Attached files
file | filename |
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EX-32.2 - EXHIBIT 32.2 - Franchise Group, Inc. | tax-07312018ex322.htm |
EX-32.1 - EXHIBIT 32.1 - Franchise Group, Inc. | tax-07312018ex321.htm |
EX-31.2 - EXHIBIT 31.2 - Franchise Group, Inc. | tax-07312018ex312.htm |
EX-31.1 - EXHIBIT 31.1 - Franchise Group, Inc. | tax-07312018ex311.htm |
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 July 31, 2018
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 o No ý
Indicate by check mark whether the registrant has submitted electronically Interactive Data File required to be submitted 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 such files). Yes o No ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.:
Large accelerated filer | o | Accelerated filer | x |
Non-accelerated filer | o | Smaller reporting company | o |
Emerging growth company | o | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. | o |
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 November 27, 2018 was 14,036,684 shares.
LIBERTY TAX, INC.
Form 10-Q for the Quarterly Period Ended July 31, 2018
Table of Contents
Page | ||
Number | ||
PART I. FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS
1
LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
July 31, 2018, April 30, 2018 and July 31, 2017
(In thousands, except share data)
July 31, 2018 | April 30, 2018 | July 31, 2017 | |||||||||
Assets | (unaudited) | (unaudited) | |||||||||
Current assets: | |||||||||||
Cash and cash equivalents | $ | 6,186 | $ | 18,522 | $ | 6,254 | |||||
Receivables: | |||||||||||
Accounts receivable | 41,224 | 52,517 | 43,225 | ||||||||
Notes receivable - current | 29,402 | 24,295 | 33,493 | ||||||||
Interest receivable, net of uncollectible amounts | 2,023 | 1,526 | 2,554 | ||||||||
Allowance for doubtful accounts - current | (11,917 | ) | (11,522 | ) | (8,745 | ) | |||||
Total current receivables, net | 60,732 | 66,816 | 70,527 | ||||||||
Assets held for sale | 5,231 | 8,941 | 14,678 | ||||||||
Income taxes receivable | 4,989 | — | 47 | ||||||||
Other current assets | 3,201 | 5,429 | 4,717 | ||||||||
Total current assets | 80,339 | 99,708 | 96,223 | ||||||||
Property, equipment, and software, net | 37,091 | 38,636 | 39,744 | ||||||||
Notes receivable, non-current | 9,882 | 6,554 | 18,202 | ||||||||
Allowance for doubtful accounts, non-current | (1,642 | ) | (965 | ) | (1,880 | ) | |||||
Total non-current notes receivables, net | 8,240 | 5,589 | 16,322 | ||||||||
Goodwill | 7,997 | 8,640 | 7,620 | ||||||||
Other intangible assets, net | 22,765 | 22,837 | 21,902 | ||||||||
Deferred income taxes | 1,272 | 343 | 173 | ||||||||
Other assets | 2,056 | 2,250 | 2,814 | ||||||||
Total assets | $ | 159,760 | $ | 178,003 | $ | 184,798 | |||||
Liabilities and Stockholders’ Equity | |||||||||||
Current liabilities: | |||||||||||
Current installments of long-term obligations | $ | 16,923 | $ | 18,113 | $ | 5,202 | |||||
Accounts payable and accrued expenses | 21,213 | 14,521 | 13,958 | ||||||||
Due to Area Developers (ADs) | 7,186 | 17,906 | 9,168 | ||||||||
Income taxes payable | — | 4,511 | 208 | ||||||||
Revolving credit facility | 12,590 | — | — | ||||||||
Deferred revenue - current | 4,018 | 2,021 | 2,854 | ||||||||
Total current liabilities | 61,930 | 57,072 | 31,390 | ||||||||
Long-term obligations, excluding current installments, net | 1,895 | 2,270 | 17,816 | ||||||||
Revolving credit facility | — | — | 20,611 | ||||||||
Deferred revenue and other - non-current | 7,870 | 4,692 | 5,466 | ||||||||
Deferred income tax liability | 919 | 1,397 | 3,585 | ||||||||
Long-term income taxes payable | 1,070 | 1,070 | — | ||||||||
Total liabilities | 73,684 | 66,501 | 78,868 | ||||||||
Commitments and contingencies | |||||||||||
Stockholders’ equity: | |||||||||||
Special voting preferred stock, $0.01 par value per share, 0, 10 and 10 shares authorized, issued and outstanding, respectively | — | — | — | ||||||||
Class A common stock, $0.01 par value per share, 21,200,000 shares authorized, 14,024,111, 12,823,020 and 12,682,550 shares issued and outstanding, respectively | 140 | 128 | 127 | ||||||||
Class B common stock, $0.01 par value per share, 1,000,000 shares authorized, 0, 200,000 and 200,000 shares issued and outstanding, respectively | — | 2 | 2 | ||||||||
Exchangeable shares, $0.01 par value per share, 1,000,000 shares authorized, 0, 1,000,000 and 1,000,000 shares issued and outstanding, respectively | — | 10 | 10 | ||||||||
Additional paid-in capital | 11,769 | 11,570 | 8,925 | ||||||||
Accumulated other comprehensive loss, net of taxes | (1,539 | ) | (1,347 | ) | (1,065 | ) | |||||
Retained earnings | 75,706 | 101,139 | 97,931 | ||||||||
Total stockholders’ equity | 86,076 | 111,502 | 105,930 | ||||||||
Total liabilities and stockholders’ equity | $ | 159,760 | $ | 178,003 | $ | 184,798 |
See accompanying notes to condensed consolidated financial statements.
2
LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three Months Ended July 31, 2018 (unaudited) and 2017 (unaudited)
(In thousands, except share count and per share data)
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
Revenue: | ||||||||
Franchise fees | $ | 557 | $ | 71 | ||||
Area Developer fees | 1,028 | 1,068 | ||||||
Royalties and advertising fees | 1,562 | 1,689 | ||||||
Financial products | 579 | 582 | ||||||
Interest income | 1,656 | 2,297 | ||||||
Assisted tax preparation fees, net of discounts | 1,518 | 1,639 | ||||||
Electronic filing fees | 28 | — | ||||||
Other revenues | 235 | 842 | ||||||
Total revenues | 7,163 | 8,188 | ||||||
Operating expenses: | ||||||||
Employee compensation and benefits | 10,769 | 9,991 | ||||||
Selling, general, and administrative expenses | 11,304 | 9,202 | ||||||
Area Developer expense | 304 | 372 | ||||||
Advertising expense | 1,685 | 2,376 | ||||||
Depreciation, amortization, and impairment charges | 3,194 | 2,196 | ||||||
Restructuring expense | 8,266 | — | ||||||
Total operating expenses | 35,522 | 24,137 | ||||||
Loss from operations | (28,359 | ) | (15,949 | ) | ||||
Other income (expense): | ||||||||
Foreign currency transaction gain | 2 | 110 | ||||||
Interest expense | (530 | ) | (281 | ) | ||||
Loss before income taxes | (28,887 | ) | (16,120 | ) | ||||
Income tax benefit | (9,516 | ) | (6,362 | ) | ||||
Net loss | (19,371 | ) | (9,758 | ) | ||||
Net loss per share of common stock: | ||||||||
Basic and diluted | $ | (1.48 | ) | $ | (0.76 | ) | ||
Weighted-average shares outstanding basic and diluted | 13,078,091 | 12,882,550 | ||||||
Dividends declared per share of common stock and common stock equivalents | $ | 0.16 | $ | 0.16 |
See accompanying notes to condensed consolidated financial statements.
3
LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss
Three Months Ended July 31, 2018 (unaudited) and 2017 (unaudited)
(In thousands)
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
Net loss | $ | (19,371 | ) | $ | (9,758 | ) | ||
Unrealized gain (loss) on interest rate swap agreement, net of taxes of $17 and $0, respectively | 10 | (15 | ) | |||||
Foreign currency translation adjustment | (202 | ) | 1,034 | |||||
Comprehensive loss | $ | (19,563 | ) | $ | (8,739 | ) |
See accompanying notes to condensed consolidated financial statements.
4
LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Three Months Ended July 31, 2018 (unaudited) and 2017 (unaudited)
(In thousands)
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (19,371 | ) | $ | (9,758 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Provision for doubtful accounts | 1,939 | 1,408 | ||||||
Depreciation, amortization, and impairment charges | 3,194 | 2,196 | ||||||
Amortization of deferred financing costs | 102 | — | ||||||
Loss on disposal of fixed and intangible assets | 4,083 | — | ||||||
Stock-based compensation expense | 205 | 554 | ||||||
Gain (loss) on bargain purchases and sales of Company-owned offices | 55 | (536 | ) | |||||
Equity in loss of affiliate | (8 | ) | — | |||||
Deferred tax expense | 45 | (34 | ) | |||||
Changes in accrued income taxes | (9,489 | ) | (6,187 | ) | ||||
Changes in other assets and liabilities | 5,587 | (2,167 | ) | |||||
Net cash used in operating activities | (13,658 | ) | (14,524 | ) | ||||
Cash flows from investing activities: | ||||||||
Issuance of operating loans to franchisees and ADs | (8,850 | ) | (11,275 | ) | ||||
Payments received on operating loans to franchisees | 1,390 | 1,545 | ||||||
Purchases of AD rights, Company-owned offices and acquired customer lists | (58 | ) | (352 | ) | ||||
Proceeds from sale of Company-owned offices and AD rights | — | 76 | ||||||
Purchases of property, equipment and software | (769 | ) | (1,110 | ) | ||||
Net cash used in investing activities | (8,287 | ) | (11,116 | ) | ||||
Cash flows from financing activities: | ||||||||
Dividends paid | — | (2,339 | ) | |||||
Repayment of long-term obligations | (2,901 | ) | (3,283 | ) | ||||
Borrowings under revolving credit facility | 12,717 | 20,706 | ||||||
Repayments under revolving credit facility | (127 | ) | (95 | ) | ||||
Cash paid for taxes on exercises/vesting of stock-based compensation | (6 | ) | — | |||||
Net cash provided by financing activities | 9,683 | 14,989 | ||||||
Effect of exchange rate changes on cash, net | (74 | ) | 478 | |||||
Net decrease in cash and cash equivalents | (12,336 | ) | (10,173 | ) | ||||
Cash and cash equivalents at beginning of period | 18,522 | 16,427 | ||||||
Cash and cash equivalents at end of period | $ | 6,186 | $ | 6,254 |
See accompanying notes to condensed consolidated financial statements.
5
LIBERTY TAX, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Three Months Ended July 31, 2018 (unaudited) and 2017 (unaudited)
(In thousands)
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest, net of capitalized interest of $3 and $145, respectively | $ | 522 | $ | 281 | ||||
Cash paid for taxes, net of refunds | (16 | ) | (137 | ) | ||||
Accrued capitalized software costs included in accounts payable | 117 | 54 | ||||||
During the three months ended July 31, 2018 and 2017, the Company acquired certain assets from ADs, franchisees, and third parties as follows: | ||||||||
Fair value of assets purchased | $ | 1,840 | $ | 3,664 | ||||
Receivables applied, net of amounts written off, due ADs and related deferred revenue | (289 | ) | (2,714 | ) | ||||
Bargain purchase gains | (191 | ) | (322 | ) | ||||
Long-term obligations and accounts payable issued to seller | (1,302 | ) | (276 | ) | ||||
Cash paid to ADs, franchisees and third parties | $ | 58 | $ | 352 | ||||
During the three months ended July 31, 2018 and 2017, the Company sold certain assets to ADs and franchisees as follows: | ||||||||
Book value of assets sold | $ | 1,163 | $ | 24 | ||||
Gain on sale - revenue deferred | — | 18 | ||||||
Gain (loss) on sale - gain (loss) recognized | (72 | ) | 37 | |||||
Notes received | (312 | ) | (3 | ) | ||||
Restructuring | (779 | ) | — | |||||
Cash received from ADs and franchisees | $ | — | $ | 76 |
See accompanying notes to condensed consolidated financial statements.
6
LIBERTY TAX, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements
July 31, 2018 and 2017
(1) Organization and Significant Accounting Policies
Description of Business
Liberty Tax, Inc. (the "Company"), a Delaware corporation, is a holding company engaged through its subsidiaries as a franchisor and, to a lesser degree, an operator of a system of income tax preparation offices located in the United States of America (the "U.S.") and Canada. 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 Refund Transfer products in the U.S. and personal income tax Refund Discounting products in Canada. The Company also offers online tax preparation services. In fiscal 2015, the Company changed its name from JTH Holding, Inc. to Liberty Tax, Inc.
The Company provides a substantial amount of lending to its franchisees and area developers ("ADs"). The Company allows franchisees and ADs to defer a portion of the franchise fee and AD fee, which are paid over time. The Company also offers its franchisees working capital loans to assist in funding their operations between tax seasons.
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 the context requires otherwise, the terms "Liberty Tax," "Liberty Tax Service," "we," the "Company," "us," and "our" refer to Liberty Tax, Inc. and its consolidated subsidiaries.
Basis of Presentation
The condensed consolidated financial statements include the accounts of the Company 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. Foreign exchange transaction gains and losses are recognized when incurred. The Company reclassifies to accounts payable checks issued in excess of funds available and reports them as cash flow from operating activities. The Company consolidates any entities in which it has a controlling interest, the usual condition of which is ownership of a majority voting interest. The Company also considers for consolidation an entity in which the Company has certain interests where a controlling financial interest may be achieved through arrangements that do not involve voting interests. Such an entity, known as a variable interest entity ("VIE"), is required to be consolidated by its primary beneficiary. The Company does not possess any ownership interests in franchisee entities; however, the Company may provide financial support to franchisee entities. Because the Company's franchise arrangements provide franchisee entities the power to direct the activities that most significantly impact their economic performance, the Company does not consider itself the primary beneficiary of any such entity that might be a VIE. Based on the results of management's analysis of potential VIEs, the Company has not consolidated any franchisee entities. The Company's maximum exposure to loss resulting from involvement with potential VIEs is attributable to accounts and notes receivables and future lease payments due from franchisees. When the Company does not have a controlling interest in an entity but has the ability to exert significant influence over the entity, the Company applies the equity method of accounting. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information. The condensed consolidated financial statements, including these notes, are unaudited and exclude some of the disclosures required only in annual financial statements. The consolidated balance sheet data as of April 30, 2018 was derived from the Company’s April 30, 2018 Annual Report on Form 10-K filed on October 5, 2018, as amended by Amendment No. 1 to the Annual Report on Form 10-K filed on October 10, 2018.
In the opinion of management, all adjustments necessary for a fair presentation of such condensed consolidated 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
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consolidated financial statements and notes thereto included in its April 30, 2018 Annual Report on Form 10-K filed on October 5, 2018, as amended by Amendment No. 1 to the Annual Report on Form 10-K filed on October 10, 2018.
Office Count
As a seasonal business, the Company works throughout the off season to open new offices, and, at the same time, some of our franchisees will choose not to reopen for the next season. Some of these decisions are not made until January of each year, and the Company expects to report office count information for the quarter ended January 31, 2019 once all offices have been opened.
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.
Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, "Leases (Topic 842)." This update will replace existing lease guidance in GAAP and will require lessees to recognize lease assets and lease liabilities on the balance sheet for all leases and disclose key information about leasing arrangements, such as information about variable lease payments and options to renew and terminate leases. When implemented, lessees and lessors will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The update is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently finalizing its implementation plan and evaluating the impact of the new pronouncement on its consolidated financial statements. The Company expects the adoption of this pronouncement to result in a material increase in the assets and liabilities on its consolidated balance sheets, but does not expect it to have a material impact on its consolidated statements of income.
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230)", which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. The update is intended to reduce the existing diversity in practice and is effective for the Company beginning with its first quarterly filing in fiscal year 2019. The Company adopted the update for all periods beginning on or after May 1, 2018.
In June 2016, the FASB issued ASU No. 2016-13, "Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which changes how companies will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through net income. The standard replaces the "incurred loss" approach with an "expected loss" model for instruments measured at amortized cost (which generally will result in the earlier recognition of allowances for losses) and requires companies to record allowances for available-for-sale debt securities, rather than reduce the carrying amount. In addition, companies will have to disclose significantly more information, including information used to track credit quality by year of origination, for most financing receivables. The ASU should be applied as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the standard is effective. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for all entities for annual periods beginning after December 15, 2018, and interim periods therein. The ASU is effective for the Company beginning in the first quarter of fiscal year 2021. The Company is currently evaluating the impact of the adoption of this newly issued standard to its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business", which clarifies the definition of a business with the objection of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. The ASU is effective for the Company beginning in the first quarter of fiscal year 2019. The Company adopted the update for all periods beginning on or after May 1, 2018 and it does not have an impact on the Company's current accounting for business combinations.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This new standard eliminates Step 2 from the goodwill impairment test. Instead, an entity should compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by
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which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The standard will be effective for the Company in the first quarter of fiscal year 2021. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of this newly issued standard to its consolidated financial statements.
In May 2014, the FASB issued Accounting Standards Codification ("ASC") 606, “Revenues from Contracts with Customers” which amends the guidance in ASC 605, “Revenue Recognition.” The core principle of this new standard is to recognize revenue when control of the promised goods or services is transferred to customers in an amount that reflects the consideration expected to be received for those goods or services. ASC 606 also requires additional disclosures around the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
The adoption of this new standard did not materially impact the Company’s recognition of revenues generated from the following:
• | Assisted tax preparation fees, net of discounts, which are recorded at the time the return is filed. The related discounts are recorded as reductions to revenues. |
• | Financial products, which are recorded at the time the return is filed. A change to certain financial products offered in the third quarter will be disclosed at that time. |
• | Royalties and advertising fees, which are based on a percent of the franchisees’ sales are recognized at the time the underlying sales occur. The Company has elected to use the right to invoice practical expedient for recognition of minimum royalties. |
• | Interest income on notes receivable, which is recognized based on the outstanding principal note balance unless it is put on non-accrual status. Interest income on notes receivable that are placed on a non-accrual basis is recognized when cash is received. Interest income on accounts receivable is recognized based on the outstanding receivable balance over 30 days old, net of an allowance. |
• | Gains on sales of Company-owned offices, which are recognized when cash is received. Losses on sales of Company-owned offices are recognized immediately. |
The details of the significant changes in revenue recognition and quantitative impact of the changes are discussed below.
Initial Franchise Fees
Typically, franchise rights are granted to franchisees for an initial term of five years with an option to renew. In exchange for initial franchise fees, royalties and advertising fees, the Company is obligated by its franchise agreements to provide training, an operations manual, site selection guidance, tax preparation software, operational assistance, tax and technical support, the ability to perform electronic filing, and marketing and advertising. Under the previous revenue recognition guidance, revenues from initial franchise fees were recognized when the obligations of the Company to prepare the franchisee for operation were substantially complete, up to the amount of cash received.
Under the new guidance, the standard requires that the transaction price received from customers be allocated to each separate and distinct performance obligation. The transaction price attributable to each separate and distinct performance obligation is then recognized as the performance obligations are satisfied. The services that the Company provides related to the initial franchise fees the Company receives from franchisees do not contain separate and distinct performance obligations from the franchise right or a financing component. Accordingly, under the new standard, initial franchise fees, as constrained for amounts the Company does not expect to collect, will be recognized over the initial term of the franchise agreement, which is generally five years.
AD Fees
Historically, the rights to develop a new territory were granted to an AD for an initial term of generally six or ten years. Under the previous revenue recognition guidance, AD fees were 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. Under the new guidance, the standard requires the Company to recognize AD fees, as constrained for amounts not expected to be collected, over the initial term of the AD agreement.
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The Company also sells a developed territory and simultaneously grants the right to operate as the exclusive AD in such developed territory to a new AD for an initial term of six years or ten years. Under the previous revenue recognition guidance, gains on sales of developed territories were recognized as revenues over the initial term, with the cumulative amount of revenues recognized not to exceed the amount of cash received. Losses on sales of developed territories were recognized immediately. Such gains and losses represented the difference between the transaction price and the net book value of the intangible asset recorded upon the Company’s reacquisition of the developed territory as of the date of the sale. Under the new guidance, the transaction price, as constrained for amounts the Company does not expect to collect, is recognized as revenues over the initial term of the AD agreement. The net book value of the intangible asset is written-off to operating expenses at the date of the sale.
Electronic Filing Fees
Electronic filing fees are recorded in the period the tax return is electronically filed. Under the previous revenue recognition guidance, the electronic filing fees and the franchisees’ share in such fees were recorded as revenues and expense in the consolidated income statement, respectively. Under the new guidance, the electronic filing fees, net of the franchisees’ share in such fees, will be recorded as revenues in the consolidated statement of operations.
Transition Method
The Company applied the new guidance on all contracts that were not completed as of May 1, 2018 using the modified retrospective method, whereby the cumulative effect of initially adopting the guidance was recognized as an adjustment to the opening balance of retained earnings at May 1, 2018 in the amount of $3.8 million decrease, net of tax, with corresponding increases in deferred revenue and notes receivable . Therefore, the results of operations from the comparative period have not been adjusted and continue to be reported under the previous revenue recognition guidance.
Impacts on Condensed Consolidated Financial Statements
The following tables summarize the impacts of adopting ASC 606 on the Company’s condensed consolidated financial statements as of and for the three months ended July 31, 2018:
Condensed Consolidated Balance Sheet | As Reported | ASC 606 Adjustment | Balances Without Adoption of ASC 606 | |||||||||
(In thousands) | ||||||||||||
Notes receivable, current | $ | 29,402 | $ | 985 | $ | 28,417 | ||||||
Allowance for doubtful accounts - current | (11,917 | ) | 161 | (12,078 | ) | |||||||
Income taxes receivable | 4,989 | (321 | ) | 5,310 | ||||||||
Notes receivable, non-current | 9,882 | 421 | 9,461 | |||||||||
Other intangible assets, net | 22,765 | (169 | ) | 22,934 | ||||||||
Deferred income taxes | 1,272 | 936 | 336 | |||||||||
Total assets | 159,760 | 2,011 | 157,749 | |||||||||
Deferred revenue, current | 4,018 | 2,163 | 1,855 | |||||||||
Deferred revenue and other, non-current | 7,870 | 3,418 | 4,452 | |||||||||
Deferred income tax liability | 919 | (456 | ) | 1,375 | ||||||||
Total liabilities | 73,684 | 5,125 | 68,559 | |||||||||
Retained earnings | 75,706 | (3,114 | ) | 78,820 | ||||||||
Total stockholders' equity | 86,076 | (3,114 | ) | 89,190 | ||||||||
Total liabilities and stockholders’ equity | $ | 159,760 | $ | 2,011 | $ | 157,749 |
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Condensed Consolidated Statement of Operations | As Reported | ASC 606 Adjustment | Balances Without Adoption of ASC 606 | |||||||||
(In thousands) | ||||||||||||
Franchise fees | $ | 557 | $ | 461 | $ | 96 | ||||||
Area Developer fees | 1,028 | 422 | 606 | |||||||||
Electronic filing fees | 28 | (112 | ) | 140 | ||||||||
Other revenues | 235 | 130 | 105 | |||||||||
Total revenues | 7,163 | 903 | 6,260 | |||||||||
Selling, general, and administrative expenses | 11,304 | (111 | ) | 11,415 | ||||||||
Total operating expenses | 35,522 | (112 | ) | 35,634 | ||||||||
Loss from operations | (28,359 | ) | 1,015 | (29,374 | ) | |||||||
Loss before income taxes | (28,887 | ) | 1,015 | (29,902 | ) | |||||||
Income tax benefit | (9,516 | ) | 334 | (9,850 | ) | |||||||
Net loss | $ | (19,371 | ) | $ | 681 | $ | (20,052 | ) |
There have been no other significant changes in the Company's condensed consolidated balance sheets or statements of operations and cash flows as a result of the adoption of ASC 606.
Contract Balances
The following table provides information about receivables and contract liabilities (deferred revenue) from contracts with customers:
July 31, 2018 | April 30, 2018 | |||||||
(In thousands) | ||||||||
Notes receivable (1) | $ | 39,284 | $ | 30,849 | ||||
Deferred revenue (2) | 10,938 | 5,667 |
(1) Notes receivable increased by $1.7 million as of May 1, 2018 due to the change in the Company's revenue recognition policy for initial franchise and AD fees upon adoption of ASC 606.
(2) Deferred revenue increased $6.9 million as of May 1, 2018 due to the cumulative effect of adopting ASC 606.
Significant changes in deferred franchise and AD fees are as follows:
Three Months Ended | ||||
July 31, 2018 | ||||
(In thousands) | ||||
Deferred franchise and AD fees at beginning of period | $ | 5,667 | ||
ASC 606 deferred franchise and AD fees adoption | 6,940 | |||
Revenue recognized during the period | (1,584 | ) | ||
New deferrals (terminations) of franchise and AD fees | (85 | ) | ||
Deferred franchise and AD fees at end of period | $ | 10,938 |
Anticipated Future Recognition of Deferred Franchise and AD Fees
The following table reflects the estimated franchise and AD fees expected to be recognized in the future related to performance obligations that are unsatisfied at the end of the period:
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Estimate for Fiscal Year | ||||
(In thousands) | ||||
2019 (a) | $ | 2,871 | ||
2020 | 3,392 | |||
2021 | 2,430 | |||
2022 | 1,401 | |||
2023 | 610 | |||
Thereafter | 234 | |||
Total | $ | 10,938 |
(1) Represents franchise and AD fees expected to be recognized for the remainder of fiscal 2019. The amount does not include $1.6 million of franchise and AD fee revenues recognized for the three months ended July 31, 2018.
The Company has applied the optional exemption, as provided for under ASC 606, which allows the Company not to disclose the transaction price allocated to unsatisfied performance obligations when the transaction price is a sales-based royalty.
Foreign Operations
Canadian operations contributed $0.8 million and $1.0 million in revenues for the three months ended July 31, 2018 and 2017, respectively.
The Company may have exposure to foreign currency fluctuations due to transactions between its U.S. and Canadian subsidiaries.
(2) Accounts and Notes Receivable
The Company provides select financing to ADs and franchisees for the purchase of franchises, areas, Company-owned offices, and operating loans for working capital and equipment needs. The franchise-related notes generally are payable over five years and the operating loans generally are due within one year. Most notes bear interest at an annual rate of 12%.
Most of the notes receivable are due from the Company's ADs and franchisees and are collateralized by the underlying franchise and, when the AD or franchise 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 franchise or AD areas.
At July 31, 2018, the Company had unfunded lending commitments for working capital loans to franchisees and ADs of $17.4 million through the end of the current fiscal year.
Allowance for Doubtful Accounts
The adequacy of the allowance for doubtful accounts is assessed on a quarterly basis and adjusted as deemed necessary. Management believes the recorded allowance is adequate based upon its consideration of the estimated fair value of the franchises and AD areas collateralizing the receivables. Any adverse change in the tax preparation industry or the individual franchise or AD areas could affect the Company's estimate of the allowance.
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Activity in the allowance for doubtful accounts for the three months ended July 31, 2018 and 2017 was as follows:
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
(In thousands) | ||||||||
Balance at beginning of period | $ | 12,487 | $ | 12,020 | ||||
Provision for doubtful accounts | 1,939 | 1,408 | ||||||
Write-offs | (840 | ) | (2,950 | ) | ||||
Foreign currency adjustment | (27 | ) | 147 | |||||
Balance at end of period | $ | 13,559 | $ | 10,625 |
Management considers specific accounts and notes receivable to be impaired if the net amounts due exceed the fair value of the underlying franchise at the time of the annual valuation performed as of April 30 of each year, and estimates an allowance for doubtful accounts based on that excess. In establishing the fair value of the underlying franchise, management considers a variety of factors, including recent sales between franchisees, sales of Company-owned stores, net fees of open offices earned during the most recently completed tax season, and the number of unopened offices. The Company performs its impairment analysis annually due to the seasonal nature of its operations. At the end of each fiscal quarter, the Company considers the activity during the period for accounts and notes receivable impaired at each prior fiscal year end and adjusts the allowance for doubtful accounts accordingly. While not specifically identifiable as of the balance sheet date, the Company's analysis of its experience also indicates that a portion of other accounts and notes receivable may not be collectible. Net amounts due include contractually obligated accounts and notes receivable plus accrued interest, reduced by unrecognized revenue, the allowance for uncollected interest, amounts due ADs, and amounts owed to the franchisee by the Company.
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The allowance for doubtful accounts at July 31, 2018, April 30, 2018 and July 31, 2017, was allocated as follows:
July 31, 2018 | April 30, 2018 | July 31, 2017 | ||||||||||
(In thousands) | ||||||||||||
Impaired: | ||||||||||||
Notes and interest receivable, net of unrecognized revenue | $ | 11,697 | $ | 11,654 | $ | 12,397 | ||||||
Accounts receivable | 13,121 | 13,891 | 10,146 | |||||||||
Less amounts due to ADs and franchisees | (1,687 | ) | (1,907 | ) | (1,312 | ) | ||||||
Amounts receivable less amounts due to ADs and franchisees | $ | 23,131 | $ | 23,638 | $ | 21,231 | ||||||
Allowance for doubtful accounts for impaired notes and accounts receivable | $ | 9,619 | $ | 10,322 | $ | 7,973 | ||||||
Non-impaired: | ||||||||||||
Notes and interest receivable, net of unrecognized revenue | $ | 29,610 | $ | 20,721 | $ | 41,852 | ||||||
Accounts receivable | 28,103 | 38,626 | 33,079 | |||||||||
Less amounts due to ADs and franchisees | (5,701 | ) | (11,722 | ) | (8,239 | ) | ||||||
Amounts receivable less amounts due to ADs and franchisees | $ | 52,012 | $ | 47,625 | $ | 66,692 | ||||||
Allowance for doubtful accounts for non-impaired notes and accounts receivable | $ | 3,940 | $ | 2,165 | $ | 2,652 | ||||||
Total: | ||||||||||||
Notes and interest receivable, net of unrecognized revenue | $ | 41,307 | $ | 32,375 | $ | 54,249 | ||||||
Accounts receivable | 41,224 | 52,517 | 43,225 | |||||||||
Less amounts due to ADs and franchisees | (7,388 | ) | (13,629 | ) | (9,551 | ) | ||||||
Amounts receivable less amounts due to ADs and franchisees | $ | 75,143 | $ | 71,263 | $ | 87,923 | ||||||
Total allowance for doubtful accounts | $ | 13,559 | $ | 12,487 | $ | 10,625 |
The Company’s average investment in impaired receivables during the three months ended July 31, 2018 and 2017 was $23.4 million and $22.7 million, respectively.
Analysis of Past Due Receivables
The breakdown of accounts and notes receivable past due at July 31, 2018 was as follows:
Past due | Current | Interest receivable, net | Total receivables | |||||||||||||
(In thousands) | ||||||||||||||||
Accounts receivable | $ | 36,310 | $ | 4,914 | $ | — | $ | 41,224 | ||||||||
Notes and interest receivable, net (1) | 13,367 | 25,917 | 2,023 | 41,307 | ||||||||||||
Total accounts, notes and interest receivable | $ | 49,677 | $ | 30,831 | $ | 2,023 | $ | 82,531 |
(1) Interest receivable is shown net of an allowance for uncollectible interest of $2.8 million.
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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. If it is determined the likelihood of collecting substantially all of the notes and accrued interest is not probable, the notes are put on non-accrual status. The Company’s investment in notes receivable on non-accrual status was $13.4 million, $13.6 million and $13.7 million at July 31, 2018, April 30, 2018, and July 31, 2017, respectively. Payments received on notes in non-accrual status are applied to the principal until the note is current and then to interest income. Non-accrual notes that are paid current and expected to remain current are moved back into accrual status during the next annual review.
(3) Restructuring Expense
In the three months ended October 31, 2017, the Company began restructuring initiatives involving a review of Company-owned stores and service providers to improve the Company's overall long-term profitability. The Company incurred $8.3 million of expenses in the three months ended July 31, 2018 related to these initiatives. The expenses incurred are presented in the Restructuring expense line item in the consolidated statements of income. The composition of the restructuring expenses incurred for the three months ended July 31, 2018 were as follows:
Expense | Cash | Accrued Expenses | Non-cash | Total Expense | ||||||||||||
(In thousands) | ||||||||||||||||
Property and intangible impairments and exit costs | 193 | 3,859 | 4,214 | 8,266 | ||||||||||||
Total | $ | 193 | $ | 3,859 | $ | 4,214 | $ | 8,266 |
The property and intangible impairments and exit costs, which were primarily recorded in assets held for sale, were comprised of expenses related to lease obligations and non-cash charges associated with intangible write-downs. The accrued restructuring expenses of $2.7 million are included in "Accounts payable and accrued expenses" in the accompanying consolidated balance sheets.
A summary of the activity in accrued expenses related to restructuring initiatives for the three months ended July 31, 2018 is as follows:
Contract termination costs - maintenance | Property and intangible impairments and exit costs | Total accrued expenses | ||||||||||
(In thousands) | ||||||||||||
Balance at beginning of period | $ | 1,359 | $ | — | $ | 1,359 | ||||||
Additions accrued against the liability | — | 3,859 | 3,859 | |||||||||
Cash payments | — | — | — | |||||||||
Balance at end of period | $ | 1,359 | $ | 3,859 | $ | 5,218 |
(4) Goodwill and Intangible Assets
Changes in the carrying amount of goodwill for the three months ended July 31, 2018 and 2017 were as follows:
July 31, 2018 | July 31, 2017 | |||||||
(In thousands) | ||||||||
Balance at beginning of period | $ | 8,640 | $ | 8,576 | ||||
Acquisitions of assets from franchisees and others | — | 22 | ||||||
Disposals and foreign currency changes, net | (643 | ) | 54 | |||||
Purchase price reallocation | — | (1,032 | ) | |||||
Balance at end of period | $ | 7,997 | $ | 7,620 |
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Components of intangible assets were as follows as of July 31, 2018, April 30, 2018 and July 31, 2017:
July 31, 2018 | ||||||||||||||
Weighted average amortization period | Gross carrying amount | Accumulated amortization | Net carrying amount | |||||||||||
(In thousands) | ||||||||||||||
Customer lists acquired from unrelated third parties | 5 years | $ | 3,187 | $ | (1,700 | ) | $ | 1,487 | ||||||
Tradenames | 3 years | 539 | (252 | ) | 287 | |||||||||
Non-compete agreements | 2 years | 241 | (175 | ) | 66 | |||||||||
Assets acquired from franchisees: | ||||||||||||||
Customer lists | 4 years | 1,459 | (1,220 | ) | 239 | |||||||||
Reacquired rights | 2 years | 1,157 | (1,122 | ) | 35 | |||||||||
AD rights | 9 years | 32,002 | (11,351 | ) | 20,651 | |||||||||
Total intangible assets | $ | 38,585 | $ | (15,820 | ) | $ | 22,765 |
April 30, 2018 | ||||||||||||||
Weighted average amortization period | Gross carrying amount | Accumulated amortization | Net carrying amount | |||||||||||
(In thousands) | ||||||||||||||
Customer lists acquired from unrelated third parties | 5 years | $ | 3,187 | $ | (1,555 | ) | $ | 1,632 | ||||||
Tradenames | 3 years | 431 | (172 | ) | 259 | |||||||||
Non-compete agreements | 2 years | 241 | (145 | ) | 96 | |||||||||
Assets acquired from franchisees: | ||||||||||||||
Customer lists | 4 years | 1,842 | (1,427 | ) | 415 | |||||||||
Reacquired rights | 2 years | 1,436 | (1,393 | ) | 43 | |||||||||
AD rights | 9 years | 30,907 | (10,515 | ) | 20,392 | |||||||||
Total intangible assets | $ | 38,044 | $ | (15,207 | ) | $ | 22,837 |
July 31, 2017 | ||||||||||||||
Weighted average amortization period | Gross carrying amount | Accumulated amortization | Net carrying amount | |||||||||||
(In thousands) | ||||||||||||||
Customer lists acquired from unrelated third parties | 5 years | $ | 3,188 | $ | (1,058 | ) | $ | 2,130 | ||||||
Tradenames | 3 years | 431 | (64 | ) | 367 | |||||||||
Non-compete agreements | 2 years | 241 | (55 | ) | 186 | |||||||||
Assets acquired from franchisees: | ||||||||||||||
Customer lists | 4 years | 1,266 | (1,000 | ) | 266 | |||||||||
Reacquired rights | 2 years | 956 | (934 | ) | 22 | |||||||||
AD rights | 10 years | 27,072 | (8,141 | ) | 18,931 | |||||||||
Total intangible assets | $ | 33,154 | $ | (11,252 | ) | $ | 21,902 |
The Company acquired $1.3 million and $0.6 million of AD rights during the three months ended July 31, 2018 and 2017, respectively.
During the three months ended July 31, 2018 and 2017, the Company did not acquire any assets of U.S. or Canadian franchisees, or third parties that were not classified as assets held for sale.
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(5) Assets Held For Sale
At the end of the first quarter of fiscal 2019 and 2018, assets acquired from U.S. franchisees were classified as assets held for sale. During the three months ended July 31, 2018, the Company acquired less than $0.1 million in assets from U.S. franchisees and third parties that were first accounted for as business combinations, with the value allocated to customer lists and reacquired rights of less than $0.1 million and goodwill of less than $0.1 million prior to being recorded as assets held for sale. During the three months ended July 31, 2017, the Company acquired $3.0 million in assets from U.S. franchisees and third parties that were first accounted for as business combinations, with the value allocated to customer lists and reacquired rights of $1.5 million and goodwill of $1.5 million prior to being recorded as assets held for sale. The Company intends to sell the majority of assets associated with Company-owned offices within one year. The acquired businesses are operated as Company-owned offices until a buyer is located and a new franchise agreement is entered into. During the three months ended July 31, 2018, the Company sold, terminated, or impaired $3.7 million in assets from U.S. franchisees, of which $3.4 million was included in the Company's restructuring initiative.
Changes in the carrying amount of assets held for sale for the three months ended July 31, 2018 and 2017 were as follows:
Three Months Ended July 31, | |||||||
2018 | 2017 | ||||||
(In thousands) | |||||||
Balance at beginning of period | $ | 8,941 | $ | 11,989 | |||
Reacquired and acquired from third parties | 37 | 2,979 | |||||
Sold or terminated, impairments and other | (3,747 | ) | (290 | ) | |||
Balance at end of period | $ | 5,231 | $ | 14,678 |
During fiscal 2018, the Company reviewed assets held for sale that were deemed unlikely to be sold in the preceding 12 months. Those identified were transferred to assets held for use and amortization expense was recorded on a cumulative basis for customer lists and reacquired rights.
(6) Long-Term Obligations
The Company has a credit facility that consists of a term loan with an original principal amount of $21.2 million and a revolving credit facility that currently allows borrowing of up to $170.0 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, which is paid monthly at a rate of the one-month London Interbank Offered Rate ("LIBOR") plus a margin ranging from 1.50% to 2.25% depending on the Company’s leverage ratio.
The average interest rate paid during the three months ended July 31, 2018 and 2017 was 3.74% and 2.81%, respectively. The indebtedness is collateralized by substantially all the assets of the Company, and both loans mature on April 30, 2019.
The credit facility contains certain financial covenants that the Company must meet, including leverage and fixed-charge coverage ratios as well as minimum net worth requirements. In addition, the Company must reduce the outstanding balance under its revolving credit facility to zero for a period of at least 45 consecutive days each fiscal year. The Company was in compliance with the financial covenants at July 31, 2018.
In December 2016, the Company obtained a mortgage payable to a bank in monthly installments of principal payments plus interest at the one-month LIBOR plus 1.85% through December 2026 with a balloon payment of $0.8 million due at maturity. The mortgage is collateralized by land and buildings.
In December 2016, in connection with obtaining a mortgage payable to a bank, the Company entered into an interest rate swap agreement that allows it to manage fluctuations in cash flow resulting from changes in the interest rate on the mortgage. This swap effectively changes the variable-rate of the Company's mortgage into a fixed rate of 4.12%. The Company has designated this swap agreement as a cash flow hedge. At July 31, 2018, the fair value of the interest rate swap is less than $0.1 million and is included in other current assets. The interest rate swap expires in December 2026.
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Long-term obligations at July 31, 2018, April 30, 2018, and July 31, 2017 consisted of the following:
July 31, 2018 | April 30, 2018 | July 31, 2017 | ||||||||||
(In thousands) | ||||||||||||
Credit Facility: | ||||||||||||
Revolver | $ | 12,590 | $ | — | $ | 20,611 | ||||||
Term loan, net of debt issuance costs | 14,334 | 14,855 | 16,409 | |||||||||
Total credit facility | 26,924 | 14,855 | 37,020 | |||||||||
Long-Term Obligations | ||||||||||||
Term loan, net of debt issuance costs | 14,334 | 14,855 | 16,409 | |||||||||
Due former ADs, franchisees and third parties | 2,477 | 3,490 | 4,479 | |||||||||
Mortgages | 2,007 | 2,038 | 2,130 | |||||||||
18,818 | 20,383 | 23,018 | ||||||||||
Less: current installments | (16,923 | ) | (18,113 | ) | (5,202 | ) | ||||||
Long-term obligations, excluding current installments, net | $ | 1,895 | $ | 2,270 | $ | 17,816 |
(7) Income Taxes
During the first quarter of fiscal 2019, the Company continued its assessment of the corporate income tax impacts expected to result from the Tax Cuts and Jobs Act (the “Tax Act”). During the three months ended July 31, 2018, the Company did not adjust its provisional amounts recorded as of April 30, 2018. The Company is finalizing its assessment of the impact of the Tax Act and the provisional estimates may change because of additional analysis of the underlying calculations or additional regulatory guidance.
Similar to prior years, pre-tax book income estimated in the fourth quarter of fiscal 2019 is expected to offset pre-tax book loss for the three months ended July 31, 2018 due to the established pattern of seasonality in the Company's primary business operations. Management has determined it is at least more-likely-than-not that realization of tax benefits recorded in the Company's financial statements will occur during fiscal 2019. The amount of tax benefit recorded for the three months ended July 31, 2018 reflects the Company’s estimated annual effective tax rate applied to the year-to-date loss from continuing operations adjusted for the tax impact of discrete items.
The Company's effective tax rate from continuing operations, including discrete income tax items, was 32.9% and 39.5% for the three months ended July 31, 2018 and 2017, respectively. The reduced effective tax rate results primarily from the decrease in the U.S. federal corporate income tax rate from 35% to 21%, effective after December 31, 2017.
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(8) Stockholders’ Equity
Stockholders' Equity Activity
During the three months ended July 31, 2018 and 2017, activity in stockholders’ equity was as follows:
Three Months Ended July 31, | ||||||||
2018 | 2017 | |||||||
(In thousands, except for share amounts) | ||||||||
Class A common stock issued from the vesting of restricted stock and as director compensation | 1,091 | — | ||||||
Class B common stock converted to Class A common stock | 200,000 | — | ||||||
Special voting preferred stock converted to Class A common stock | 1,000,000 | — | ||||||
Stock-based compensation expense | $ | 205 | $ | 554 | ||||
Dividends declared | $ | 2,267 | $ | 2,339 |
During the three months ended July 31, 2018, the sole holder of the Company's Class B common stock entered into a stock purchase agreement to sell all of their outstanding shares of the Company's Class A common stock and Class B common stock owned directly and indirectly by them. In connection with the sale, the shares of the Company’s Class B common stock converted into shares of the Company’s Class A common stock on a one-for-one basis and for no additional consideration. As of July 31, 2018, no shares of the Company’s Class B common stock remained outstanding. In addition, an agreement was reached which converted the 10 shares of special voting preferred stock to 1,000,000 shares of Class A common stock.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss at July 31, 2018, April 30, 2018 and July 31, 2017 were as follows.
July 31, 2018 | April 30, 2018 | July 31, 2017 | ||||||||||
(In thousands) | ||||||||||||
Foreign currency adjustment | $ | (1,583 | ) | $ | (1,381 | ) | $ | (1,026 | ) | |||
Unrealized gain on interest rate swap agreement, net of taxes | 44 | 34 | (39 | ) | ||||||||
Total accumulated other comprehensive loss | $ | (1,539 | ) | $ | (1,347 | ) | $ | (1,065 | ) |
Net 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 stock and participating securities (exchangeable shares) and using the weighted-average number of common stock outstanding during the period. Undistributed losses are not allocated to participating securities because they do not meet the required criteria for such allocation.
Diluted net income (loss) per share is computed using the weighted-average number of common stock and, if dilutive, the potential common stock outstanding during the period. Potential common stock consists of the incremental common stock issuable upon the exercise of stock options and vesting of restricted stock units. The dilutive effect of outstanding stock options and restricted stock units 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.
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The computation of basic and diluted net loss per share for the three months ended July 31, 2018 and 2017 is as follows:
Three Months Ended July 31, 2018 | Three Months Ended July 31, 2017 | |||||||||||||||
Class A | Class B | Class A | Class B | |||||||||||||
Common Stock | Common Stock | 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 | $ | (19,081 | ) | $ | (290 | ) | $ | (9,607 | ) | $ | (151 | ) | ||||
Denominator | ||||||||||||||||
Weighted-average common stock outstanding | 12,882,439 | 195,652 | 12,682,550 | 200,000 | ||||||||||||
Basic and diluted net loss per share | $ | (1.48 | ) | $ | (1.48 | ) | $ | (0.76 | ) | $ | (0.76 | ) | ||||
As a result of the net losses for the periods shown, diluted net loss per share excludes the impact of shares of potential common stock from the exercise of options to purchase 692,205 and 1,391,423 shares for the three months ended July 31, 2018 and 2017, respectively, because the effect would be anti-dilutive.
(9) Stock Compensation Plans
Stock Options
The Company has an equity and cash incentive plan, for the issuance of up to 2,500,000 shares of Class A common stock in which employees and outside directors are eligible to receive awards. At July 31, 2018, 1,530,432 shares of Class A common stock remain available for grant.
Stock option activity during the three months ended July 31, 2018 was as follows:
Number of options | Weighted average exercise price | ||||||
Balance at beginning of period | 472,503 | $ | 17.41 | ||||
Granted | 572,569 | 9.78 | |||||
Expired or forfeited | (297,586 | ) | 18.61 | ||||
Balance at end of period | 747,486 | $ | 11.09 |
Intrinsic value is defined as the fair value of the stock less the cost to exercise. No options were exercised during the three months ended July 31, 2018. The total intrinsic value of stock options outstanding at July 31, 2018 was $0.4 million. Stock options vest from the date of grant to five years after the date of grant and expire from four to seven years after the vesting date.
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Nonvested stock options activity during the three months ended July 31, 2018 was as follows:
Nonvested options | Weighted average exercise price | ||||||
Balance at beginning of period | 267,433 | $ | 14.27 | ||||
Granted | 572,569 | 9.78 | |||||
Vested | (50,000 | ) | 8.30 | ||||
Forfeited | (197,088 | ) | 14.30 | ||||
Balance at end of period | 592,914 | $ | 10.04 |
At July 31, 2018, unrecognized compensation costs related to nonvested stock options were $1.0 million. These costs are expected to be recognized through fiscal 2022.
The following table summarizes information about stock options outstanding and exercisable at July 31, 2018:
Options Outstanding | Options Exercisable | |||||||||||||||
Range of exercise prices | Number of shares outstanding | Weighted average exercise price | Weighted average remaining contractual life (in years) | Number of options exercisable | Weighted average exercise price | |||||||||||
$0.00 - $10.89 | 572,569 | $ | 9.78 | 6.7 | 50,000 | $ | 8.30 | |||||||||
$10.90 - $16.38 | 124,738 | 11.72 | 3.8 | 54,393 | 12.79 | |||||||||||
$16.39 - $26.17 | 37,471 | 21.44 | 1.5 | 37,471 | 21.44 | |||||||||||
$26.18 - $33.38 | 12,708 | 33.38 | 1.1 | 12,708 | 33.38 | |||||||||||
747,486 | $ | 11.09 | 154,572 | $ | 15.13 |
Restricted Stock Units
Restricted stock activity during the three months ended July 31, 2018 was as follows:
Number of Restricted stock units | Weighted average fair value at grant date | ||||||
Balance at beginning of period | 127,030 | $ | 12.48 | ||||
Granted | 112,923 | 9.86 | |||||
Vested | (1,690 | ) | 14.30 | ||||
Forfeited | (68,096 | ) | 12.43 | ||||
Balance at end of period | 170,167 | $ | 10.74 |
At July 31, 2018, unrecognized compensation costs related to restricted stock units were $1.4 million. These costs are expected to be recognized through fiscal 2022.
(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. |
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• | 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. The following tables present, at July 31, 2018, April 30, 2018 and July 31, 2017, 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):
July 31, 2018 | ||||||||||||||||
Fair value measurements using | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets: | ||||||||||||||||
Recurring assets: | ||||||||||||||||
Interest rate swap agreement | $ | 61 | $ | — | $ | 61 | $ | — | ||||||||
Total recurring assets | 61 | — | 61 | — | ||||||||||||
Nonrecurring assets: | ||||||||||||||||
Impaired accounts and notes receivable, net of unrecognized revenue and allowance | 15,199 | — | — | 15,199 | ||||||||||||
Total nonrecurring assets | 15,199 | — | — | 15,199 | ||||||||||||
Total recurring and nonrecurring assets | $ | 15,260 | $ | — | $ | 61 | $ | 15,199 | ||||||||
Liabilities: | ||||||||||||||||
Recurring liabilities: | ||||||||||||||||
Contingent consideration included in obligations due to former ADs, franchisees and others | $ | 1,432 | $ | — | $ | — | $ | 1,432 | ||||||||
Total recurring liabilities | $ | 1,432 | $ | — | $ | — | $ | 1,432 |
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April 30, 2018 | ||||||||||||||||
Fair value measurements using | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets: | ||||||||||||||||
Recurring assets: | ||||||||||||||||
Cash equivalents | $ | 12,056 | $ | 12,056 | $ | — | $ | — | ||||||||
Interest rate swap agreement | 57 | — | 57 | — | ||||||||||||
Total recurring assets | 12,113 | 12,056 | 57 | — | ||||||||||||
Nonrecurring assets: | ||||||||||||||||
Impaired accounts and notes receivable, net of unrecognized revenue and allowance | 15,223 | — | — | 15,223 | ||||||||||||
Impaired goodwill | 109 | — | — | 109 | ||||||||||||
Impaired customer lists | 4 | — | — | 4 | ||||||||||||
Assets held for sale | 8,941 | — | — | 8,941 | ||||||||||||
Total nonrecurring assets | 24,277 | — | — | 24,277 | ||||||||||||
Total recurring and nonrecurring assets | $ | 36,390 | $ | 12,056 | $ | 57 | $ | 24,277 | ||||||||
Liabilities: | ||||||||||||||||
Recurring liabilities: | ||||||||||||||||
Contingent consideration included in obligations due to former ADs, franchisees and others | $ | 1,545 | $ | — | $ | — | $ | 1,545 | ||||||||
Total recurring liabilities | $ | 1,545 | $ | — | $ | — | $ | 1,545 |
July 31, 2017 | ||||||||||||||||
Fair value measurements using | ||||||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Assets: | ||||||||||||||||
Nonrecurring assets: | ||||||||||||||||
Impaired accounts and notes receivable, net of unrecognized revenue and allowance | $ | 14,570 | $ | — | $ | — | $ | 14,570 | ||||||||
Total recurring and nonrecurring assets | $ | 14,570 | $ | — | $ | — | $ | 14,570 | ||||||||
Liabilities: | 9539 | |||||||||||||||
Recurring liabilities: | ||||||||||||||||
Interest rate swap agreement | $ | 39 | $ | — | $ | 39 | $ | — | ||||||||
Contingent consideration included in obligations due to former ADs, franchisees and others | 4,186 | — | — | 4,186 | ||||||||||||
Total recurring liabilities | $ | 4,225 | $ | — | $ | 39 | $ | 4,186 |
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 each of the three months ended July 31, 2018 and 2017.
The following methods and assumptions are used to estimate the fair value of our 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.
Impaired accounts and notes receivable, net of unrecognized revenue: Accounts and notes receivable are considered to be impaired if the net amounts due exceed the fair value of the underlying franchise or if management considers it probable
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that all principal and interest will not be collected when contractually due. In establishing the estimated fair value of the underlying franchise, consideration is given to recent sales between franchisees, sales of Company-owned stores, the net fees of open offices, and the number of unopened offices.
Impaired goodwill, reacquired rights, and customer lists: Goodwill, reacquired rights and customer lists associated with a Company-owned office are considered 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 related net fees and third-party transactions of franchises and when appropriate a discounted cash flow model.
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 prior year net fees and marketplace transactions.
Contingent consideration included in obligations due to former ADs, franchisee and others: Obligations due to former ADs and franchisees related to estimated contingent consideration are carried at fair value. The fair value of these obligations was determined using a discounted cash flow model.
Interest rate swap agreement: Value of interest rate swap on variable rate mortgage debt. The fair value of this instrument was determined based on third-party market research.
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.
Notes receivable: The carrying amount 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 obligations: The carrying amount approximates fair value because the interest rate paid has a variable component (Level 2).
(11) Related Party Transactions
The Company considers directors and their affiliated companies, as well as named executive officers and members of their immediate families, to be related parties.
Nicole Ossenfort’s (Chief Executive Officer) franchise agreement
The Company is or was a participant in the following related party transactions with Ms. Ossenfort since the beginning of fiscal 2019:
Ossenfort Franchise. Ms. Ossenfort, together with her husband, Scott Ossenfort (together, with Ms. Ossenfort, the “Ossenforts”), jointly own a Company franchise through JL Enterprises. JL Enterprises borrows operating funds for working capital to operate the franchises each year. During the three months ended July 31, 2018, JL Enterprises did not borrow operating funds for working capital to operate the franchise. During the three months ended July 31, 2018, the Company has recorded $34,642 of accounts receivable from the Ossenforts for royalties, advertising and financial product charges, of which a balance of $6,434 remained outstanding and payable to the Company as of July 31, 2018.
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Shaun York’s (Chief Operating Officer) franchises and AD agreements
The Company is or was a participant in the following related party transactions with Mr. York since the beginning of fiscal 2019:
York Franchises. Mr. York operates eleven Company franchises through Yorkompany LLC, S&P Holding Group LLC, My Business Group LLC and Core Fitness Partners LLC (the “York Franchise Entities”). The York Franchise Entities borrow operating funds from the Company for working capital to operate the franchises each year. During the three months ended July 31, 2018, the York Franchise Entities borrowed operating funds in the amount of $40,065, of which $40,065 remained outstanding and payable to the Company as of July 31, 2018. In addition, during the three months ended July 31, 2018, the Company recorded $46,997 of accounts receivable from the York Franchise Entities for royalties, advertising and financial product charges, of which $41,332 remained outstanding and payable to the Company as of July 31, 2018.
York AD. Mr. York has Area Development arrangements with the Company that are conducted through Yorkompany LLC, S&P Holding Group LLC and TNT Florida Investments LLC (the “York AD Entities”). The York AD Entities were acquired by Mr. York through various transactions with the Company and through third party agreements with AD sellers. In connection with those transactions, the York AD Entities financed a total of $4,059,460 through the Company to acquire the Area Development territories and associated rights. The loans are payable by the York AD Entities in annual installments at 12% interest. As of July 31, 2018, the aggregate outstanding principal balance owed by the York AD Entities on the notes was $1,789,040.
As of July 31, 2018, the Company had accounts receivable from the York AD Entities of $3,105. The York AD Entities earned $73,620 for their portion of franchise fees, royalties and interest during the three months ended July 31, 2018.
York Debt Guarantees. Mr. York also has entered into multiple guarantee agreements with the Company whereby Mr. York has guaranteed all or a portion of the indebtedness owed by other franchisees and ADs to the Company as related to certain financial transactions for which Mr. York had an interest. The indebtedness owed by these franchisees and ADs as of July 31, 2018 is approximately $3,416,535.
John Seal’s (Director) AD agreement
The Company is or was a participant in the following related party transactions with Mr. Seal since the beginning of fiscal 2019:
JMS Tax, an entity controlled by Mr. Seal, a former director of the Company, owns an AD territory in Texas which a portion of the purchase price was financed through a note issued by the Company. There was no outstanding principal balance on the note as of July 31, 2018.
As of July 31, 2018, the Company had accounts receivable from JMS Tax of $675. JMS Tax earned $11,453 for their portion of franchise fees, royalties and interest during the three months ended July 31, 2018.
(12) Commitments and Contingencies
In the ordinary course of operations, the Company may become a party to legal proceedings. Based upon information currently available, management believes that such legal proceedings, individually or in the aggregate, will not have a material adverse effect on the Company's business, financial condition, cash flows, or results of operations except as provided below.
Delaware Derivative Litigation
Asbestos Workers’ Philadelphia Pension Fund, derivatively on behalf of Liberty Tax, Inc., v. John Hewitt, Defendant, and Liberty Tax, Inc., Nominal Defendant, Case No. 2017-0883, filed in the Court of Chancery of the State of Delaware on December 12, 2017. Plaintiff alleges that the Company's former CEO, John T. Hewitt (“Hewitt”), breached his fiduciary duties as an officer based upon certain allegations of misconduct on his part. The Plaintiff also alleges breach of fiduciary duty against Hewitt in his capacity as a director of LT, Inc. The Complaint seeks compensatory damages and attorney’s fees. No claim or relief is asserted against the Company, which is named solely as a Nominal Defendant.
Erie County Employees Retirement System, derivatively on behalf of Liberty Tax, Inc., v. John T. Hewitt, Defendant, and Liberty Tax, Inc., Nominal Defendant, Case No. 2017-0914, brought a second derivative suit filed in the Court of Chancery of the State of Delaware on December 22, 2017. Plaintiff also alleges that Hewitt breached his fiduciary duties as an
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officer based upon certain allegations of misconduct on his part. The Plaintiff also alleges breach of fiduciary duty against Hewitt in his capacity as a director of the Company. The Complaint seeks to enjoin Hewitt from managing our business operations, and seeks compensatory damages and attorney’s fees.
On December 27, 2017, the two above-referenced shareholder matters were consolidated into the case with the caption In Re: Liberty Tax, Inc. Stockholder Litigation, C.A. No. 2017-0883. On April 17, 2018, Plaintiffs filed an amended complaint (the "Amended Complaint"). The Amended Complaint added Gordon D’Angelo, Ellen McDowell, Nicole Ossenfort, and John Seal, with Hewitt as individual defendants (the “Individual Defendants”) and asserted class action allegations. Plaintiffs seek (i) a declaration that the Individual Defendants have breached the Company's Nominating Charter; (ii) a declaration that the Individual Defendants have breached their fiduciary duties; (iii) an award to the Plaintiffs and the Class in the amount of damages sustained as a result of the Individual breaches; (iv) certification of the action as a class action; (v) an award to the Company in the amount of damages sustained as a result of the Individual Defendants’ breaches of their fiduciary duties; (vi) a grant of further appropriate equitable relief to remedy the Individual Defendants’ breaches, including injunctive relief; (vii) an award to Plaintiffs of the costs and disbursements of this action, including reasonable attorneys’ fees, accountants’ and experts’ fees, costs and expenses; and (viii) such further relief as the Court deems just and proper. The Company has answered the Amended Complaint and discovery is underway. The individuals have filed a notice of motion to dismiss. No briefing schedule has been set on the motion. A mediation took place on November 12, 2018 but did not result in a resolution. A scheduling order has been entered which currently schedules trial in this matter to begin on March 18, 2019.
Eastern District of New York Securities Litigation
Rose Mauro, individually and on behalf of all others similarly situated v. Liberty Tax, Inc., Edward L. Brunot, John T. Hewitt, and Kathleen E. Donovan, filed in the United States District Court for the Eastern District of New York on January 12, 2018, Case No. 18 CV 245. Plaintiff filed a securities class action asserting violations of Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and Rule 10b-5 against all defendants and a second count for violations of Section 20(a) of the Exchange Act against the individual defendants. According to the complaint, throughout the class period, the Company allegedly issued materially false and misleading statements and/or failed to disclose that: (1) Hewitt created an inappropriate tone at the top; (2) the inappropriate tone at the top led to ineffective entity level controls over the organization; and (3) as a result, defendants’ statements about the operations and prospects were materially false and misleading and/or lacked a reasonable basis at all relevant times.