
 
$
(103
)
 
$
491

 
$
66

Unrealized gain on available-for-sale securities, net of taxes of $-, $707, and $-, respectively
 
—

 
1,148

 
—

Total accumulated other comprehensive income (loss)
 
$
(103
)
 
$
1,639

 
$
66


Net Income (Loss) per Share
 
Net income (loss) per share of Class A and Class B common stock is computed using the two-class method. Basic net income (loss) per share is computed by allocating undistributed earnings to common shares and participating securities (exchangeable shares) and using the weighted-average number of common shares outstanding during the period.  Undistributed losses are not allocated to participating securities because they do not meet the required criteria for such allocation. 

16


 
Diluted net income (loss) per share is computed using the weighted-average number of common shares and, if dilutive, the potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options. The dilutive effect of outstanding stock options is reflected in diluted earnings per share by application of the treasury stock method. Additionally, the computation of the diluted net income (loss) per share of Class A common stock assumes the conversion of Class B common stock and exchangeable shares, if dilutive, while the diluted net loss per share of Class B common stock does not assume conversion of those shares.
 
The rights, including liquidation and dividend rights, of the holders of Class A and Class B common stock are identical, with the exception of the election of directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common stock as if the earnings for the year had been distributed.  Participating securities have dividend rights that are identical to Class A and Class B common stock.
The computation of basic and diluted net loss per share for the three and six months ended October 31, 2014 and 2013 was as follows:
 
 
Three Months Ended 
 October 31, 2014
 
 
Class A
 
Class B
 
 
Common Stock
 
Common Stock
 
 
(in thousands, except for share and per
share amounts)
Basic and diluted net loss per share:
 
 

 
 

Numerator
 
 

 
 

Allocation of undistributed losses
 
$
(10,524
)
 
$
(804
)
Denominator
 
 
 
 
Weighted-average common shares outstanding
 
11,780,306

 
900,000

 
 
 
 
 
Basic and diluted net loss per share
 
$
(0.89
)
 
$
(0.89
)

 
 
Six Months Ended 
 October 31, 2014
 
 
Class A
 
Class B
 
 
Common Stock
 
Common Stock
 
 
(in thousands, except for share and per
share amounts)
Basic and diluted net loss per share:
 
 

 
 

Numerator
 
 

 
 

Allocation of undistributed losses
 
$
(18,565
)
 
$
(1,407
)
Denominator
 
 
 
 

Weighted-average common shares outstanding
 
11,873,789

 
900,000

 
 
 
 
 
Basic and diluted net loss per share
 
$
(1.56
)
 
$
(1.56
)

As a result of the net losses for the periods, diluted net loss per share excludes the impact of shares of potential common stock from the exercise of options to purchase 1,144,742 and 1,264,909 shares for the three and six months ended October 31, 2014, respectively, because the effect would be antidilutive.


17




Three Months Ended 
 October 31, 2013
 

Class A

Class B
 

Common Stock

Common Stock
 

(in thousands, except for share and per
share amounts)
Basic and diluted net loss per share:

 


 

Numerator

 


 

Allocation of undistributed earnings

$
(7,888
)
 
$
(590
)
Denominator

 


 

Weighted-average common shares outstanding

12,026,060

 
900,000

 






Basic and diluted net loss per share

$
(0.66
)
 
$
(0.66
)
 
 
Six Months Ended 
 October 31, 2013
 
 
Class A
 
Class B
 
 
Common Stock
 
Common Stock
 
 
(in thousands, except for share and per
share amounts)
Basic and diluted net loss per share:
 
 

 
 

Numerator
 
 

 
 

Allocation of undistributed losses
 
$
(13,401
)
 
$
(1,004
)
Denominator
 
 
 
 
Weighted-average common shares outstanding
 
12,010,673

 
900,000

 
 
 
 
 
Basic and diluted net loss per share
 
$
(1.12
)
 
$
(1.12
)
 
As a result of the net losses for the periods, diluted net loss per share excludes the impact of shares of potential common stock from the exercise of options to purchase 2,247,000 and 2,375,000 shares for the three and six months ended October 31, 2013, respectively, because the effect would be antidilutive.

(9) Stock Compensation Plans
 
Stock Options
 
In August 2011, the Board of Directors approved the JTH Holding, Inc. 2011 Equity and Cash Incentive Plan. Employees and outside directors are eligible to receive awards and a total of 2,500,000 shares of Class A common stock were authorized for grant under the plan. At October 31, 2014, 1,484,769 shares of Class A common stock remained available for grant.
The following table summarizes the information for options granted during the six months ended October 31, 2014:
Weighted average fair value of options granted
 
$
10.13

Dividend yield
 
0.0
%
Expected volatility
 
31.1% - 31.2%

Expected terms (in years)
 
5.0

Risk-free interest rates
 
1.6% - 1.9%






18


Stock option activity during the six months ended October 31, 2014 was as follows:
 
 
Number of
options
 
Weighted
average
exercise price
Balance at beginning of period
 
1,940,406

 
$
16.68

Granted
 
140,416

 
33.60

Exercised
 
(503,436
)
 
16.18

Canceled
 
(4,850
)
 
15.00

Balance at end of period
 
1,572,536

 
18.36


Intrinsic value is defined as the fair value of the stock less the cost to exercise. The total intrinsic value of options exercised during the six months ended October 31, 2014 was approximately $8.6 million. The total intrinsic value of stock options outstanding at October 31, 2014 was $30.7 million. Stock options have vesting schedules that range from six months to six years from the date of grant and expire from four to five years after the vesting date.
Nonvested stock options (options that had not vested in the period reported) activity during the six months ended October 31, 2014 was as follows: 
 
 
Nonvested
options
 
Weighted
average
exercise price
Balance at beginning of period
 
485,000

 
$
20.92

Granted
 
140,416

 
33.60

Vested
 
(155,000
)
 
20.46

Canceled
 
—

 
—

Balance at end of period
 
470,416

 
24.86

 
At October 31, 2014, unrecognized compensation costs related to nonvested stock options were $3.4 million. These costs are expected to be recognized from fiscal 2015 through fiscal 2020.
The following table summarizes information about stock options outstanding and exercisable at October 31, 2014:
 
 
Options Outstanding
 
Options Exercisable
Range of exercise prices
 
Number of shares outstanding at
 
Weighted average exercise price
 
Weighted average remaining contractual life (in years)
 
Number of options exercisable at
 
Weighted average exercise price
 
October 31, 2014
 
 
 
October 31, 2014
 
$
10.50

 
$
35,000

 
$
10.50

 
0.8
 
35,000

 
$
10.50

14.00-16.50

 
839,048

 
15.04

 
2.2
 
799,048

 
15.05

15.00

 
105,503

 
15.00

 
2.6
 
105,503

 
15.00

16.38-19.75

 
277,569

 
18.01

 
4.9
 
127,569

 
16.95

26.18

 
175,000

 
26.18

 
7.2
 
35,000

 
26.18

33.38-33.79

 
140,416

 
33.60

 
7.0
 
—

 
—



 
1,572,536

 
18.36

 

 
1,102,120

 
15.58


During the fiscal year ended April 30, 2013, the settlement of certain stock option transactions caused a change in the classification of the related outstanding stock options to liability instruments from equity instruments, which resulted in an increase in stock compensation expense of $2.6 million. At April 30, 2013, the value of the liability for the 997,824 options that changed classifications from equity to liability instruments was $5.1 million. On June 11, 2013, the Company's board of directors voted to prohibit those types of transactions, therefore, the Company reclassified the stock options back to equity instruments, resulting in a reduction to stock compensation expense of $872 thousand. The liability was removed and the remainder was reclassified to additional paid-in capital.




19


Restricted Stock Units
 
Restricted stock activity during the six months ended October 31, 2014 was as follows:
 
 
Number of
RSUs
 
Weighted
average fair value at grant date
Balance at beginning of period
 
21,445

 
$
16.87

Granted
 
26,889

 
33.38

Vested
 
—

 
—

Canceled
 
(1,172
)
 
22.68

Balance at end of period
 
47,162

 
26.14

 
At October 31, 2014, unrecognized compensation costs related to restricted stock units were $904 thousand. These costs are expected to be recognized through 2021.

(10) Fair Value of Financial Instruments
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities subject to fair value measurements on a recurring basis are classified according to a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. Valuation methodologies for the fair value hierarchy are as follows:
 
•
Level 1 — Quoted prices for identical assets and liabilities in active markets.
 
•
Level 2 — Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-based valuations in which all significant inputs are observable in the market.

•
Level 3 — Unobservable inputs in which little or no market data exists, therefore, requiring an entity to develop its own assumptions.

The Company measures or monitors certain of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for those assets and liabilities for which fair value is the primary basis of accounting. Other assets and liabilities are measured at fair value on a nonrecurring basis; that is, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. At October 31, 2014, October 31, 2013, and April 30, 2014, the following tables present, for each of the fair value hierarchy levels, the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis (in thousands):
 
 
October 31, 2014
 
 
 
 
Fair value measurements using
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Nonrecurring:
 
 

 
 

 
 

 
 

Impaired accounts and notes receivable
 
$
5,601

 
$
—

 
$
—

 
$
5,601

Total recurring and nonrecurring assets
 
$
5,601

 
$
—

 
$
—

 
$
5,601


20




 
 
October 31, 2013
 
 
 
 
Fair value measurements using
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Recurring:
 
 

 
 

 
 

 
 

Available-for-sale securities
 
$
4,606

 
$
4,606

 
$
—

 
$
—

Nonrecurring:
 
 

 
 

 
 

 
 

Impaired accounts and notes receivable
 
6,624

 
—

 
—

 
6,624

Total recurring and nonrecurring assets
 
$
11,230

 
$
4,606

 
$
—

 
$
6,624



 
 
April 30, 2014
 
 
 
 
Fair value measurements using
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Recurring:
 
 

 
 

 
 

 
 

Cash equivalents
 
$
42,918

 
$
42,918

 
$
—

 
$
—

Nonrecurring:
 
 

 
 

 
 

 
 

Impaired accounts and notes receivable
 
7,747

 
—

 
—

 
7,747

Impaired goodwill
 
86

 
—

 
—

 
86

Impaired reacquired rights
 
42

 
—

 
—

 
42

Impaired customer lists
 
52

 
—

 
—

 
52

Assets held for sale
 
4,413

 
—

 
—

 
4,413

Total nonrecurring assets
 
12,340

 
—

 
—

 
12,340

Total recurring and nonrecurring assets
 
$
55,258

 
$
42,918

 
$
—

 
$
12,340


The Company’s policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers into or out of level 1 or 2 requiring fair value measurements for the six months ended October 31, 2014.

The Company uses the following methods and assumptions to estimate the fair value of financial instruments.
 
Cash equivalents: The carrying amounts approximate fair value because of the short maturity of these instruments. Cash equivalent financial instruments consist of money market accounts.

Available-for-sale securities: Available-for-sale securities are carried at their aggregate fair value. Fair values for available-for-sale securities are based on published market prices.

Impaired accounts and notes receivable: Management considers accounts and notes receivable to be impaired if the net amounts due exceed the fair value of the underlying franchise or if management considers it probable we will not collect all principal and interest when contractually due. In establishing the estimated fair value of the underlying franchise, consideration is given to recent sales between franchisees, the net fees of open offices, and the number of unopened offices.

Impaired goodwill, reacquired rights, and customer lists: Management considers goodwill, reacquired rights, and customer lists associated with a Company-owned office to be impaired if the net carrying amount exceeds the fair value of the underlying office. In establishing the fair value of the underlying office, consideration is given to the net fees of the underlying office.

Assets held for sale: Assets held for sale are recorded at the lower of the carrying value or the sales price, less costs to sell, which approximates fair value. The sales price is calculated as a percentage of net fees.


21



Other Fair Value Measurements

Additionally, accounting standards require the disclosure of the estimated fair value of financial instruments that are not recorded at fair value. For the financial instruments that the Company does not record at fair value, estimates of fair value are made at a point in time based on relevant market data and information about the financial instrument. No readily available market exists for a significant portion of the Company's financial instruments. Fair value estimates for these instruments are based on current economic conditions, interest rate risk characteristics, and other factors. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision. Therefore, the calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. In addition, changes in assumptions could significantly affect these fair value estimates. The following methods and assumptions were used by the Company in estimating fair value of these financial instruments.

Receivables other than notes, other current assets, accounts payable and accrued expenses, and due to ADs: The carrying amounts approximate fair value because of the short maturity of these instruments (Level 3).

Notes receivable: The carrying amount of the Company’s notes receivable approximates fair value because the interest rate charged by the Company on these notes approximates rates currently offered by local lending institutions for loans of similar terms to individuals/entities with comparable credit risk (Level 3).

Long-term debt: Because the Company's long-term debt has a variable interest component, the carrying amount approximates fair value (Level 2).

(11) Related Party Transactions
The Company considers directors and their affiliated companies as well as executive officers and members of their immediate family to be related parties. For the six months ended October 31, 2014 and 2013, the Company repurchased common stock from related parties as follows: 
 
 
Six Months Ended 
 October 31, 2014
 
Six Months Ended 
 October 31, 2013
Common stock repurchases:
 
 

 
 

Number of shares
 
982,065

 
122,249

Amount
 
$
26,121,018

 
$
2,232,183


The Company has entered into a multi-year contract to purchase a license for the use of Canadian tax software at a price of $657 thousand from a company in which it has an investment accounted for under the equity method. One of the members of the Company's Board of Directors is affiliated with the company providing this service.

The Company has entered into an agreement to purchase the right to distribute cloud and mobile accounting solutions to its franchisees. One of the members of the Company's Board of Directors is affiliated with the company providing this service.

(12) Commitments and Contingencies

ERC class action litigation. The Company was sued in November 2011 in federal courts in Arkansas, California, Florida and Illinois, and additional lawsuits were filed in federal courts in January 2012 in Maryland and North Carolina, in February 2012 in Wisconsin, and in May 2012 in New York and Minnesota, since the initial filings. In April 2012, a motion to consolidate all of the then-pending cases before a single judge in federal court in the Northern District of Illinois was granted, and in June 2012, the plaintiffs filed a new complaint in the consolidated action. The consolidated complaint alleges that an electronic refund check ("ERC") represents a form of refund anticipation loan ("RAL") because the taxpayer is "loaned" the tax preparation fee, and that an ERC is therefore subject to federal truth-in-lending disclosure and state law requirements regulating RALs. The plaintiffs therefore allege violations of state-specific RAL and other consumer statutes. The lawsuit purports to be a class action, and the plaintiffs allege potential damages in excess of $5.0 million, but the Company may be able to recover any damages from the providers of the financial products that designed the programs and related disclosures. The Company is aware that virtually identical lawsuits have been filed against several of its competitors. The Company has not concluded that a loss related to this matter is probable, nor has the Company accrued a loss contingency related to this matter. The Company

22


believes it has meritorious defenses to the claims in this case, and intends to defend the case vigorously, but there can be no assurances as to the outcome or the impact on the Company's consolidated financial position, results of operations and cash flows. The case is at an early procedural stage, and the Company is presently appealing a ruling related to the ability to arbitrate certain of the claims. The parties are presently engaged in mediation as part of the process required by the appellate court.

TCPA class action litigation. The Company was sued in September 2013 in federal court in Illinois in connection with alleged violations of the Telephone Consumer Protection Act. Plaintiff alleges that the Company inappropriately made auto-dialed telephone calls to cellular telephones, seeks the certification of a nationwide class action, and claims statutory damages of $500-$1,500 per violation. The Company tendered the defense of this litigation to a third party entity that had contracted with the Company to solicit potential franchisees, and that third party entity has acknowledged its defense and indemnification obligations to the Company. However, because the third party contractor may not have the financial resources to satisfy its defense and indemnity obligations, the Company concluded that it could not rely fully upon the fulfillment of those obligations. In September 2014, the parties reached a tentative settlement of this litigation, but that settlement remains subject to the final negotiation of a settlement agreement, approval of the court, and other conditions typical in a class action. The Company believes that the net impact of the settlement will be reduced by payments expected to be made by principals of the third party contractor.

The Company is also party to claims and lawsuits that are considered to be ordinary, routine litigation incidental to the business, including claims and lawsuits concerning the preparation of customers' income tax returns, the fees charged to customers for various products and services, relationships with franchisees, intellectual property disputes, employment matters and contract disputes. Although the Company cannot provide assurance that it will ultimately prevail in each instance, the Company believes the amount, if any, it will be required to pay in the discharge of liabilities or settlements in these claims will not have a material adverse impact on its consolidated results of operations or cash flows.

ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
Special Note Regarding Forward-Looking Statements
 
This quarterly report contains forward-looking statements concerning our business, operations, financial performance, and condition as well as our plans, objectives, and expectations for our business operations and financial performance and condition. Any statements contained herein that are not of historical facts may be deemed to be forward-looking statements. You can identify these statements by words such as “aim,” “anticipate,” “assume,” “believe,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends. These forward-looking statements are based on current expectations, estimates, forecasts, projections about our business and the industry in which we operate, and our management’s beliefs and assumptions. They are not guarantees of future performance or development and involve known and unknown risks, uncertainties, and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this quarterly report may turn out to be inaccurate. Factors that may cause such differences include, but are not limited to, the risks described under “Item 1A—Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended April 30, 2014 and risks described in all other filings with the Securities and Exchange Commission, including:
 
•
our possible inability to sustain growth at our historical pace;
 
•
the seasonality of our business;
 
•
our inability to secure reliable sources of the tax settlement products we make available to our customers;
 
•
the continued service of our senior management team and our ability to attract additional talent;
 
•
government regulation and oversight, including the regulation of our tax settlement products such as refund transfers and loan settlement products;
 
•
government initiatives that simplify tax return preparation, improve the timing and efficiency of processing tax returns,  limit payments to tax preparers or decrease the number of tax returns filed or the size of the refunds;

•
government initiatives to pre-populate income tax returns;

23


 
•
increased regulation of the products and services that we offer;
 
•
the possible characterization of refund transfers as a form of loan or extension of credit;
 
•
changes in the tax settlement products offered to our customers that make our services less attractive to customers or more costly to us;
 
•
our ability to maintain relationships with our tax settlement product service providers;
 
•
our ability and the ability of our franchisees to comply with regulatory requirements;
 
•
the ability of our franchisees to open new territories and operate them successfully;
 
•
the ability of our franchisees to generate sufficient revenue to repay their indebtedness to us;

•
our ability to manage Company-owned offices and tax kiosks;

•
our exposure to litigation;
 
•
our ability and our franchisees’ ability to protect customers’ personal information, including from a cyber-security incident; 

•
our ability to access the credit markets and satisfy our covenants to lenders;
 
•
challenges in deploying accurate tax software in a timely way each tax season;

•
delays in the commencement of the tax season attributable to late Congressional action affecting tax matters and the resulting inability of federal and state tax agencies to accept tax returns on a timely basis;
 
•
competition in the tax preparation market;

•
the effect of federal and state legislation that affects the demand for paid tax preparation, such as the Affordable Care Act and potential immigration reform;

•
the effect of federal executive action affecting immigration;
 
•
our reliance on technology systems, including the deployment of our LibPRO (formerly NextGen) project and electronic communications;
 
•
our ability to deploy our LibPRO software in a timely manner and with all the features our customers require;

•
the impact of any acquisitions or dispositions, including our ability to integrate acquisitions and capitalize on their anticipated synergies; and

•
risks relating to our management's determination that there was a material weakness in our internal control over financial reporting, and as a result that our disclosure controls and procedures were not effective during periods at and prior to January 31, 2014.
 
Potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on the forward-looking statements. These forward-looking statements speak only as of the date of this quarterly report. Unless required by law, we do not intend to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. A potential investor or other vendor should, however, review the factors and risks we describe in the reports we will file from time to time with the U.S. Securities and Exchange Commission ("SEC") after the date of this quarterly report.





24


Overview
 
We are one of the leading providers of tax preparation services in the United States and Canada. As measured by both the number of returns prepared and the number of retail offices, we are the third largest retail preparer of individual tax returns in the United States and the second largest retail preparer of individual tax returns in Canada.

Our tax preparation services and related tax settlement products are offered primarily through franchised locations, although we operate a limited number of Company-owned offices each tax season. All of the offices are operated under the Liberty Tax Service brand.

Approximately 58% of our revenue for fiscal 2014 was derived from franchise fees, area developer fees, royalties and advertising fees. For this reason, continued growth in and seasoning of our franchise locations is viewed by management as the key to our future performance. During the 2014 tax season, we and our franchisees operated 4,438 tax offices.

Our revenue primarily consists of the following components:
 
•
Franchise Fees: Our standard franchise fee per territory is $40,000 and we offer our franchisees flexible structures and financing options for franchise fees. Franchise fee revenue is recognized when our obligations to prepare the franchisee for operation are substantially complete and as cash is received.
•
AD Fees: Our fees for AD areas vary based on our assessment of the revenue potential of each AD area and also depend on the performance of any existing franchisees within the AD area being sold. AD fees received are recognized as revenue on a straight-line basis over the initial contract term of each AD agreement with the cumulative amount of revenue recognized not to exceed the amount of cash received. The length of our AD agreements has historically been ten years. The Company recently changed the term of new and renewal AD contracts to 6 years and the revenue for these contracts will be recognized over that period, subject to the receipt of cash.
•
Royalties: Our franchise agreement requires franchisees to pay us a base royalty typically equal to 14% of the franchisee's tax preparation revenue, subject to certain specified minimums.
•
Advertising Fees: Our franchise agreement requires all franchisees to pay us an advertising fee of 5% of the franchisee's tax preparation revenue, which we use primarily to fund collective advertising efforts.
•
Financial Products: We offer tax settlement financial products to our customers. The refund transfer products provide a means by which a customer may receive his or her refund more quickly and conveniently. We earn fees from the use of these financial products.
•
Interest Income: We earn interest income from our franchisees and ADs related to both indebtedness for the unpaid portions of their franchise fees and AD territory fees, and for other loans we extend to our franchisees related to the operation of their territories. For franchise fees and AD loans upon which the underlying revenue has not been recognized, we recognize the interest income only to the extent of actual payment.
•
Tax Preparation Fees: We also earn tax preparation revenue directly from both the operation of Company-owned offices and providing tax preparation services through our online tax return products.
•
Other Revenue: Other revenue primarily includes the gain or loss on sale of territories, commission fees charged to our ADs when we assist in selling a franchise within an AD area, and transfer fees earned from franchisee to franchisee territory sales.

A significant portion of our period-to-period increase in expenses is attributable to the continuing expansion of our franchise network and other initiatives designed to support both the growth of that network and of the tax preparation businesses of our franchisees. Although the Company has experienced substantial growth in the past, we have a significant number of undeveloped territories remaining, and continue to dedicate corporate resources to the expansion of our franchise system. In addition, we are at the early stages of two corporate initiatives that we believe will foster continued growth in both our franchise and customer bases, but that require us to incur expenses. The first of these initiatives relates to the close connection between the tax system and the Affordable Care Act ("ACA"). Many of the interactions by consumers with the ACA involve the tax system, through which exemptions, subsidies and penalties for failing to obtain coverage are handled. We believe the ACA provides a substantial opportunity for our tax offices to engage with consumers to explain the insurance alternatives available to them, to maximize the availability of exemptions and insurance subsidies, and to minimize the tax consequences of failing to obtain insurance. For this reason, we have devoted significant resources during the first six months of fiscal 2015 to providing our franchisees the ability to better educate both existing and new customers about the ACA and

25


access to insurance alternatives. During the first six months of fiscal 2015, we also incurred significant start-up expenses in launching a new franchise tax brand, SiempreTax+, which we believe will fill the growing need to provide retail tax and related services to the Hispanic community. We expect to have a limited number of SiempreTax+ stores open during the 2015 tax season, and to continue to grow that brand in future periods.
For purposes of this section and throughout this quarterly report, all references to “fiscal 2015” and “fiscal 2014” refer to our fiscal years ended April 30, 2015 and 2014, respectively, and corresponding references to fiscal quarters are references to quarters within those fiscal years. For purposes of this section and throughout this quarterly report, all references to “year” or “years” are the respective fiscal year or years ended April 30 unless otherwise noted in this quarterly report, and all references to “tax season” refer to the period between January 1 and April 30 of the referenced year.

Results of Operations

During the first half of fiscal 2015, we sold approximately 105 new territories, compared to approximately 65 during the prior year period and 190 during the same period of 2013. The 2013 number of new territories includes 81 territories purchased under the now discontinued "zero franchise fee" program. The 2013 number, net of these zero franchise fee purchases, was approximately 109. New territories include territories sold to new franchisees and additional territories sold to existing franchisees.

This information gives insight into a portion of our sales season; however, in order to predict total office count, other factors, including terminations and the opening of previously sold territories, must be considered as well. We expect the total office count to increase over last year, adding more year-round offices and decreasing the number of seasonal offices.

Our new brand, SiempreTax+, will open approximately 60 locations during the 2015 tax season. These locations consist primarily of expansions by current franchisees and conversions of Liberty Tax offices. In cases where a new Liberty Tax location and a SiempreTax+ location are sold in the same new territory, this territory is only counted once in our new territory count.
The table below shows results of operations for the three and six months ended October 31, 2014 and 2013.
 
 
Three Months Ended October 31,
 
Six Months Ended October 31,
 
 
 
 
 
 
Change
 
 
 
 
 
Change
 
 
2014
 
2013
 
$
 
%
 
2014
 
2013
 
$
 
%
(dollars in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenues
 
$
7,734

 
$
7,317

 
$
417

 
6
 %
 
$
15,573

 
$
15,382

 
$
191

 
1
 %
Loss from operations
 
(18,216
)
 
(13,580
)
 
(4,636
)
 
(34
)%
 
(32,239
)
 
(22,960
)
 
(9,279
)
 
(40
)%
Net loss
 
(11,328
)
 
(8,478
)
 
(2,850
)
 
(34
)%
 
(19,972
)
 
(14,405
)
 
(5,567
)
 
(39
)%

Revenue. The table below sets forth the components and changes in our revenue for the three and six months ended October 31, 2014 and