H&R BLOCK INC 10-Q

ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS: (unaudited, in 000s, except per share amounts) Three months ended September 30, 2022 2021 REVENUES: Service revenues $ 167,194 $ 176,977 Royalty, product and other revenues 12,791 15,647 179,985 192,624 OPERATING EXPENSES: Costs of revenues 260,662 241,532 Selling, general and administrative 128,434 125,864 Total operating expenses 389,096 367,396 Other income (expense), net 3,611 284 Interest expense on borrowings ( 15,824 ) ( 22,830 ) Loss from continuing operations before income tax benefit ( 221,324 ) ( 197,318 ) Income tax benefit ( 53,957 ) ( 47,373 ) Net loss from continuing operations ( 167,367 ) ( 149,945 ) Net loss from discontinued operations, net of tax benefits of $ 316 and $ 495 ( 1,054 ) ( 1,656 ) NET LOSS $ ( 168,421 ) $ ( 151,601 ) BASIC AND DILUTED LOSS PER SHARE: Continuing operations $ ( 1.05 ) $ ( 0.84 ) Discontinued operations ( 0.01 ) ( 0.01 ) Consolidated $ ( 1.06 ) $ ( 0.85 ) DIVIDENDS DECLARED PER SHARE $ 0.29 $ 0.27 COMPREHENSIVE LOSS: Net loss $ ( 168,421 ) $ ( 151,601 ) Change in foreign currency translation adjustments ( 32,345 ) ( 11,177 ) Other comprehensive loss ( 32,345 ) ( 11,177 ) Comprehensive loss $ ( 200,766 ) $ ( 162,778 ) See accompanying notes to consolidated financial statements. H&R Block, Inc. |Q1 FY2023 Form 10-Q 1 Table of Contents CONSOLIDATED BALANCE SHEETS (unaudited, in 000s, except share and per share amounts) As of September 30, 2022 June 30, 2022 ASSETS Cash and cash equivalents $ 322,824 $ 885,015 Cash and cash equivalents - restricted 108,550 165,698 Receivables, less allowance for credit losses of $ 65,217 and $ 65,351 61,035 58,447 Income taxes receivable 154,123 202,838 Prepaid expenses and other current assets 77,906 72,460 Total current assets 724,438 1,384,458 Property and equipment, at cost, less accumulated depreciation and amortization of $ 867,402 and $ 857,468 127,934 123,912 Operating lease right of use assets 412,823 427,783 Intangible assets, net 303,483 309,644 Goodwill 746,711 760,401 Deferred tax assets and income taxes receivable 193,761 208,948 Other noncurrent assets 50,082 54,012 Total assets $ 2,559,232 $ 3,269,158 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Accounts payable and accrued expenses $ 168,496 $ 160,929 Accrued salaries, wages and payroll taxes 56,162 154,764 Accrued income taxes and reserves for uncertain tax positions 188,118 280,115 Operating lease liabilities 197,491 206,898 Deferred revenue and other current liabilities 179,956 196,107 Total current liabilities 790,223 998,813 Long-term debt 1,487,407 1,486,876 Deferred tax liabilities and reserves for uncertain tax positions 229,340 226,362 Operating lease liabilities 222,914 228,820 Deferred revenue and other noncurrent liabilities 94,333 116,656 Total liabilities 2,824,217 3,057,527 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, no par, stated value $ 0.01 per share, 800,000,000 shares authorized, shares issued of 188,644,066 and 193,571,309 1,887 1,936 Additional paid-in capital 759,629 772,182 Accumulated other comprehensive loss ( 53,990 ) ( 21,645 ) Retained earnings (deficit) ( 311,671 ) 120,405 Less treasury shares, at cost, of 33,176,727 and 33,640,988 ( 660,840 ) ( 661,247 ) Total stockholders' equity (deficiency) ( 264,985 ) 211,631 Total liabilities and stockholders' equity $ 2,559,232 $ 3,269,158 See accompanying notes to consolidated financial statements. 2 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, in 000s) Three months ended September 30, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ ( 168,421 ) $ ( 151,601 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 33,624 35,715 Provision 1,077 1,850 Deferred taxes 16,918 ( 13,547 ) Stock-based compensation 7,654 6,847 Changes in assets and liabilities, net of acquisitions: Receivables 3,702 35,913 Prepaid expenses, other current and noncurrent assets ( 2,669 ) 8,610 Accounts payable, accrued expenses, salaries, wages and payroll taxes ( 129,908 ) ( 134,215 ) Deferred revenue, other current and noncurrent liabilities ( 41,549 ) ( 27,990 ) Income tax receivables, accrued income taxes and income tax reserves ( 41,659 ) ( 72,768 ) Other, net ( 435 ) ( 1,438 ) Net cash used in operating activities ( 321,666 ) ( 312,624 ) CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures ( 16,161 ) ( 15,620 ) Payments made for business acquisitions, net of cash acquired ( 16,507 ) ( 4,265 ) Franchise loans funded ( 6,686 ) ( 4,474 ) Payments from franchisees 2,270 2,839 Other, net ( 274 ) 2,067 Net cash used in investing activities ( 37,358 ) ( 19,453 ) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid ( 43,093 ) ( 48,996 ) Repurchase of common stock, including shares surrendered ( 202,845 ) ( 165,800 ) Proceeds from exercise of stock options — 3,385 Other, net ( 955 ) ( 5,911 ) Net cash used in financing activities ( 246,893 ) ( 217,322 ) Effects of exchange rate changes on cash ( 13,422 ) ( 3,959 ) Net decrease in cash and cash equivalents, including restricted balances ( 619,339 ) ( 553,358 ) Cash, cash equivalents and restricted cash, beginning of period 1,050,713 1,584,164 Cash, cash equivalents and restricted cash, end of period $ 431,374 $ 1,030,806 SUPPLEMENTARY CASH FLOW DATA: Income taxes paid (received), net $ ( 29,811 ) $ 38,419 Interest paid on borrowings 19,792 12,594 Accrued purchase of common stock 32,356 4,785 Accrued additions to property and equipment 4,704 6,273 New operating right of use assets and related lease liabilities 52,265 29,371 Accrued dividends payable to common shareholders 46,100 47,940 See accompanying notes to consolidated financial statements. H&R Block, Inc. | Q1 FY2023 Form 10-Q 3 Table of Contents CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (amounts in 000s, except per share amounts) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) (1) Retained Earnings (Deficit) Treasury Stock Total Stockholders’ Equity Shares Amount Shares Amount Balances as of July 1, 2022 193,571 $ 1,936 $ 772,182 $ ( 21,645 ) $ 120,405 ( 33,641 ) $ ( 661,247 ) $ 211,631 Net loss — — — — ( 168,421 ) — — ( 168,421 ) Other comprehensive loss — — — ( 32,345 ) — — — ( 32,345 ) Stock-based compensation — — 5,630 — — — — 5,630 Stock-based awards exercised or vested — — ( 15,276 ) — ( 742 ) 805 15,839 ( 179 ) Acquisition of treasury shares (2) — — — — — ( 341 ) ( 15,432 ) ( 15,432 ) Repurchase and retirement of common shares ( 4,927 ) ( 49 ) ( 2,907 ) — ( 216,813 ) — — ( 219,769 ) Cash dividends declared - $ 0.29 per share — — — — ( 46,100 ) — — ( 46,100 ) Balances as of September 30, 2022 188,644 $ 1,887 $ 759,629 $ ( 53,990 ) $ ( 311,671 ) ( 33,177 ) $ ( 660,840 ) $ ( 264,985 ) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) (1) Retained Earnings (Deficit) Treasury Stock Total Stockholders’ Equity Shares Amount Shares Amount Balances as of July 1, 2021 216,656 $ 2,167 $ 779,465 $ 88 $ 286,694 ( 34,842 ) $ ( 680,356 ) $ 388,058 Net loss — — — — ( 151,601 ) — — ( 151,601 ) Other comprehensive loss — — — ( 11,177 ) — — — ( 11,177 ) Stock-based compensation — — 5,627 — — — — 5,627 Stock-based awards exercised or vested — — ( 10,328 ) — ( 291 ) 705 13,765 3,146 Acquisition of treasury shares (2) — — — — — ( 205 ) ( 4,817 ) ( 4,817 ) Repurchase and retirement of common shares ( 6,802 ) ( 68 ) ( 4,081 ) — ( 161,619 ) — — ( 165,768 ) Cash dividends declared - $ 0.27 per share — — — — ( 47,940 ) — — ( 47,940 ) Balances as of September 30, 2021 209,854 $ 2,099 $ 770,683 $ ( 11,089 ) $ ( 74,757 ) ( 34,342 ) $ ( 671,408 ) $ 15,528 (1) The balance of our accumulated other comprehensive income (loss) consists of foreign currency translation adjustments. (2) Represents shares swapped or surrendered to us in connection with the vesting or exercise of stock-based awards. See accompanying notes to consolidated financial statements. 4 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION – The consolidated balance sheets as of September 30, 2022 and June 30, 2022, the consolidated statements of operations and comprehensive loss for the three months ended September 30, 2022 and 2021, the consolidated statements of cash flows for the three months ended September 30, 2022 and 2021, and the consolidated statements of stockholders' equity for the three months ended September 30, 2022 and 2021 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 September 30, 2022 and 2021 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., to H&R Block, Inc. and its subsidiaries, or to H&R Block, Inc.'s operating 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 United States (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 June 30, 2022 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of June 30, 2022 or for the year then ended are derived from our Annual Report 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, reserves for uncertain tax positions, fair value of reporting units, 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 note 9 for additional information on loss contingencies related to our discontinued operations. H&R Block, Inc. |Q1 FY2023 Form 10-Q 5 Table of Contents NOTE 2: REVENUE RECOGNITION The majority of our revenues are from our U.S. tax services business. The following table disaggregates our U.S. tax services revenues by major service line, with revenues from our international tax services businesses and from Wave included as separate lines: (in 000s) Three months ended September 30, 2022 2021 Revenues: U.S. assisted tax preparation $ 36,312 $ 33,607 U.S. royalties 6,228 7,358 U.S. DIY tax preparation 3,158 4,061 Refund Transfers 1,284 1,665 Peace of Mind® Extended Service Plan 24,770 24,836 Tax Identity Shield® 5,167 5,153 Emerald Card® and Spruce SM 11,612 28,258 Interest and fee income on Emerald Advance SM 614 479 International 58,834 58,325 Wave 22,646 19,137 Other 9,360 9,745 Total revenues $ 179,985 $ 192,624 Changes in the balances of deferred revenue and wages for our Peace of Mind® Extended Service Plan (POM) are as follows: (in 000s) POM Deferred Revenue Deferred Wages Three months ended September 30, 2022 2021 2022 2021 Balance, beginning of the period $ 173,486 $ 172,759 $ 19,495 $ 17,867 Amounts deferred 1,360 1,492 5 7 Amounts recognized on previous deferrals ( 28,703 ) ( 28,948 ) ( 2,988 ) ( 2,847 ) Balance, end of the period $ 146,143 $ 145,303 $ 16,512 $ 15,027 As of September 30, 2022, deferred revenue related to POM was $ 146.1 million. We expect that $ 97.0 million will be recognized over the next twelve months , while the remaining balance will be recognized over the following five years . As of September 30, 2022 and 2021, Tax Identity Shield® (TIS) deferred revenue was $ 21.2 million and $ 23.5 million, respectively. Deferred revenue related to TIS was $ 25.8 million and $ 28.3 million as of June 30, 2022 and June 30, 2021, respectively. All deferred revenue related to TIS will be recognized by April 2023 . NOTE 3: EARNINGS PER SHARE AND STOCKHOLDERS' EQUITY EARNINGS PER SHARE – Basic and diluted earnings (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 (loss) from continuing operations attributable to common shareholders by the weighted average shares outstanding during each period. 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 4.4 million shares and 5.3 million shares for the three months ended September 30, 2022 and 2021, respectively, as the effect would be antidilutive due to the net loss from continuing operations during the periods. 6 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents The computations of basic and diluted earnings (loss) per share from continuing operations are as follows: (in 000s, except per share amounts) Three months ended September 30, 2022 2021 Net loss from continuing operations attributable to shareholders $ ( 167,367 ) $ ( 149,945 ) Amounts allocated to participating securities ( 179 ) ( 239 ) Net loss from continuing operations attributable to common shareholders $ ( 167,546 ) $ ( 150,184 ) Basic weighted average common shares 159,284 178,099 Potential dilutive shares — — Dilutive weighted average common shares 159,284 178,099 Loss per share from continuing operations attributable to common shareholders: Basic $ ( 1.05 ) $ ( 0.84 ) Diluted ( 1.05 ) ( 0.84 ) The decrease in the weighted average shares outstanding is due to share repurchases completed in the current and prior fiscal years. STOCK-BASED COMPENSATION – During the three months ended September 30, 2022, we granted 0.9 million shares under our stock-based compensation plan. We granted awards of 1.4 million shares under our stock-based compensation plans during the three months ended September 30, 2021. Stock-based compensation expense of our continuing operations totaled $ 7.7 million for the three months ended September 30, 2022 and $ 6.8 million for the three months ended September 30, 2021. As of September 30, 2022, unrecognized compensation cost for stock options totaled $ 0.4 million, and for nonvested shares and units totaled $ 76.9 million. NOTE 4: RECEIVABLES Receivables, net of their related allowance, consist of the following: (in 000s) As of September 30, 2022 June 30, 2022 Short-term Long-term Short-term Long-term Loans to franchisees $ 9,628 $ 23,054 $ 6,194 $ 22,036 Receivables for U.S. assisted and DIY tax preparation and related fees 14,104 2,337 18,893 2,560 H&R Block's Instant Refund SM receivables 1,412 112 3,491 198 H&R Block Emerald Advance® lines of credit 6,800 7,098 6,691 8,825 Software receivables from retailers 607 — 3,992 — Royalties and other receivables from franchisees 6,208 55 3,682 73 Wave payment processing receivables 1,306 — 1,393 — Other 20,970 1,679 14,111 1,172 Total $ 61,035 $ 34,335 $ 58,447 $ 34,864 Balances presented above as short-term are included in receivables, while the long-term portions are included in other noncurrent assets in the consolidated balance sheets. LOANS TO FRANCHISEES – Franchisee loan balances consist of term loans made primarily to finance the purchase of franchises and revolving lines of credit primarily for the purpose of funding working capital needs. As of September 30, 2022 and June 30, 2022, loans with a principal balance more than 90 days past due, or on non-accrual status, are not material. H&R Block, Inc. |Q1 FY2023 Form 10-Q 7 Table of Contents H&R BLOCK'S INSTANT REFUND SM – H&R Block's Instant Refund SM amounts are generally received from the Canada Revenue Agency within 60 days of filing the client's return, with the remaining balance collectible from the client. We review the credit quality of our Instant Refund receivables based on pools, which are segregated by the tax return year of origination, with older years being deemed more unlikely to be repaid. We establish an allowance for credit losses at an amount that we believe reflects the receivable at net realizable value. In December of each year we charge-off the receivables to an amount we believe represents the net realizable value. B alances and amounts on non-accrual status and classified as impaired, or more than 60 days past due, by tax return year of origination, as of September 30, 2022 are as foll ows: (in 000s) Tax return year of origination Current Balance More Than 60 Days Past Due 2021 $ 2,781 $ 2,261 2020 and prior 111 111 2,892 $ 2,372 Allowance ( 1,368 ) Net balance $ 1,524 H&R BLOCK EMERALD ADVANCE ® LINES OF CREDIT – We review the credit quality of our purchased participation interests in Emerald Advance SM (EA) receivables based on pools, which are segregated by the fiscal year of origination, with older years being deemed more unlikely to be repaid. We establish an allowance for credit losses at an amount that we believe reflects the receivable at net realizable value. In December of each year we charge-off the receivables to an amount we believe represents the net realizable value. Balances and amounts on non-accrual status and classified as impaired, or more than 60 days past due, by fiscal year of origination, as of September 30, 2022 are as follows: (in 000s) Fiscal year of origination Current Balance Non-Accrual 2022 $ 23,865 $ 23,865 2021 and prior 429 429 Revolving loans 15,745 14,369 40,039 $ 38,663 Allowance ( 26,141 ) Net balance $ 13,898 ALLOWANCE FOR CREDIT LOSSES – Activity in the allowance for credit losses for our EA and all other short-term and long-term receivables for the three months ended September 30, 2022 and 2021 is as follows: (in 000s) EAs All Other Total Balances as of July 1, 2022 $ 26,141 $ 51,126 $ 77,267 Provision — 1,077 1,077 Charge-offs, recoveries and other — ( 1,281 ) ( 1,281 ) Balances as of September 30, 2022 $ 26,141 $ 50,922 $ 77,063 Balances as of July 1, 2021 $ 27,704 $ 60,272 $ 87,976 Provision — 1,850 1,850 Charge-offs, recoveries and other — ( 3,583 ) ( 3,583 ) Balances as of September 30, 2021 $ 27,704 $ 58,539 $ 86,243 8 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents NOTE 5: GOODWILL AND INTANGIBLE ASSETS Changes in the carrying amount of goodwill for the three months ended September 30, 2022 are as follows: (in 000s) Goodwill Accumulated Impairment Losses Net Balances as of July 1, 2022 $ 898,698 $ ( 138,297 ) $ 760,401 Acquisitions 7,879 — 7,879 Disposals and foreign currency changes, net ( 21,569 ) — ( 21,569 ) Impairments — — — Balances as of September 30, 2022 $ 885,008 $ ( 138,297 ) $ 746,711 We test goodwill for impairment annually as of February 1, 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. Components of intangible assets are as follows: (in 000s) Gross Carrying Amount Accumulated Amortization Net As of September 30, 2022: Reacquired franchise rights $ 383,809 $ ( 200,442 ) $ 183,367 Customer relationships 335,766 ( 283,515 ) 52,251 Internally-developed software 138,600 ( 112,561 ) 26,039 Noncompete agreements 41,949 ( 38,106 ) 3,843 Franchise agreements 19,201 ( 17,708 ) 1,493 Purchased technology 122,700 ( 90,125 ) 32,575 Trade name 5,800 ( 1,885 ) 3,915 $ 1,047,825 $ ( 744,342 ) $ 303,483 As of June 30, 2022: Reacquired franchise rights $ 379,114 $ ( 197,068 ) $ 182,046 Customer relationships 331,020 ( 278,717 ) 52,303 Internally-developed software 137,638 ( 107,111 ) 30,527 Noncompete agreements 41,789 ( 37,684 ) 4,105 Franchise agreements 19,201 ( 17,388 ) 1,813 Purchased technology 122,700 ( 87,910 ) 34,790 Trade name 5,800 ( 1,740 ) 4,060 $ 1,037,262 $ ( 727,618 ) $ 309,644 We made payments to acquire businesses totaling $ 16.5 million and $ 4.3 million during the three months ended September 30, 2022 and 2021, respectively. The amounts and weighted-average lives of intangible assets acquired H&R Block, Inc. |Q1 FY2023 Form 10-Q 9 Table of Contents during the three months e nded September 30, 2022, including amounts capitalized related to internally-developed software, a re as follows: (dollars in 000s) Amount Weighted-Average Life (in years) Internally-developed software $ 1,254 2 Customer relationships 6,331 5 Reacquired franchise rights 4,897 4 Noncompete agreements 220 5 Total $ 12,702 4 Amortization of intangible assets for the three months ended September 30, 2022 was $ 18.4 million compared to $ 19.8 million for the three months ended September 30, 2021. Estimated amortization of intangible assets for fiscal years ending June 30, 2023, 2024, 2025, 2026, and 2027 is $ 68.8 million, $ 49.1 million, $ 27.5 million, $ 19.3 million and $ 13.8 million, respectively. NOTE 6: LONG-TERM DEBT The components of long-term debt are as follows: (in 000s) As of September 30, 2022 June 30, 2022 Senior Notes, 5.250 %, due October 2025 $ 350,000 $ 350,000 Senior Notes, 2.500 %, due July 2028 500,000 500,000 Senior Notes, 3.875 %, due August 2030 650,000 650,000 Debt issuance costs and discounts ( 12,593 ) ( 13,124 ) Total long-term debt 1,487,407 1,486,876 Less: Current portion — — Long-term portion $ 1,487,407 $ 1,486,876 Estimated fair value of long-term debt $ 1,312,000 $ 1,377,000 Our unsecured committed line of credit (CLOC) provides for an unsecured senior revolving credit facility in the aggregate principal amount of $ 1.5 billion, which includes a $ 175.0 million sublimit for swingline loans and a $ 50.0 million sublimit for standby letters of credit. We may request increases in the aggregate principal amount of the revolving credit facility of up to $ 500.0 million, subject to obtaining commitments from lenders and meeting certain other conditions. The CLOC will mature on June 11, 2026, unless extended pursuant to the terms of the CLOC, at which time all outstanding amounts thereunder will be due and payable. Our CLOC includes an annual facility fee, which will vary depending on our then current credit ratings. The CLOC is subject to various conditions, triggers, events or occurrences that could result in earlier termination and contains customary representations, warranties, covenants and events of default, including, without limitation: (1) a covenant requiring the Company to maintain a debt-to-EBITDA ratio, as defined by the CLOC agreement, calculated on a consolidated basis of no greater than (a) 3.50 to 1.00 as of the last day of each fiscal quarter ending on March 31, June 30, and September 30 of each year and (b) 4.50 to 1.00 as of the last day of each fiscal quarter ending on December 31 of each year; (2) a covenant requiring us to maintain an interest coverage ratio (EBITDA-to-interest expense) calculated on a consolidated basis of not less than 2.50 to 1.00 as of the last date of any fiscal quarter; and (3) covenants restricting our ability to incur certain additional debt, incur liens, merge or consolidate with other companies, sell or dispose of assets (including equity interests), liquidate or dissolve, engage in certain transactions with affiliates or enter into certain restrictive agreements. The CLOC includes provisions for an equity cure which could potentially allow us to independently cure certain defaults. Proceeds under the CLOC may be used for working capital needs or for other general corporate pu rposes. We were in compliance with these requirements as of September 30, 2022. 10 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents We had no outst anding balance under our CLOC and amounts available to borrow were limited by the debt-to-EBITDA covenant to approximately $ 1.47 billion as of September 30, 2022. NOTE 7: INCOME TAXES We file a consolidated federal income tax return in the U.S. with the Internal Revenue Service (IRS) and file tax returns in various state, local, and foreign jurisdictions. Tax returns are typically examined and either settled upon completion of the examination or through the appeals process. Our U.S. federal income tax returns for 2015, 2016, 2019 and later years remain open for examination. Our U.S. federal income tax returns for 2018, 2017, 2014 and all years prior to 2014 are closed. On October 4, 2022, the IRS notified us that it plans to audit our 2020 tax return and related carryback claims. With respect to federal, state and local jurisdictions and countries outside of the U.S., we are typically subject to examination for three to six years after the income tax returns have been filed. Although the outcome of tax audits is always uncertain, we believe that adequate amounts of tax, interest, and penalties have been provided for in the accompanying consolidated financial statements for any adjustments that might be incurred due to federal, state, local or foreign audits. We had gross unrecognized tax benefits of $ 231.7 million and $ 232.0 million as of September 30, 2022 and June 30, 2022, respectively. The gross unrecognized tax benefits decreased by $ 0.3 million during the three months ended September 30, 2022 due to settlements with state tax authorities. We believe it is reasonably possible that the balance of unrecognized tax benefits could decrease by approximately $ 33.1 million within the next twelve months. The anticipated decrease is due to the expiration of statutes of limitations and anticipated closure of various state matters currently under examination or in appeals. For such matters where a change in the balance of unrecognized tax benefits is not yet deemed reasonably possible, no estimate has been included. Our effective tax rate for continuing operations, including the effects of discrete tax items, was 24.4 % and 24.0 % for the three months ended September 30, 2022 and 2021, respectively. Consistent with prior years, our pretax loss for the three months ended September 30, 2022 is expected to be offset by income in our third and fourth quarters due to the established pattern of seasonality in our primary business operations. As such, management has determined that it is more-likely-than-not that realization of tax benefits recorded in our financial statements will occur within our fiscal year. The amount of tax benefit recorded for the three months ended September 30, 2022 reflects management’s estimate of the annual effective tax rate applied to year-to-date loss from continuing operations adjusted for the tax impact of discrete items for the periods presented. NOTE 8: COMMITMENTS AND CONTINGENCIES Assisted tax returns are covered by our 100% accuracy guarantee, whereby we will reimburse a client for penalties and interest attributable to an H&R Block error on a return. DIY tax returns are covered by our 100% accuracy guarantee, whereby we will reimburse a client up to a maximum of $ 10,000 if our software makes an arithmetic error that results in payment of penalties and/or interest to the IRS that a client would otherwise not have been required to pay. Our liability related to estimated losses under the 100% accuracy guarantee was $ 12.7 million and $ 14.0 million as of September 30, 2022 and June 30, 2022, respectively. The short-term and long-term portions of this liability are included in deferred revenue and other liabilities in the consolidated balance sheets. Liabilities related to acquisitions for (1) estimated contingent consideration based on expected financial performance of the acquired business and economic conditions at the time of acquisition and (2) estimated accrued compensation related to continued employment of key employees were $ 16.0 million and $ 12.9 million as of September 30, 2022 and June 30, 2022, respectively, with amounts recorded in deferred revenue and other liabilities. Should actual results differ from our estimates, future payments made will differ from the above estimate and any differences will be recorded in results from continuing operations. We have contractual commitments to fund certain franchises with approved revolving lines of credit. Our total obligation under these lines of credit was $ 15.3 million at September 30, 2022, and net of amounts drawn and outstanding, our remaining commitment to fund totaled $ 8.7 million. H&R Block, Inc. |Q1 FY2023 Form 10-Q 11 Table of Contents NOTE 9: LITIGATION AND OTHER RELATED CONTINGENCIES We are a defendant in numerous litigation and arbitration matters, arising both in the ordinary course of business and otherwise, including as described below. The matters described below are not all of the lawsuits or arbitrations to which we are subject. In some of the matters, very large or indeterminate amounts, including punitive damages, may be sought. U.S. jurisdictions permit considerable variation in the assertion of monetary damages or other relief. Jurisdictions may permit claimants not to specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction. In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding reasonably possible verdicts in the jurisdiction for similar matters. We believe that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value due to this variability in pleadings and our experience in handling and resolving numerous claims over an extended period of time. The outcome of a matter and the amount or range of potential loss at particular points in time may be difficult to ascertain. Among other things, uncertainties can include how fact finders will evaluate documentary evidence and the credibility and effectiveness of witness testimony, and how courts and arbitrators will apply the law. Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will view the relevant evidence and applicable law. In addition to litigation and arbitration matters, we are also subject to other loss contingencies arising out of our business activities, including as described below. We accrue liabilities for litigation, arbitration, and other related loss contingencies and any related settlements when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. If a range of loss is estimated, and some amount within that range appears to be a better estimate than any other amount within that range, then that amount is accrued. If no amount within the range can be identified as a better estimate than any other amount, we accrue the minimum amount in the range. For such matters where a loss is believed to be reasonably possible, but not probable, or the loss cannot be reasonably estimated, no accrual has been made. It is possible that such matters could require us to pay damages or make other expenditures or accrue liabilities in amounts that could not be reasonably estimated as of September 30, 2022. While the potential future liabilities could be material in the particular quarterly or annual periods in which they are recorded, based on information currently known, we do not believe any such liabilities are likely to have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows. Our total accrued liabilities were $ 1.7 million as of September 30, 2022 and June 30, 2022. Our estimate of the aggregate range of reasonably possible losses includes (1) matters where a liability has been accrued and there is a reasonably possible loss in excess of the amount accrued for that liability, and (2) matters where a liability has not been accrued but we believe a loss is reasonably possible. This aggregate range only represents those losses as to which we are currently able to estimate a reasonably possible loss or range of loss. It does not represent our maximum loss exposure. Matters for which we are not currently able to estimate the reasonably possible loss or range of loss are not included in this range. We are often unable to estimate the possible loss or range of loss until developments in such matters have provided sufficient information to support an assessment of the reasonably possible loss or range of loss, such as precise information about the amount of damages or other remedies being asserted, the defenses to the claims being asserted, discovery from other parties and investigation of factual allegations, rulings by courts or arbitrators on motions or appeals, analyses by experts, or the status or terms of any settlement negotiations. The estimated range of reasonably possible loss is based upon currently available information and is subject to significant judgment and a variety of assumptions, as well as known and unknown uncertainties. The matters underlying the estimated range will change from time to time, and actual results may vary significantly from the current estimate. As of September 30, 2022, we believe the estimate of the aggregate range of reasonably possible losses in excess of amounts accrued, where the range of loss can be estimated, is not material. 12 Q1 FY2023 Form 10-Q| H&R Block, Inc. Table of Contents At the end of each reporting period, we review relevant information with respect to litigation, arbitration and other related loss contingencies and update our accruals, disclosures, and estimates of reasonably possible loss or range of loss based on such reviews. Costs incurred with defending matters are expensed as incurred. Any receivable for insurance recoveries is recorded separately from the corresponding liability, and only if recovery is determined to be probable and reasonably estimable. We believe we have meritorious defenses to the claims asserted in the various matters described in this note, and we intend to defend them vigorously. The amounts claimed in the matters are substantial, however, and there can be no assurances as to their outcomes. In the event of unfavorable outcomes, it could require modifications to our operations; in addition, the amounts that may be required to be paid to discharge or settle the matters could be substantial and could have a material adverse impact on our business and our consolidated financial position, results of operations, and cash flows. LITIGATION, CLAIMS OR OTHER LOSS CONTINGENCIES PERTAINING TO CONTINUING OPERATIONS – Free File Litigation. On May 6, 2019, the Los Angeles City Attorney filed a lawsuit on behalf of the People of the State of California in the Superior Court of California, County of Los Angeles (Case No. 19STCV15742). The case is styled The People of the State of California v. HRB Digital LLC, et al . The complaint alleges that H&R Block, Inc. and HRB Digital LLC engaged in unfair, fraudulent and deceptive business practices and acts in connection with the IRS Free File Program in violation of the California Unfair Competition Law, California Business and Professions Code §§17200 et seq. The complaint seeks injunctive relief, restitution of monies paid to H&R Block by persons in the State of California who were eligible to file under the IRS Free File Program for the time period starting 4 years prior to the date of the filing of the complaint, pre-judgment interest, civil penalties and costs. The City Attorney subsequently dismissed H&R Block, Inc. from the case and amended its complaint to add HRB Tax Group, Inc. We filed a motion to stay the case based on the primary jurisdiction doctrine, which was denied. We filed a motion for summary judgment, which remains pending. A trial date is set for August 14, 2023. We have not concluded that a loss related to this matter is probable, nor have we accrued a liability related to this matter. We have also received and are responding to certain governmental inquiries relating to the IRS Free File Program. DISCONTINUED MORTGAGE OPERATIONS – Although SCC ceased its mortgage loan origination activities in December 2007 and sold its loan servicing business in April 2008, SCC or the Company has been and may in the future be, subject to litigation and other loss contingencies, including indemnification and contribution claims, pertaining to SCC's mortgage business activities that occurred prior to such termination and sale. Parties, including underwriters, depositors, and securitization trustees, have been, remain, or may in the future be, involved in lawsuits, threatened lawsuits, or settlements related to securitization transactions in which SCC participated. A variety of claims are alleged in these matters, including violations of federal and state securities laws and common law fraud, breaches of representations and warranties, or violations of statutory requirements. SCC has received notices of potential indemnification or contribution obligations relating to such matters. Additional lawsuits against the parties to the securitization transactions may be filed in the future, and SCC may receive additional notices of potential indemnification, contribution or similar obligations with respect to existing or new lawsuits or settlements of such lawsuits or other claims. We have not concluded that a loss related to any of these potential indemnification or contribution claims is probable, nor have we accrued a liability related to any of these claims. It is difficult to predict either the likelihood of new matters being initiated or the outcome of existing matters. In many of these matters it is not possible to estimate a reasonably possible loss or range of loss due to, among other things, the inherent uncertainties involved in these matters and the indeterminate damages sought. If the amount that SCC is ultimately required to pay with respect to loss contingencies, together with payment of SCC's related administration and legal expense, exceeds SCC's net assets, the creditors of SCC, other potential claimants, or a bankruptcy trustee if SCC were to file or be forced into bankruptcy, may attempt to assert claims against us for payment of SCC's obligations. Claimants also may attempt to assert claims against or seek payment directly from the Company even if SCC's assets exceed its liabilities. SCC's principal assets, as of September 30, 2022, total approximately $ 264 million and consist of an intercompany note receivable. We believe our legal position is strong on any potential corporate veil-piercing arguments; however, if this position is challenged and not upheld, it could H&R Block, Inc. |Q1 FY2023 Form 10-Q 13 Table of Contents have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows. OTHER – We are from time to time a party to litigation, arbitration and other loss contingencies not discussed herein arising out of our business operations. These matters may include actions by state attorneys general, other state regulators, federal regulators, individual plaintiffs, and cases in which plaintiffs seek to represent others who may be similarly situated. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay to discharge or settle these other matters will not have a material adverse impact on our business and our consolidated financial position, results of operations, and cash flows.