HRB 2014.07.31 10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 
 
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended July 31, 2014
 
 
OR
¨

 
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 1-6089
H&R Block, Inc.
(Exact name of registrant as specified in its charter)
MISSOURI
 
44-0607856
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
One H&R Block Way, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(816) 854-3000
(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 þ No ¨
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No ¨
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 þ          Accelerated filer ¨         Non-accelerated filer ¨         Smaller reporting company ¨
(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 ¨ No  þ
The number of shares outstanding of the registrant's Common Stock, without par value, at the close of business on August 31, 2014: 275,088,388 shares.
 


Table of Contents

Form 10-Q for the Period Ended July 31, 2014

Table of Contents

 
 
 
 
 
Consolidated Statements of Operations and Comprehensive Income (Loss)
 
 
Three months ended July 31, 2014 and 2013
1
 
 
 
 
Consolidated Balance Sheets
 
 
As of July 31, 2014, July 31, 2013 and April 30, 2014
 
 
 
 
Condensed Consolidated Statements of Cash Flows
 
 
Three months ended July 31, 2014 and 2013
 
 
 
 
Notes to Consolidated Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Legal Proceedings
 
 
 
Risk Factors
 
 
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
 
 
 
Exhibits
 
 
 
 


Table of Contents

PART I    FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
 
(unaudited, in 000s, except 
per share amounts)
 
Three months ended July 31,
2014

 
2013

 
 
 
 
 
REVENUES:
 
 
 
 
Service revenues
 
$
115,473

 
$
107,800

Royalty, product and other revenues
 
8,814

 
8,198

Interest income
 
9,299

 
11,197

 
 
133,586

 
127,195

OPERATING EXPENSES:
 
 
 
 
Cost of revenues:
 
 
 
 
Compensation and benefits
 
51,855

 
46,312

Occupancy and equipment
 
83,306

 
78,736

Provision for bad debt and loan losses
 
4,364

 
11,491

Interest
 
13,940

 
14,446

Depreciation and amortization
 
25,085

 
18,620

Other
 
32,971

 
40,448

 
 
211,521

 
210,053

Selling, general and administrative:
 
 
 
 
Marketing and advertising
 
8,145

 
7,123

Compensation and benefits
 
60,964

 
53,047

Depreciation and amortization
 
8,601

 
4,254

Other selling, general and administrative
 
19,490

 
32,273


 
97,200

 
96,697

Total operating expenses
 
308,721

 
306,750

Operating loss
 
(175,135
)
 
(179,555
)
Other income (expense), net
 
(681
)
 
(4,939
)
Loss from continuing operations before income tax benefit
 
(175,816
)
 
(184,494
)
Income tax benefit
 
(66,965
)
 
(71,224
)
Net loss from continuing operations
 
(108,851
)
 
(113,270
)
Net loss from discontinued operations, net of tax benefits of $4,564 and $1,209
 
(7,381
)
 
(1,917
)
NET LOSS
 
$
(116,232
)
 
$
(115,187
)
 
 
 
 
 
BASIC AND DILUTED LOSS PER SHARE:
 
 
 
 
Continuing operations
 
$
(0.40
)
 
$
(0.42
)
Discontinued operations
 
(0.02
)
 

Consolidated
 
$
(0.42
)
 
$
(0.42
)
 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
 
$
0.20

 
$
0.20

 
 
 
 
 
COMPREHENSIVE INCOME (LOSS):
 
 
 
 
Net loss
 
$
(116,232
)
 
$
(115,187
)
Unrealized gains (losses) on securities, net of taxes:
 
 
 
 
Unrealized holding losses arising during the period
 
(723
)
 
(7,715
)
Reclassification adjustment for losses included in income
 
574

 

Change in foreign currency translation adjustments
 
455

 
(3,092
)
Other comprehensive income (loss)
 
306

 
(10,807
)
Comprehensive loss
 
$
(115,926
)
 
$
(125,994
)
 
 
 
 
 
See accompanying notes to consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS
 
(in 000s, except share and 
per share amounts)
 
As of
 
July 31, 2014

 
July 31, 2013

 
April 30, 2014

 
 
(unaudited)

 
(unaudited)

 
 
ASSETS
 
 
 
 
 
 
Cash and cash equivalents
 
$
1,429,489

 
$
1,163,876

 
$
2,185,307

Cash and cash equivalents - restricted
 
71,917

 
55,477

 
115,319

Receivables, less allowance for doubtful accounts of $51,400, $52,606 and $52,578
 
122,315

 
121,309

 
191,618

Prepaid expenses and other current assets
 
264,666

 
364,270

 
198,267

Investments in available-for-sale securities
 
403,774

 

 
423,495

Total current assets
 
2,292,161

 
1,704,932

 
3,114,006

Mortgage loans held for investment, less allowance for loan losses of $10,561, $15,514 and $11,272
 
259,732

 
309,681

 
268,428

Investments in available-for-sale securities
 
4,289

 
487,033

 
4,329

Property and equipment, at cost less accumulated depreciation and amortization of $468,372, $432,681 and $446,049
 
314,531

 
286,584

 
304,911

Intangible assets, net
 
347,890

 
280,455

 
355,622

Goodwill
 
478,845

 
435,667

 
436,117

Other assets
 
193,371

 
258,536

 
210,116

Total assets
 
$
3,890,819

 
$
3,762,888

 
$
4,693,529

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
LIABILITIES:
 
 
 
 
 
 
Customer banking deposits
 
$
482,975

 
$
757,929

 
$
769,785

Accounts payable, accrued expenses and other current liabilities
 
485,205

 
443,065

 
569,007

Accrued salaries, wages and payroll taxes
 
30,996

 
32,926

 
167,032

Accrued income taxes
 
284,038

 
215,834

 
406,655

Current portion of long-term debt
 
400,705

 
730

 
400,637

Total current liabilities
 
1,683,919

 
1,450,484

 
2,313,116

Long-term debt
 
505,714

 
905,902

 
505,837

Other noncurrent liabilities
 
303,986

 
301,187

 
318,027

Total liabilities
 
2,493,619

 
2,657,573

 
3,136,980

COMMITMENTS AND CONTINGENCIES
 


 


 


STOCKHOLDERS' EQUITY:
 
 
 
 
 
 
Common stock, no par, stated value $.01 per share, 800,000,000 shares authorized, shares issued of 316,628,110
 
3,166

 
3,166

 
3,166

Convertible preferred stock, no par, stated value $0.01 per share, 500,000 shares authorized
 

 

 

Additional paid-in capital
 
766,014

 
753,209

 
766,654

Accumulated other comprehensive income (loss)
 
5,483

 
(257
)
 
5,177

Retained earnings
 
1,418,124

 
1,163,651

 
1,589,297

Less treasury shares, at cost
 
(795,587
)
 
(814,454
)
 
(807,745
)
Total stockholders' equity
 
1,397,200

 
1,105,315

 
1,556,549

Total liabilities and stockholders' equity
 
$
3,890,819

 
$
3,762,888

 
$
4,693,529

 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(unaudited, in 000s)
 
Three months ended July 31,
 
2014

 
2013

 
 
 
 
 
NET CASH USED IN OPERATING ACTIVITIES
 
$
(381,585
)
 
$
(318,742
)
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchases of available-for-sale securities
 
(100
)
 
(45,158
)
Maturities of and payments received on available-for-sale securities
 
18,484

 
32,061

Principal payments on mortgage loans held for investment, net
 
6,250

 
11,707

Capital expenditures
 
(25,841
)
 
(34,386
)
Payments made for business acquisitions, net of cash acquired
 
(40,533
)
 
(1,303
)
Franchise loans:
 
 
 
 
Loans funded
 
(7,398
)
 
(6,657
)
Payments received
 
18,674

 
7,164

Other, net
 
4,130

 
7,482

Net cash used in investing activities
 
(26,334
)
 
(29,090
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Customer banking deposits, net
 
(287,609
)
 
(179,364
)
Dividends paid
 
(54,852
)
 
(54,550
)
Proceeds from exercise of stock options
 
13,368

 
21,953

Other, net
 
(19,316
)
 
(17,294
)
Net cash used in financing activities
 
(348,409
)
 
(229,255
)
 
 
 
 
 
Effects of exchange rate changes on cash
 
510

 
(6,621
)
 
 
 
 
 
Net decrease in cash and cash equivalents
 
(755,818
)
 
(583,708
)
Cash and cash equivalents at beginning of the period
 
2,185,307

 
1,747,584

Cash and cash equivalents at end of the period
 
$
1,429,489

 
$
1,163,876

 
 
 
 
 
SUPPLEMENTARY CASH FLOW DATA:
 
 
 
 
Income taxes paid, net of refunds received
 
$
88,924

 
$
106,467

Interest paid on borrowings
 
15,415

 
15,883

Interest paid on deposits
 
201

 
640

Transfers of foreclosed loans to other assets
 
1,818

 
2,100

Accrued additions to property and equipment
 
11,988

 
8,048

Transfer of mortgage loans held for investment to held for sale
 

 
7,608

 
 
 
 
 
See accompanying notes to consolidated financial statements.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  (unaudited)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The consolidated balance sheets as of July 31, 2014 and 2013, the consolidated statements of operations and comprehensive income (loss) for the three months ended July 31, 2014 and 2013, and the condensed consolidated statements of cash flows for the three months ended July 31, 2014 and 2013 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows as of July 31, 2014 and 2013 and for all periods presented have been made.
"H&R Block," "the Company," "we," "our" and "us" are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the U. S. (GAAP) have been condensed or omitted. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2014 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of April 30, 2014 or for the year then ended are derived from our April 30, 2014 Annual Report to Shareholders on Form 10-K.
MANAGEMENT ESTIMATES The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates, assumptions and judgments are applied in the evaluation of contingent losses arising from our discontinued mortgage business, contingent losses associated with pending claims and litigation, valuation allowances on deferred tax assets, reserves for uncertain tax positions and related matters. Estimates have been prepared based on the best information available as of each balance sheet date. As such, actual results could differ materially from those estimates.
SEASONALITY OF BUSINESS Our operating revenues are seasonal in nature with peak revenues typically occurring in the months of February through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
DISCONTINUED OPERATIONS – Our discontinued operations include the results of operations of Sand Canyon Corporation, previously known as Option One Mortgage Corporation (including its subsidiaries, collectively, SCC), which exited its mortgage business in fiscal year 2008. See notes 12 and 13 for additional information on litigation, claims and other loss contingencies related to our discontinued operations.
NOTE 2: H&R BLOCK BANK
In April 2014, our subsidiaries, H&R Block Bank (HRB Bank) and Block Financial LLC, the sole shareholder of HRB Bank (Block Financial), entered into a definitive Purchase and Assumption Agreement (P&A Agreement) with BofI Federal Bank, a federal savings bank (BofI). The P&A Agreement is subject to various closing conditions, including the receipt of certain required approvals, entry into certain additional agreements, and the fulfillment of various other customary conditions. If closing conditions (including regulatory approvals) are satisfied, we will complete a transaction in which we will sell assets and assign certain liabilities, including all of HRB Bank’s deposit liabilities, to BofI (P&A Transaction). Due to the seasonality of our business, the timing of any closing will impact the amount of deposit liabilities transferred.
If a closing had occurred as of July 31, 2014, we would have made a cash payment to BofI for the difference in the carrying value of assets sold and the carrying value of liabilities transferred of approximately $465 million. The amount of the cash payment made at closing will primarily be equal to the carrying value of the liabilities to be transferred since the carrying value of the assets to be transferred is immaterial. Actual amounts at closing will differ from amounts as of July 31, 2014. In connection with the closing we intend to liquidate the AFS securities held by HRB Bank, which totaled $404 million at July 31, 2014.
In connection with the additional agreements being entered into upon the closing of the P&A Transaction, BofI will offer H&R Block-branded financial products distributed by the Company to the Company's clients. An operating subsidiary of the Company will provide certain marketing, servicing and operational support to BofI with respect to such financial products.

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The P&A Transaction is part of a three-step transaction pursuant to which the Company plans to divest HRB Bank (Divestiture Transaction), including: (1) the conversion of HRB Bank from a federal savings bank to a national bank; (2) the sale of certain HRB Bank assets and liabilities, including all deposit liabilities, to BofI in the P&A Transaction; and (3) the merger of HRB Bank with and into Block Financial.
The Company, H&R Block Group, Inc. and Block Financial (our Holding Companies) are savings and loan holding companies (SLHCs) because they control HRB Bank. By consummating the Divestiture Transaction, our Holding Companies will cease to be SLHCs and will no longer be subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) as SLHCs or to the regulatory capital requirements applicable to SLHCs.
The obligations of the parties to complete the P&A Transaction are subject to the fulfillment of numerous conditions, including regulatory approval. We cannot be certain when or if the conditions to and other components of the P&A Transaction will be satisfied, or whether the P&A Transaction will be completed. In addition, there may be changes to the terms and conditions of the P&A Agreement and other contemplated agreements as part of the regulatory approval process.
NOTE 3: LOSS PER SHARE AND STOCKHOLDERS' EQUITY
LOSS PER SHARE – Basic and diluted loss per share is computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income from continuing operations attributable to common shareholders by the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share except in those periods with a loss from continuing operations. Diluted earnings per share excludes the impact of shares of common stock issuable upon the lapse of certain restrictions or the exercise of options to purchase 5.5 million shares for the three months ended July 31, 2014, and 6.3 million shares for the three months ended July 31, 2013, as the effect would be antidilutive due to the net loss from continuing operations during those periods.
The computations of basic and diluted earnings per share from continuing operations are as follows:
(in 000s, except per share amounts)
 
Three months ended July 31,
2014

 
2013

Net loss from continuing operations attributable to shareholders
 
$
(108,851
)
 
$
(113,270
)
Amounts allocated to participating securities
 
(89
)
 
(62
)
Net loss from continuing operations attributable to common shareholders
 
$
(108,940
)
 
$
(113,332
)
 
 
 
 
 
Basic weighted average common shares
 
274,575

 
273,080

Potential dilutive shares
 

 

Dilutive weighted average common shares
 
274,575

 
273,080

 
 
 
 
 
Loss per share from continuing operations attributable to common shareholders:
 
 
 
 
Basic
 
$
(0.40
)
 
$
(0.42
)
Diluted
 
(0.40
)
 
(0.42
)
STOCK-BASED COMPENSATION – During the three months ended July 31, 2014, we acquired 0.3 million shares of our common stock at an aggregate cost of $9.4 million. These shares represent shares swapped or surrendered to us in connection with the vesting or exercise of stock-based awards. During the three months ended July 31, 2013, we acquired 0.2 million shares at an aggregate cost of $4.2 million for similar purposes.
During the three months ended July 31, 2014 and 2013, we issued 1.1 million and 1.4 million shares of common stock, respectively, due to the vesting or exercise of stock-based awards.
During the three months ended July 31, 2014, we granted equity awards equivalent to 0.9 million shares under our stock-based compensation plans, consisting primarily of nonvested units. Nonvested units generally either vest over a three-year period with one-third vesting each year or cliff vest at the end of a three-year period. Stock-based compensation expense of our continuing operations totaled $7.5 million for the three months ended July 31, 2014

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and $4.6 million for the three months ended July 31, 2013. As of July 31, 2014, unrecognized compensation cost for stock options totaled $0.6 million, and for nonvested shares and units totaled $49.4 million.
OTHER COMPREHENSIVE INCOME Components of other comprehensive income include foreign currency translation adjustments and the change in net unrealized gains or losses on AFS marketable securities, and are as follows:
(in 000s)
 
 
 
Foreign Currency
Translation Adjustments

 
Unrealized Gain (Loss)
on AFS Securities

 
Total

Balances as of May 1, 2014
 
$
3,334

 
$
1,843

 
$
5,177

Other comprehensive income (loss) before reclassifications:
 
 
 
 
 
 
Gross gains (losses) arising during the year
 
455

 
(1,183
)
 
(728
)
Tax expense (benefit)
 

 
(460
)
 
(460
)
 
 
455

 
(723
)
 
(268
)
Amounts reclassified to net income:
 
 
 
 
 
 
Gross amount reclassified (1)
 

 
941

 
941

Tax benefit (expense)
 

 
367

 
367

 
 

 
574

 
574

Net other comprehensive income (loss)
 
455

 
(149
)
 
306

Balances as of July 31, 2014
 
$
3,789

 
$
1,694

 
$
5,483

 
 
 
 
 
 
 
Balances as of May 1, 2013
 
$
6,809

 
$
3,741

 
$
10,550

Other comprehensive income (loss) before reclassifications:
 
 
 
 
 
 
Gross losses arising during the year
 
(3,092
)
 
(12,780
)
 
(15,872
)
Tax benefit
 

 
(5,065
)
 
(5,065
)
Net other comprehensive loss
 
(3,092
)
 
(7,715
)
 
(10,807
)
Balances as of July 31, 2013
 
$
3,717

 
$
(3,974
)
 
$
(257
)
 
 
 
 
 
 
 
(1) 
Amount represents other-than-temporary impairments on AFS securities.
Gross amounts reclassified out of accumulated other comprehensive income are included in other income (expense), net in the consolidated income statements.
NOTE 4: RECEIVABLES
Receivables consist of the following:
(in 000s)
 
As of
 
July 31, 2014
 
July 31, 2013
 
April 30, 2014
 
 
Short-term

 
Long-term
 
Short-term

 
Long-term

 
Short-term

 
Long-term

Loans to franchisees
 
$
62,195

 
$
83,013

 
$
64,041

 
$
106,119

 
$
63,716

 
$
90,747

Receivables for tax preparation and related fees
 
38,204

 

 
37,547

 

 
45,619

 

Cash Back® receivables
 
4,170

 

 
2,412

 

 
48,812

 

Emerald Advance lines of credit
 
20,239

 
2,839

 
22,649

 
6,906

 
20,577

 
3,862

Royalties from franchisees
 
4,278

 

 
4,070

 

 
9,978

 

Note receivable
 

 

 

 
61,561

 

 

Other
 
44,629

 
15,294

 
43,196

 
27,774

 
55,494

 
17,186

 
 
173,715

 
101,146

 
173,915

 
202,360

 
244,196

 
111,795

Allowance for doubtful accounts
 
(51,400
)
 

 
(52,606
)
 
(4,272
)
 
(52,578
)
 

 
 
$
122,315

 
$
101,146

 
$
121,309

 
$
198,088

 
$
191,618

 
$
111,795

 
 
 
 
 
 
 
 
 
 
 
 
 

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Balances presented above as short-term are included in receivables, while the long-term portions are included in other assets in the consolidated balance sheets.
H&R BLOCK EMERALD ADVANCE® LINES OF CREDIT We review the credit quality of our H&R Block Emerald Advance® lines of credit (EA) receivables based on pools, which are segregated by the year of origination, with older years being deemed more unlikely to be repaid. These amounts as of July 31, 2014, by year of origination, are as follows:
(in 000s)
 
Credit Quality Indicator – Year of origination:
 
 
2014
 
$
4,350

2013
 
1,614

2012 and prior
 
4,496

Revolving loans
 
12,618

 
 
$
23,078

 
 
 
As of July 31, 2014 and 2013 and April 30, 2014, $20.0 million, $26.8 million and $20.7 million of EAs were on non-accrual status and classified as impaired, or more than 60 days past due, respectively.
LOANS TO FRANCHISEES Franchisee loan balances as of July 31, 2014 and 2013 and April 30, 2014, consisted of $99.7 million, $124.2 million and $109.1 million, respectively, in term loans made primarily to finance the purchase of franchises and $45.5 million, $46.0 million and $45.4 million, respectively, in revolving lines of credit primarily for the purpose of funding off-season working capital needs.
As of July 31, 2014 and 2013, loans with a principal balance of $0.8 million and $2.5 million, respectively, were more than 30 days past due, while we had no loans more than 30 days past due at April 30, 2014. We had no loans to franchisees on non-accrual status.
CANADIAN CASH BACK® PROGRAM Refunds advanced under the Cash Back program are not subject to credit approval, therefore the primary indicator of credit quality is the age of the receivable amount. Cash Back amounts are generally received within 60 days of filing the client's return. As of July 31, 2014 and 2013 and April 30, 2014, $1.1 million, $0.8 million and $1.9 million of Cash Back balances were more than 60 days old, respectively.
ALLOWANCE FOR DOUBTFUL ACCOUNTS Activity in the allowance for doubtful accounts for our short-term and long-term receivables for the three months ended July 31, 2014 and 2013 is as follows:
(in 000s)
 
 
 
EAs

 
Loans to 
Franchisees

 
Cash Back ®

 
All Other

 
Total

Balances as of May 1, 2014
 
$
7,530

 
$

 
$
3,002

 
$
42,046

 
$
52,578

Provision
 

 

 
113

 
2,729

 
2,842

Charge-offs
 

 

 
(789
)
 
(3,231
)
 
(4,020
)
Balances as of July 31, 2014
 
$
7,530

 
$

 
$
2,326

 
$
41,544

 
$
51,400

 
 
 
 
 
 
 
 
 
 
 
Balances as of May 1, 2013
 
$
7,390

 
$

 
$
2,769

 
$
47,544

 
$
57,703

Provision
 

 

 
158

 
2,901

 
3,059

Charge-offs
 

 

 
(673
)
 
(3,211
)
 
(3,884
)
Balances as of July 31, 2013
 
$
7,390

 
$

 
$
2,254

 
$
47,234

 
$
56,878

 
 
 
 
 
 
 
 
 
 
 

H&R Block, Inc. | Q1 FY2015 Form 10-Q
7

Table of Contents

NOTE 5: MORTGAGE LOANS HELD FOR INVESTMENT
The composition of our mortgage loan portfolio is as follows:
(dollars in 000s)
 
As of
 
July 31, 2014
 
July 31, 2013
 
April 30, 2014
 
 
Amount

 
% of Total

 
Amount

 
% of Total

 
Amount

 
% of Total

Adjustable-rate loans
 
$
144,096

 
54
%
 
$
174,481

 
54
%
 
$
149,480

 
54
%
Fixed-rate loans
 
123,991

 
46
%
 
147,973

 
46
%
 
127,943

 
46
%
 
 
268,087

 
100
%
 
322,454

 
100
%
 
277,423

 
100
%
Unamortized deferred fees and costs
 
2,206

 
 
 
2,741

 
 
 
2,277

 
 
Less: Allowance for loan losses
 
(10,561
)
 
 
 
(15,514
)
 
 
 
(11,272
)
 
 
 
 
$
259,732

 
 
 
$
309,681

 
 
 
$
268,428

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Our loan loss allowance as a percent of mortgage loans was 3.9% as of July 31, 2014, compared to 4.8% as of July 31, 2013 and 4.1% as of April 30, 2014.
Activity in the allowance for loan losses for the three months ended July 31, 2014 and 2013 is as follows:
(in 000s)
 
Three months ended July 31,
 
2014

 
2013

Balance at beginning of the period
 
$
11,272

 
$
14,314

Provision
 
725

 
7,603

Recoveries
 
679

 
767

Charge-offs
 
(2,115
)
 
(7,170
)
Balance at end of the period
 
$
10,561

 
$
15,514

 
 
 
 
 
When determining our allowance for loan losses, we evaluate loans less than 60 days past due on a pooled basis, while loans we consider impaired, including those loans more than 60 days past due or modified as a troubled debt restructuring (TDR), are evaluated individually. The balance of these loans and the related allowance is as follows:
(in 000s)
 
As of
 
July 31, 2014
 
July 31, 2013
 
April 30, 2014
 
 
Portfolio 
Balance

 
Related 
Allowance

 
Portfolio 
Balance

 
Related 
Allowance

 
Portfolio 
Balance

 
Related 
Allowance

Pooled (less than 60 days past due)
 
$
152,427

 
$
4,242

 
$
186,082

 
$
5,734

 
$
158,496

 
$
4,508

Impaired:
 
 
 
 
 
 
 
 
 
 
 
 
Individually (TDRs)
 
41,649

 
4,070

 
50,136

 
4,866

 
43,865

 
4,346

Individually (60 days or more past due)
 
74,011

 
2,249

 
86,236

 
4,914

 
75,062

 
2,418

 
 
$
268,087

 
$
10,561

 
$
322,454

 
$
15,514

 
$
277,423

 
$
11,272

 
 
 
 
 
 
 
 
 
 
 
 
 
Detail of our mortgage loans held for investment and the related allowance as of July 31, 2014 is as follows:
(dollars in 000s)
 
 
 
Outstanding Principal Balance

 
Loan Loss Allowance
 
% 30+ Days
Past Due

 
 
 
Amount

 
% of Principal

 
Purchased from SCC
 
$
154,176

 
$
8,420

 
5.5
%
 
26.6
%
All other
 
113,911

 
2,141

 
1.9
%
 
7.3
%
 
 
$
268,087

 
$
10,561

 
3.9
%
 
18.4
%
 
 
 
 
 
 
 
 
 

8
Q1 FY2015 Form 10-Q | H&R Block, Inc.

Table of Contents

Credit quality indicators as of July 31, 2014 include the following:
(in 000s)
 
Credit Quality Indicators
 
Purchased from SCC

 
All Other

 
Total Portfolio

Occupancy status:
 
 
 
 
 
 
Owner occupied
 
$
113,361

 
$
75,436

 
$
188,797

Non-owner occupied
 
40,815

 
38,475

 
79,290

 
 
$
154,176

 
$
113,911

 
$
268,087

Documentation level:
 
 
 
 
 
 
Full documentation
 
$
51,544

 
$
81,354

 
$
132,898

Limited documentation
 
4,789

 
12,459

 
17,248

Stated income
 
85,256

 
12,480

 
97,736

No documentation
 
12,587

 
7,618

 
20,205

 
 
$
154,176

 
$
113,911

 
$
268,087

Internal risk rating:
 
 
 
 
 
 
High
 
$
43,423

 
$

 
$
43,423

Medium
 
110,753

 

 
110,753

Low
 

 
113,911

 
113,911

 
 
$
154,176

 
$
113,911

 
$
268,087

 
 
 
 
 
 
 
Loans given our internal risk rating of "high" generally had no documentation or were based on stated income. Loans given our internal risk rating of "medium" generally had full documentation or were based on stated income, with loan-to-value ratios at origination of more than 80%, and were made to borrowers with credit scores below 700 at origination. Loans given our internal risk rating of "low" generally had loan-to-value ratios at origination of less than 80% and were made to borrowers with credit scores greater than 700 at origination.
Our mortgage loans held for investment include concentrations of loans to borrowers in certain states, which may result in increased exposure to loss as a result of changes in real estate values and underlying economic or market conditions related to a particular geographical location. Approximately 51% of our mortgage loan portfolio consists of loans to borrowers located in the states of Florida, California and New York.
Detail of the aging of the mortgage loans in our portfolio as of July 31, 2014 is as follows:
(in 000s)
 
 
 
Less than 60
Days Past Due

 
60 – 89 Days
Past Due

 
90+ Days
Past Due(1)

 
Total
Past Due

 
Current

 
Total

Purchased from SCC
 
$
9,245

 
$
1,623

 
$
50,524

 
$
61,392

 
$
92,784

 
$
154,176

All other
 
6,489

 
195

 
8,334

 
15,018

 
98,893

 
113,911

 
 
$
15,734

 
$
1,818

 
$
58,858

 
$
76,410

 
$
191,677

 
$
268,087

 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
We do not accrue interest on loans past due 90 days or more.

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9

Table of Contents

Information related to our non-accrual loans is as follows:
(in 000s)
 
As of
 
July 31, 2014

 
July 31, 2013

 
April 30, 2014

Loans:
 
 
 
 
 
 
Purchased from SCC
 
$
62,389

 
$
68,740

 
$
61,767

Other
 
12,017

 
14,860

 
12,528

 
 
74,406

 
83,600

 
74,295

TDRs:
 
 
 
 
 
 
Purchased from SCC
 
4,394

 
3,247

 
4,648

Other
 
828

 
500

 
951

 
 
5,222

 
3,747

 
5,599

Total non-accrual loans
 
$
79,628

 
$
87,347

 
$
79,894

 
 
 
 
 
 
 
Information related to impaired loans is as follows:
(in 000s)
 
 
 
Balance
With Allowance

 
Balance
With No Allowance

 
Total
Impaired Loans

 
Related Allowance

As of July 31, 2014:
 
 
 
 
 
 
 
 
Purchased from SCC
 
$
28,239

 
$
68,507

 
$
96,746

 
$
5,211

Other
 
4,359

 
14,555

 
18,914

 
1,108

 
 
$
32,598

 
$
83,062

 
$
115,660

 
$
6,319

As of July 31, 2013:
 
 
 
 
 
 
 
 
Purchased from SCC
 
$
33,088

 
$
80,132

 
$
113,220

 
$
7,396

Other
 
6,603

 
16,549

 
23,152

 
2,384

 
 
$
39,691

 
$
96,681

 
$
136,372

 
$
9,780

As of April 30, 2014:
 
 
 
 
 
 
 
 
Purchased from SCC
 
$
27,924

 
$
71,075

 
$
98,999

 
$
3,239

Other
 
5,176

 
14,752

 
19,928

 
3,525

 
 
$
33,100

 
$
85,827

 
$
118,927

 
$
6,764

 
 
 
 
 
 
 
 
 
Information related to the allowance for impaired loans is as follows:
(in 000s)
 
As of
 
July 31, 2014

 
July 31, 2013

 
April 30, 2014

Portion of total allowance for loan losses allocated to impaired loans and TDR loans:
 
 
 
 
 
 
Based on collateral value method
 
$
2,249

 
$
4,914

 
$
2,418

Based on discounted cash flow method
 
4,070

 
4,866

 
4,346

 
 
$
6,319

 
$
9,780

 
$
6,764

 
 
 
 
 
 
 
Information related to activities of our non-performing assets is as follows:
(in 000s)
 
Three months ended July 31,
 
2014

 
2013

Average impaired loans:
 
 
 
 
Purchased from SCC
 
$
105,682

 
$
130,287

All other
 
20,691

 
25,328

 
 
$
126,373

 
$
155,615

 
 
 
 
 

10
Q1 FY2015 Form 10-Q | H&R Block, Inc.

Table of Contents

NOTE 6: INVESTMENTS
The amortized cost and fair value of securities classified as available-for-sale (AFS) are summarized below:
(in 000s)
 
 
 
Amortized
Cost

 
Gross
Unrealized
Gains

 
Gross
Unrealized
Losses

 
Fair Value

As of July 31, 2014:
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
$
401,092

 
$
2,582

 
$

 
$
403,674

Municipal bonds
 
4,106

 
183

 

 
4,289

U.S. treasury bills
 
100

 

 

 
100

 
 
$
405,298

 
$
2,765

 
$

 
$
408,063

As of July 31, 2013:
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
489,401

 
3,825

 
(10,623
)
 
482,603

Municipal bonds
 
4,164

 
266

 

 
4,430

 
 
$
493,565

 
$
4,091

 
$
(10,623
)
 
$
487,033

As of April 30, 2014:
 
 
Mortgage-backed securities
 
$
420,697

 
$
2,798

 
$

 
$
423,495

Municipal bonds
 
4,120

 
209

 

 
4,329

 
 
$
424,817

 
$
3,007

 
$

 
$
427,824

 
 
 
 
 
 
 
 
 
Substantially all AFS debt securities held as of July 31, 2014 mature after five years.
NOTE 7: GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying amount of goodwill of our Tax Services segment for the three months ended July 31, 2014 and 2013 are as follows:
(in 000s)
 
 
 
Goodwill

 
Accumulated Impairment Losses

 
Net

Balances as of April 30, 2014
 
$
468,414

 
$
(32,297
)
 
$
436,117

Acquisitions
 
42,274

 

 
42,274

Disposals and foreign currency changes, net
 
454

 

 
454

Impairments
 

 

 

Balances as of July 31, 2014
 
$
511,142

 
$
(32,297
)
 
$
478,845

 
 
 
 
 
 
 
Balances as of April 30, 2013
 
$
467,079

 
$
(32,297
)
 
$
434,782

Acquisitions
 
2,155

 

 
2,155

Disposals and foreign currency changes, net
 
(1,270
)
 

 
(1,270
)
Impairments
 

 

 

Balances as of July 31, 2013
 
$
467,964

 
$
(32,297
)
 
$
435,667

 
 
 
 
 
 
 
The increase in goodwill resulted from acquired franchisee and competitor businesses during the period. We expect the purchase price allocation to be finalized during fiscal year 2015.
We test goodwill for impairment annually or more frequently if events occur or circumstances change which would, more likely than not, reduce the fair value of a reporting unit below its carrying value.

H&R Block, Inc. | Q1 FY2015 Form 10-Q
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Table of Contents

Components of the intangible assets of our Tax Services segment are as follows:
(in 000s)
 
 
 
Gross
Carrying
Amount

 
Accumulated
Amortization

 
Net

As of July 31, 2014:
 
 
 
 
 
 
Reacquired franchise rights
 
$
233,749

 
$
(29,152
)
 
$
204,597

Customer relationships
 
123,130

 
(62,514
)
 
60,616

Internally-developed software
 
104,580

 
(75,243
)
 
29,337

Noncompete agreements
 
24,697

 
(22,408
)
 
2,289

Franchise agreements
 
19,201

 
(7,254
)
 
11,947

Purchased technology
 
54,974

 
(15,870
)
 
39,104

 
 
$
560,331

 
$
(212,441
)
 
$
347,890

As of July 31, 2013:
 
 
 
 
 
 
Reacquired franchise rights
 
$
214,330

 
$
(19,235
)
 
$
195,095

Customer relationships
 
100,688

 
(51,007
)
 
49,681

Internally-developed software
 
93,739

 
(74,572
)
 
19,167

Noncompete agreements
 
23,024

 
(21,789
)
 
1,235

Franchise agreements
 
19,201

 
(5,974
)
 
13,227

Purchased technology
 
14,800

 
(12,750
)
 
2,050

 
 
$
465,782

 
$
(185,327
)
 
$
280,455

As of April 30, 2014:
 
 
 
 
 
 
Reacquired franchise rights
 
$
233,749

 
$
(26,136
)
 
$
207,613

Customer relationships
 
123,110

 
(59,521
)
 
63,589

Internally-developed software
 
101,162

 
(72,598
)
 
28,564

Noncompete agreements
 
24,694

 
(22,223
)
 
2,471

Franchise agreements
 
19,201

 
(6,934
)
 
12,267

Purchased technology
 
54,900

 
(13,782
)
 
41,118

 
 
$
556,816

 
$
(201,194
)
 
$
355,622

 
 
 
 
 
 
 
Amortization of intangible assets of continuing operations for the three months ended July 31, 2014 and 2013 was $11.2 million and $6.1 million, respectively. Estimated amortization of intangible assets for fiscal years 2015, 2016, 2017, 2018 and 2019 is $43.0 million, $35.8 million, $30.0 million, $26.1 million and $22.9 million, respectively.
NOTE 8: FAIR VALUE
FAIR VALUE MEASUREMENT
Assets measured on a recurring basis are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Our investments in available-for-sale securities are carried at fair value on a recurring basis with gains and losses reported as a component of other comprehensive income, except for losses assessed to be other than temporary. These include certain agency and agency-sponsored mortgage-backed securities and municipal bonds. Quoted market prices are not available for these securities, as they are not actively traded and have fewer observable transactions. As a result, we use third-party pricing services to determine fair value and classify the securities as Level 2. The third-party pricing services' models are based on market data and utilize available trade, bid and other market information for similar securities. There were no transfers of AFS securities between hierarchy levels during the three months ended July 31, 2014 and 2013. See note 6 for details of our AFS securities that were remeasured at fair value on a recurring basis during the three months ended July 31, 2014 and 2013 and the unrealized gains or losses on those remeasurements.

12
Q1 FY2015 Form 10-Q | H&R Block, Inc.

Table of Contents

The following table presents the assets that were remeasured at fair value on a non-recurring basis during the three months ended July 31, 2014 and 2013 and the losses on those remeasurements:
(dollars in 000s)
 
 
 
Total

 
Level 1

 
Level 2

 
Level 3

 
Losses

As of July 31, 2014:
 
 
 
 
 
 
 
 
 
 
Impaired mortgage loans held for investment
 
$
59,635

 
$

 
$

 
$
59,635

 
$
(842
)
As a percentage of total assets
 
1.5
%
 
%
 
%
 
1.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
As of July 31, 2013:
 
 
 
 
 
 
 
 
 
 
Impaired mortgage loans held for investment
 
$
76,699

 
$

 
$

 
$
76,699

 
$
(1,390
)
As a percentage of total assets
 
2.0
%
 
%
 
%
 
2.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
The fair value of impaired mortgage loans held for investment is generally based on the net present value of discounted cash flows for TDR loans or the appraised value of the underlying collateral for all other loans. Impaired and TDR loans are required to be remeasured at least annually, based on HRB Bank's loan policy. These loans are classified as Level 3.
We have established various controls and procedures to ensure that the unobservable inputs used in the fair value measurement of these instruments are appropriate. Appraisals are obtained from certified appraisers and reviewed internally by HRB Bank's asset management group. The inputs and assumptions used in our discounted cash flow model for TDRs are reviewed and approved by HRB Bank management each time the balances are remeasured. Significant changes in fair value from the previous measurement are presented to HRB Bank management for approval. There were no changes to the unobservable inputs used in determining the fair values of our Level 3 financial assets.
The following table presents the quantitative information about our Level 3 fair value measurements, which utilize significant unobservable internally-developed inputs:
(in 000s)
 
 
Fair Value as of July 31, 2014

 
Valuation
Technique
 
Unobservable Input
 
Range
(Weighted Average)
Impaired mortgage loans held for investment – non TDRs
 
$
71,762

 
Collateral-
based
 
Cost to list/sell
Time to sell (months)
Collateral depreciation
Loss severity
 
0% – 188%(9%)
24 - 26 (24)
(166%) – 100%(38%)
0% – 100%(61%)
Impaired mortgage loans held for investment – TDRs
 
$
37,579

 
Discounted
cash flow
 
Aged default performance
Loss severity
 
25% – 40%(33%)
0% – 22%(6%)

H&R Block, Inc. | Q1 FY2015 Form 10-Q
13

Table of Contents

ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of our financial instruments are as follows:
(in 000s)
 
As of
 
July 31, 2014
 
July 31, 2013
 
April 30, 2014
 
 
Carrying
Amount

 
Estimated
Fair Value

 
Carrying
Amount

 
Estimated
Fair Value

 
Carrying
Amount

 
Estimated
Fair Value

Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
1,429,489

 
$
1,429,489

 
$
1,163,876

 
$
1,163,876

 
$
2,185,307

 
$
2,185,307

Cash and cash equivalents - restricted
 
71,917

 
71,917

 
55,477

 
55,477

 
115,319

 
115,319

Receivables, net - short-term
 
122,315

 
122,315

 
121,309

 
124,218

 
191,618

 
191,618

Mortgage loans held for investment, net
 
259,732

 
193,920

 
309,681

 
194,882

 
268,428

 
192,281

Investments in AFS securities
 
408,063

 
408,063

 
487,033

 
487,033

 
427,824

 
427,824

Receivables, net - long-term
 
101,146

 
101,146

 
198,088

 
210,234

 
111,795

 
111,795

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Customer banking deposits