H&R BLOCK INC - Quarter Report: 2008 July (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C.
20549
FORM
10-Q
(Mark One) | ||
[X]
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended July 31, 2008 | ||
OR
|
||
[ ]
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission file
number 1-6089
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525101.gif)
H&R
Block, Inc.
(Exact name of registrant as
specified in its charter)
MISSOURI | 44-0607856 | |
(State or other jurisdiction
of incorporation or organization) |
(I.R.S. Employer Identification No.) |
One
H&R Block Way
Kansas
City, Missouri 64105
(Address of principal executive
offices, including zip code)
(816) 854-3000
(Registrants 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 Ö No
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in
Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated
filer Ö
|
Accelerated filer | Non-accelerated filer | Smaller Reporting company | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange Act).
Yes No Ö
The number of shares outstanding of the registrants Common
Stock, without par value, at the close of business on
July 31, 2008 was 328,088,753 shares.
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525102.gif)
Form 10-Q
for the Period Ended July 31, 2008
Table of
Contents
Page | ||||||
PART I
|
Financial Information
|
|||||
Item 1.
|
Condensed Consolidated Balance Sheets
July 31, 2008 and April 30, 2008 |
1 | ||||
Condensed Consolidated Statements of Operations and
Comprehensive Income (Loss) Three Months Ended July 31, 2008 and 2007 |
2 | |||||
Condensed Consolidated Statements of Cash Flows
Three Months Ended July 31, 2008 and 2007 |
3 | |||||
Condensed Consolidated Statement of Stockholders Equity
July 31, 2008 and 2007 |
4 | |||||
Notes to Condensed Consolidated Financial Statements
|
5 | |||||
Item 2.
|
Managements Discussion and Analysis of Financial
Condition and Results of Operations |
20 | ||||
Item 3.
|
Quantitative and Qualitative Disclosures about Market Risk
|
29 | ||||
Item 4.
|
Controls and Procedures
|
29 | ||||
PART II
|
Other Information
|
|||||
Item 1.
|
Legal Proceedings
|
30 | ||||
Item 1A.
|
Risk Factors
|
33 | ||||
Item 2.
|
Unregistered Sales of Equity Securities
|
33 | ||||
Item 6.
|
Exhibits
|
33 | ||||
SIGNATURES
|
34 | |||||
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525102.gif)
CONDENSED
CONSOLIDATED BALANCE
SHEETS (amounts
in 000s, except share and per share amounts)
July 31, 2008 | April 30, 2008 | |||||||
(Unaudited) | ||||||||
ASSETS
|
||||||||
Cash and cash equivalents
|
$ | 355,998 | $ | 726,845 | ||||
Cash and cash equivalents restricted
|
221,338 | 219,031 | ||||||
Receivables from customers, brokers, dealers and clearing
organizations, less
allowance for doubtful accounts of $2,077 and $2,119 |
401,859 | 438,899 | ||||||
Receivables, less allowance for doubtful accounts of
$123,685 and $123,849 |
383,224 | 552,871 | ||||||
Prepaid expenses and other current assets
|
438,872 | 443,934 | ||||||
Total current assets
|
1,801,291 | 2,381,580 | ||||||
Mortgage loans held for investment, less allowance for
loan losses of $46,853 and $45,401 |
868,603 | 966,301 | ||||||
Property and equipment, at cost, less accumulated depreciation
and
amortization of $677,357 and $670,008 |
380,804 | 380,738 | ||||||
Intangible assets, net
|
142,533 | 147,368 | ||||||
Goodwill
|
1,006,207 | 1,005,268 | ||||||
Other assets
|
704,044 | 742,170 | ||||||
Total assets
|
$ | 4,903,482 | $ | 5,623,425 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY
|
||||||||
Liabilities:
|
||||||||
Short-term borrowings
|
$ | | $ | 25,000 | ||||
Customer banking deposits
|
777,080 | 785,624 | ||||||
Accounts payable to customers, brokers and dealers
|
592,688 | 559,658 | ||||||
Accounts payable, accrued expenses and other current liabilities
|
665,973 | 782,280 | ||||||
Accrued salaries, wages and payroll taxes
|
142,690 | 393,148 | ||||||
Accrued income taxes
|
263,784 | 439,380 | ||||||
Current portion of long-term debt
|
108,839 | 111,286 | ||||||
Total current liabilities
|
2,551,054 | 3,096,376 | ||||||
Long-term debt
|
1,034,117 | 1,031,784 | ||||||
Other noncurrent liabilities
|
481,589 | 507,447 | ||||||
Total liabilities
|
4,066,760 | 4,635,607 | ||||||
Commitments and contingencies
|
||||||||
Stockholders equity:
|
||||||||
Common stock, no par, stated value $.01 per share,
800,000,000 shares authorized, 435,890,796 shares issued at July 31, 2008 and April 30, 2008 |
4,359 | 4,359 | ||||||
Additional paid-in capital
|
686,802 | 695,959 | ||||||
Accumulated other comprehensive income
|
833 | 2,486 | ||||||
Retained earnings
|
2,204,940 | 2,384,449 | ||||||
Less treasury shares, at cost
|
(2,060,212 | ) | (2,099,435 | ) | ||||
Total stockholders equity
|
836,722 | 987,818 | ||||||
Total liabilities and stockholders equity
|
$ | 4,903,482 | $ | 5,623,425 | ||||
See Notes to
Condensed Consolidated Financial Statements
1
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525102.gif)
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) |
(unaudited,
amounts in 000s, except per share amounts) |
Three Months
Ended |
||||||||
July 31, | ||||||||
2008 | 2007 | |||||||
Revenues:
|
||||||||
Service revenues
|
$ | 301,521 | $ | 325,090 | ||||
Other revenues:
|
||||||||
Interest income
|
25,238 | 41,838 | ||||||
Product and other revenues
|
12,879 | 14,281 | ||||||
339,638 | 381,209 | |||||||
Operating expenses:
|
||||||||
Cost of services
|
369,606 | 385,115 | ||||||
Cost of other revenues
|
42,823 | 43,529 | ||||||
Selling, general and administrative
|
140,470 | 144,109 | ||||||
552,899 | 572,753 | |||||||
Operating loss
|
(213,261 | ) | (191,544 | ) | ||||
Other income (expense), net
|
(1,355 | ) | 7,964 | |||||
Loss from continuing operations before tax benefit
|
(214,616 | ) | (183,580 | ) | ||||
Income tax benefit
|
(85,247 | ) | (73,757 | ) | ||||
Net loss from continuing operations
|
(129,369 | ) | (109,823 | ) | ||||
Net loss from discontinued operations
|
(3,350 | ) | (192,757 | ) | ||||
Net loss
|
$ | (132,719 | ) | $ | (302,580 | ) | ||
Basic and diluted loss per share:
|
||||||||
Net loss from continuing operations
|
$ | (0.40 | ) | $ | (0.34 | ) | ||
Net loss from discontinued operations
|
(0.01 | ) | (0.59 | ) | ||||
Net loss
|
$ | (0.41 | ) | $ | (0.93 | ) | ||
Basic and diluted shares
|
327,141 | 323,864 | ||||||
Dividends per share
|
$ | 0.143 | $ | 0.136 | ||||
Comprehensive income (loss):
|
||||||||
Net loss
|
$ | (132,719 | ) | $ | (302,580 | ) | ||
Change in unrealized gain on
available-for-sale
securities, net
|
(1,967 | ) | (463 | ) | ||||
Change in foreign currency translation adjustments
|
314 | 4,311 | ||||||
Comprehensive loss
|
$ | (134,372 | ) | $ | (298,732 | ) | ||
See Notes to
Condensed Consolidated Financial Statements
2
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525102.gif)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS | (unaudited, amounts in 000s) |
Three Months Ended July 31, | 2008 | 2007 | ||||||
Cash flows from operating activities:
|
||||||||
Net loss
|
$ | (132,719 | ) | $ | (302,580 | ) | ||
Adjustments to reconcile net loss to net cash used in operating
activities:
|
||||||||
Depreciation and amortization
|
29,556 | 37,075 | ||||||
Stock-based compensation
|
5,487 | 7,398 | ||||||
Operating cash flows of discontinued operations
|
- | 212,323 | ||||||
Other, net of business acquisitions
|
(218,660 | ) | (289,562 | ) | ||||
Net cash used in operating activities
|
(316,336 | ) | (335,346 | ) | ||||
Cash flows from investing activities:
|
||||||||
Principal repayments on mortgage loans held for investment, net
|
31,619 | 14,327 | ||||||
Purchases of property and equipment, net
|
(16,189 | ) | (14,497 | ) | ||||
Payments made for business acquisitions, net of cash acquired
|
(2,251 | ) | (20,887 | ) | ||||
Net cash provided by investing activities of discontinued
operations
|
- | 3,068 | ||||||
Other, net
|
2,891 | 6,699 | ||||||
Net cash provided by (used in) investing activities
|
16,070 | (11,290 | ) | |||||
Cash flows from financing activities:
|
||||||||
Repayments of commercial paper
|
- | (3,463,719 | ) | |||||
Proceeds from issuance of commercial paper
|
- | 3,622,874 | ||||||
Repayments of other short-term borrowings
|
(40,000 | ) | (560,000 | ) | ||||
Proceeds from other short-term borrowings
|
15,000 | 485,000 | ||||||
Customer deposits, net
|
(8,795 | ) | (90,378 | ) | ||||
Dividends paid
|
(46,790 | ) | (43,937 | ) | ||||
Acquisition of treasury shares
|
(4,116 | ) | (5,372 | ) | ||||
Proceeds from exercise of stock options
|
20,520 | 9,788 | ||||||
Net cash used in financing activities of discontinued operations
|
- | (47,535 | ) | |||||
Other, net
|
(6,400 | ) | (44,252 | ) | ||||
Net cash used in financing activities
|
(70,581 | ) | (137,531 | ) | ||||
Net decrease in cash and cash equivalents
|
(370,847 | ) | (484,167 | ) | ||||
Cash and cash equivalents at beginning of the period
|
726,845 | 921,838 | ||||||
Cash and cash equivalents at end of the period
|
$ | 355,998 | $ | 437,671 | ||||
Supplementary cash flow data:
|
||||||||
Income taxes paid, net of refunds received of $1,198 and $1,867
|
$ | 83,111 | $ | 9,653 | ||||
Interest paid on borrowings
|
27,258 | 27,833 | ||||||
Interest paid on deposits
|
4,048 | 15,792 |
See Notes to
Condensed Consolidated Financial Statements
3
![(H and R BLOCK LOGO)](https://www.sec.gov/Archives/edgar/data/0000012659/000095013708011375/c35251c3525102.gif)
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY |
(unaudited,
amounts in 000s, except per share amounts) |
Accumulated |
||||||||||||||||||||||||||||||||||||||||
Convertible |
Additional |
Other |
||||||||||||||||||||||||||||||||||||||
Common Stock | Preferred Stock |
Paid-in |
Comprehensive |
Retained |
Treasury Stock |
Total |
||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Capital | Income (Loss) | Earnings | Shares | Amount | Equity | |||||||||||||||||||||||||||||||
Balances at April 30, 2007
|
435,891 | $ | 4,359 | - | $ | - | $ | 676,766 | $ | (1,320 | ) | $ | 2,886,440 | (112,672 | ) | $ | (2,151,746 | ) | $ | 1,414,499 | ||||||||||||||||||||
Remeasurement of uncertain tax positions upon adoption of
FIN 48
|
- | - | - | - | - | - | (9,716 | ) | - | - | (9,716 | ) | ||||||||||||||||||||||||||||
Net loss
|
- | - | - | - | - | - | (302,580 | ) | - | - | (302,580 | ) | ||||||||||||||||||||||||||||
Unrealized translation gain (loss)
|
- | - | - | - | - | 4,311 | - | - | - | 4,311 | ||||||||||||||||||||||||||||||
Change in net unrealized gain on
available-for-sale
securities
|
- | - | - | - | - | (463 | ) | - | - | - | (463 | ) | ||||||||||||||||||||||||||||
Stock-based compensation
|
- | - | - | - | 9,226 | - | - | - | - | 9,226 | ||||||||||||||||||||||||||||||
Shares issued for:
|
||||||||||||||||||||||||||||||||||||||||
Option exercises
|
- | - | - | - | (1,431 | ) | - | - | 668 | 12,758 | 11,327 | |||||||||||||||||||||||||||||
Nonvested shares
|
- | - | - | - | (13,349 | ) | - | - | 663 | 12,669 | (680 | ) | ||||||||||||||||||||||||||||
ESPP
|
- | - | - | - | 400 | - | - | 218 | 4,161 | 4,561 | ||||||||||||||||||||||||||||||
Acquisitions
|
- | - | - | - | 35 | - | - | 8 | 151 | 186 | ||||||||||||||||||||||||||||||
Acquisition of treasury shares
|
- | - | - | - | - | - | - | (230 | ) | (5,372 | ) | (5,372 | ) | |||||||||||||||||||||||||||
Cash dividends paid $0.14 per share
|
- | - | - | - | - | - | (43,937 | ) | - | - | (43,937 | ) | ||||||||||||||||||||||||||||
Balances at July 31, 2007
|
435,891 | $ | 4,359 | - | $ | - | $ | 671,647 | $ | 2,528 | $ | 2,530,207 | (111,345 | ) | $ | (2,127,379 | ) | $ | 1,081,362 | |||||||||||||||||||||
Balances at April 30, 2008
|
435,891 | $ | 4,359 | - | $ | - | $ | 695,959 | $ | 2,486 | $ | 2,384,449 | (109,880 | ) | $ | (2,099,435 | ) | $ | 987,818 | |||||||||||||||||||||
Net loss
|
- | - | - | - | - | - | (132,719 | ) | - | - | (132,719 | ) | ||||||||||||||||||||||||||||
Unrealized translation gain
|
- | - | - | - | - | 314 | - | - | - | 314 | ||||||||||||||||||||||||||||||
Change in net unrealized gain (loss) on
available-for-sale
securities
|
- | - | - | - | - | (1,967 | ) | - | - | - | (1,967 | ) | ||||||||||||||||||||||||||||
Stock-based compensation
|
- | - | - | - | 5,487 | - | - | - | - | 5,487 | ||||||||||||||||||||||||||||||
Shares issued for:
|
||||||||||||||||||||||||||||||||||||||||
Option exercises
|
- | - | - | - | (3,760 | ) | - | - | 1,557 | 29,759 | 25,999 | |||||||||||||||||||||||||||||
Nonvested shares
|
- | - | - | - | (10,456 | ) | - | - | 510 | 9,749 | (707 | ) | ||||||||||||||||||||||||||||
ESPP
|
- | - | - | - | (453 | ) | - | - | 192 | 3,668 | 3,215 | |||||||||||||||||||||||||||||
Acquisitions
|
- | - | - | - | 25 | - | - | 9 | 163 | 188 | ||||||||||||||||||||||||||||||
Acquisition of treasury shares
|
- | - | - | - | - | - | - | (190 | ) | (4,116 | ) | (4,116 | ) | |||||||||||||||||||||||||||
Cash dividends paid $0.14 per share
|
- | - | - | - | - | - | (46,790 | ) | - | - | (46,790 | ) | ||||||||||||||||||||||||||||
Balances at July 31, 2008
|
435,891 | $ | 4,359 | - | $ | - | $ | 686,802 | $ | 833 | $ | 2,204,940 | (107,802 | ) | $ | (2,060,212 | ) | $ | 836,722 | |||||||||||||||||||||
See Notes to
Condensed Consolidated Financial Statements
4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS | (unaudited) |
1. | Basis of Presentation |
The condensed consolidated balance sheet as of July 31,
2008, the condensed consolidated statements of operations and
comprehensive income (loss) for the three months ended
July 31, 2008 and 2007, the condensed consolidated
statements of cash flows for the three months ended
July 31, 2008 and 2007, and the condensed consolidated
statement of stockholders equity for the three months
ended July 31, 2008 and 2007 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, cash flows and changes in stockholders equity
at July 31, 2008 and for all periods presented have been
made. The preparation of financial statements in conformity with
U.S. generally accepted accounting principles 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. Actual results could differ from
those estimates.
H&R Block, the Company,
we, our and us are used
interchangeably to refer to H&R Block, Inc. or to H&R
Block, Inc. and its subsidiaries, as appropriate to the context.
Certain reclassifications have been made to prior year amounts
to conform to the current year presentation. These
reclassifications had no effect on our results of operations or
stockholders equity as previously reported.
Certain information and footnote disclosures normally included
in financial statements prepared in accordance with
U.S. generally accepted accounting principles have been
condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the financial
statements and notes thereto included in our April 30, 2008
Annual Report to Shareholders on
Form 10-K.
All amounts presented herein as of April 30, 2008 or for
the year then ended, are derived from our April 30, 2008
Annual Report to Shareholders on
Form 10-K.
Operating revenues of the Tax Services and Business Services
segments 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.
2. | Earnings (Loss) Per Share |
Basic and diluted loss per share is computed using the weighted
average shares outstanding during each period. The dilutive
effect of potential common shares is included in diluted
earnings per share except in those periods with a loss from
continuing operations. Diluted earnings per share excludes the
impact of shares of common stock issuable upon the lapse of
certain restrictions or the exercise of options to purchase
25.7 million shares and 31.3 million shares for the
three months ended July 31, 2008 and 2007, respectively, as
the effect would be antidilutive due to the net loss from
continuing operations during each period.
The weighted average shares outstanding for the three months
ended July 31, 2008 increased to 327.1 million from
323.9 million at July 31, 2007, primarily due the
issuance of treasury shares related to our stock-based
compensation plans.
During the three months ended July 31, 2008 and 2007, we
issued 2.3 million and 1.6 million shares of common
stock, respectively, due to the exercise of stock options,
employee stock purchases and awards of nonvested shares.
During the three months ended July 31, 2008, we acquired
0.2 million shares of our common stock, which represent
shares swapped or surrendered to us in connection with the
vesting of nonvested shares and the exercise of stock options,
at an aggregate cost of $4.1 million. During the three
months ended July 31, 2007, we acquired 0.2 million
shares of our common stock, which represent shares swapped or
surrendered to us in connection with the vesting of nonvested
shares and the exercise of stock options, at an aggregate cost
of $5.4 million.
During the three months ended July 31, 2008, we granted
4.1 million stock options and 0.9 million nonvested
shares and units in accordance with our stock-based compensation
plans. The weighted average fair value of options granted was
$3.70 for manager options and $2.83 for options granted to our
5
seasonal associates. At July 31, 2008, the total
unrecognized compensation cost for options and nonvested shares
and units was $19.0 million and $34.1 million,
respectively.
3. | Goodwill and Intangible Assets |
Changes in the carrying amount of goodwill for the three months
ended July 31, 2008 consist of the following:
(in
000s)
April 30, 2008 | Additions | Other | July 31, 2008 | |||||||||||||
Tax Services
|
$ | 431,981 | $ | 2,350 | $ | (915 | ) | $ | 433,416 | |||||||
Business Services
|
399,333 | - | (496 | ) | 398,837 | |||||||||||
Consumer Financial Services
|
173,954 | - | - | 173,954 | ||||||||||||
Total
|
$ | 1,005,268 | $ | 2,350 | $ | (1,411 | ) | $ | 1,006,207 | |||||||
We test goodwill for impairment annually at the beginning of our
fourth quarter, or more frequently if events occur indicating it
is more likely than not the fair value of a reporting
units net assets has been reduced below its carrying
value. No impairments of goodwill were identified within any of
our operating segments during the three months ended
July 31, 2008.
Intangible assets consist of the following:
(in 000s) | ||||||||||||||||||||||||
July 31, 2008 | April 30, 2008 | |||||||||||||||||||||||
Gross |
Gross |
|||||||||||||||||||||||
Carrying |
Accumulated |
Carrying |
Accumulated |
|||||||||||||||||||||
Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||
Tax Services:
|
||||||||||||||||||||||||
Customer relationships
|
$ | 46,465 | $ | (23,315 | ) | $ | 23,150 | $ | 46,479 | $ | (22,007 | ) | $ | 24,472 | ||||||||||
Noncompete agreements
|
22,966 | (20,329 | ) | 2,637 | 22,966 | (19,981 | ) | 2,985 | ||||||||||||||||
Purchased technology
|
12,500 | (2,773 | ) | 9,727 | 12,500 | (2,283 | ) | 10,217 | ||||||||||||||||
Trade name
|
1,025 | (142 | ) | 883 | 1,025 | (117 | ) | 908 | ||||||||||||||||
Business Services:
|
||||||||||||||||||||||||
Customer relationships
|
144,031 | (103,143 | ) | 40,888 | 143,402 | (100,346 | ) | 43,056 | ||||||||||||||||
Noncompete agreements
|
32,442 | (18,193 | ) | 14,249 | 32,303 | (17,589 | ) | 14,714 | ||||||||||||||||
Trade name amortizing
|
3,290 | (3,060 | ) | 230 | 3,290 | (3,043 | ) | 247 | ||||||||||||||||
Trade name
non-amortizing
|
55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | ||||||||||||||||
Consumer Financial Services:
|
||||||||||||||||||||||||
Customer relationships
|
- | - | - | 293,000 | (293,000 | ) | - | |||||||||||||||||
$ | 318,356 | $ | (175,823 | ) | $ | 142,533 | $ | 610,602 | $ | (463,234 | ) | $ | 147,368 | |||||||||||
Amortization of intangible assets for the three months ended
July 31, 2008 and 2007 was $5.6 million and
$15.5 million, respectively. Estimated amortization of
intangible assets for fiscal years 2009 through 2013 is
$22.8 million, $20.2 million, $18.4 million,
$15.7 million and $11.7 million, respectively.
4. | Income Taxes |
We file a consolidated federal income tax return in the United
States and file tax returns in various state and foreign
jurisdictions. The consolidated tax returns for the years
1999 2005 are currently under examination by the
Internal Revenue Service (IRS). Tax years prior to 1999 are
closed by statute. Historically, tax returns in various foreign
and state jurisdictions are examined and settled upon completion
of the exam.
During the three months ended July 31, 2008, we accrued an
additional $2.9 million of interest & penalties
related to our uncertain tax positions. We had unrecognized tax
benefits of $137.2 million and $137.6 million at
July 31, 2008 and April 30, 2008, respectively. There
were no significant changes in our unrealized tax positions
during the quarter. We have classified the liability for
unrecognized tax benefits, including corresponding accrued
interest, as long-term at July 31, 2008, which is included
in other noncurrent liabilities on the condensed consolidated
balance sheet. Amounts that we expect to pay, or for which
statutes expire, within the next twelve months have been
included in accounts payable, accrued expenses and other current
liabilities on the condensed consolidated balance sheet.
6
Based upon the expiration of statutes of limitations, payments
of tax and other factors in several jurisdictions, we believe it
is reasonably possible that the total amount of previously
unrecognized tax benefits may decrease by approximately $9 to
$10 million within twelve months of July 31, 2008.
5. | Interest Income and Expense |
The following table shows the components of interest income and
expense of our continuing operations. Operating interest expense
is included in cost of other revenues, and interest expense on
acquisition debt is included in other income, net on our
consolidated statements of operations.
(in
000s)
Three Months Ended July 31, | 2008 | 2007 | ||||||||
Interest income:
|
||||||||||
Mortgage loans, net
|
$ | 13,265 | $ | 22,491 | ||||||
Margin receivables
|
5,025 | 7,437 | ||||||||
Other
|
6,948 | 11,910 | ||||||||
25,238 | 41,838 | |||||||||
Operating interest expense:
|
||||||||||
Borrowings
|
18,430 | 12,360 | ||||||||
Deposits
|
4,043 | 14,243 | ||||||||
Federal Home Loan Bank (FHLB) advances
|
1,328 | 1,890 | ||||||||
23,801 | 28,493 | |||||||||
Interest expense acquisition debt
|
413 | 595 | ||||||||
Net interest income
|
$ | 1,024 | $ | 12,750 | ||||||
6. | Fair Value |
On May 1, 2008, we adopted Statement of Financial
Accounting Standards No. 157, Fair Value
Measurements (SFAS 157). SFAS 157 defines fair
value, establishes a framework for measuring fair value and
expands disclosure requirements for fair value measurements. We
elected to defer the application of SFAS 157 for
nonfinancial assets and nonfinancial liabilities until fiscal
year 2010, as provided for by FASB Staff Position
FAS 157-2,
Effective Date of FASB Statement No. 157
(FSP 157-2).
The adoption of SFAS 157 did not have an impact on our
consolidated results of operations or financial position.
Fair Value Hierarchy
SFAS 157 establishes a fair value hierarchy that
prioritizes the inputs used to measure fair value into three
broad levels, considering the relative reliability of the
inputs, as follows:
n | Level 1 Quoted prices in active markets for identical assets or liabilities. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. | |
n | Level 2 Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market. | |
n | Level 3 Valuation is modeled using significant inputs that are unobservable in the market. These unobservable inputs reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. |
Estimation of Fair
Value
The following is a description of the valuation methodologies
used for assets and liabilities measured at fair value and the
general classification of these instruments pursuant to the fair
value hierarchy.
n | Trading and available-for-sale securities Trading and available-for-sale securities are carried at fair value on a recurring basis. When available, fair value is based on quoted prices in an active market and as such, would be classified as Level 1. If quoted market prices are not available, fair values are estimated using quoted prices of securities with similar characteristics, discounted cash flows or other pricing models. Trading and available- for-sale securities that we classify as Level 2 include certain agency and non-agency mortgage-backed securities, U.S. states and political subdivisions debt securities and other debt and equity securities. |
7
n | Mortgage loans held for sale The fair values of loans held for sale are generally based on observable market prices of securities that have loan collateral or interests in loans that are similar to the held-for-sale loans or whole loan sale prices if formally committed. These loans are classified as Level 2. | |
n | Residual interests in securitizations Determination of the fair value of residual interests in securitizations requires the use of unobservable inputs. We value these securities using a discounted cash flow approach that incorporates expectations of prepayment speeds and expectations of delinquencies and losses. Risk-adjusted discount rates are based on quotes from third party sources. These assets are classified as Level 3. |
Assets and
Liabilities Measured at Fair Value on a Recurring Basis
The following table presents for each hierarchy level the assets
that are measured at fair value on a recurring basis at
July 31, 2008:
(dollars
in 000s)
Total | Level 1 | Level 2 | Level 3 | |||||||||||||
Trading securities
|
$ | 11,664 | $ | 1,542 | $ | 10,122 | $ | - | ||||||||
Available-for-sale
securities
|
52,438 | 4,994 | 47,444 | - | ||||||||||||
Mortgage loans held for sale
|
8,804 | - | 8,804 | - | ||||||||||||
Residual interests in securitizations
|
8,466 | - | - | 8,466 | ||||||||||||
$ | 81,372 | $ | 6,536 | $ | 66,370 | $ | 8,466 | |||||||||
As a percentage of total assets
|
1.7% | 0.1% | 1.4% | 0.2% | ||||||||||||
The following table presents changes in Level 3 assets
measured at fair value on a recurring basis for the three months
ended July 31, 2008:
(in 000s) | ||||||
Fair value, beginning of period
|
$ | 16,678 | ||||
Losses:
|
||||||
Included in earnings
|
(4,953 | ) | ||||
Included in other comprehensive income (loss)
|
(2,320 | ) | ||||
Cash received
|
(939 | ) | ||||
Fair value, end of period
|
$ | 8,466 | ||||
Trading securities and mortgage loans held for sale are included
in prepaid expenses and other current assets, and
available-for-sale
securities and residual interests in securitizations are
included in other assets on our condensed consolidated balance
sheets.
Fair Value Option
We adopted Statement of Financial Accounting Standards
No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities (SFAS 159) on
May 1, 2008. SFAS 159 permits an instrument by
instrument irrevocable election to account for selected
financial assets and financial liabilities at fair value. We did
not elect to apply the fair value option to any eligible
financial assets or financial liabilities on May 1, 2008 or
during the three months ended July 31, 2008. Subsequent to
the initial adoption, we may elect to account for selected
financial assets and financial liabilities at fair value. Such
an election could be made at the time an eligible financial
asset, financial liability or firm commitment is recognized or
when certain specified reconsideration events occur.
7. | Regulatory Requirements |
Registered
Broker-Dealer
H&R Block Financial Advisors, Inc. (HRBFA) is subject to
regulatory requirements intended to ensure the general financial
soundness and liquidity of broker-dealers. At July 31,
2008, HRBFAs net capital of $60.4 million, which was
14.4% of aggregate debit items, exceeded its minimum required
net capital of $8.4 million by $52.0 million.
HRBFA had pledged customer-owned securities with a fair value of
$48.5 million at July 31, 2008 with a clearing
organization to satisfy margin deposit requirements of
$40.4 million.
8
Banking
H&R Block Bank (HRB Bank) and the Company are subject to
various regulatory capital guidelines and requirements
administered by federal banking agencies. Failure to meet
minimum capital requirements can trigger certain mandatory and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on HRB Bank and
our consolidated financial statements. All savings associations
are subject to the capital adequacy guidelines and the
regulatory framework for prompt corrective action. HRB Bank must
meet specific capital guidelines that involve quantitative
measures of HRB Banks assets, liabilities and certain
off-balance sheet items, as calculated under regulatory
accounting practices. HRB Banks capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
HRB Bank files its regulatory Thrift Financial Report (TFR) on a
calendar quarter basis.
Quantitative measures established by regulation to ensure
capital adequacy require HRB Bank to maintain minimum amounts
and ratios of tangible equity, total risk-based capital and
Tier 1 capital, as set forth in the table below. In
addition to these minimum ratio requirements, HRB Bank is
required to continually maintain a 12.0% minimum leverage ratio
as a condition of its charter-approval order through fiscal year
2009. This condition was extended through fiscal year 2012 as a
result of a Supervisory Directive issued on May 29, 2007.
As of July 31, 2008, HRB Banks leverage ratio was
12.3%.
As of June 30, 2008, our most recent TFR filing with the
Office of Thrift Supervision (OTS), HRB Bank was a well
capitalized institution under the prompt corrective action
provisions of the Federal Deposit Insurance Corporation (FDIC).
The five capital categories are: (1) well
capitalized (total risk-based capital ratio of 10%,
Tier 1 Risk-based capital ratio of 6% and leverage ratio of
5%); (2) adequately capitalized
(3) undercapitalized
(4) significantly undercapitalized and
(5) critically undercapitalized. There are no
conditions or events since June 30, 2008 that management
believes have changed HRB Banks category.
The following table sets forth HRB Banks regulatory
capital requirements at June 30, 2008, as calculated in the
most recently filed TFR:
(dollars in 000s) | ||||||||||||||||||||||||
To Be Well |
||||||||||||||||||||||||
Capitalized |
||||||||||||||||||||||||
For Capital Adequacy
|
Under Prompt |
|||||||||||||||||||||||
Actual | Purposes | Corrective Action Provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
Total risk-based capital
ratio(1)
|
$ | 147,747 | 23.4% | $ | 50,557 | 8.0% | $ | 63,197 | 10.0% | |||||||||||||||
Tier 1 risk-based capital
ratio(2)
|
$ | 139,558 | 22.1% | n/a | n/a | $ | 37,918 | 6.0% | ||||||||||||||||
Tier 1 capital ratio
(leverage)(3)
|
$ | 139,558 | 13.1% | $ | 128,177 | 12.0% | $ | 53,407 | 5.0% | |||||||||||||||
Tangible equity
ratio(4)
|
$ | 139,558 | 13.1% | $ | 16,022 | 1.5% | n/a | n/a | ||||||||||||||||
(1) | Total risk-based capital divided by risk-weighted assets. | |
(2) | Tier 1 (core) capital less deduction for low-level recourse and residual interest divided by risk-weighted assets. | |
(3) | Tier 1 (core) capital divided by adjusted total assets. | |
(4) | Tangible capital divided by tangible assets. |
8. | Commitments and Contingencies |
Changes in the deferred revenue liability related to our Peace
of Mind (POM) program, the current portion of which is included
in accounts payable, accrued expenses and other current
liabilities and the long-term portion of which is included in
other noncurrent liabilities in the condensed consolidated
balance sheets, are as follows:
(in 000s) | ||||||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||||
Balance, beginning of period
|
$ | 140,583 | $ | 142,173 | ||||||
Amounts deferred for new guarantees issued
|
513 | 470 | ||||||||
Revenue recognized on previous deferrals
|
(27,241 | ) | (27,237 | ) | ||||||
Balance, end of period
|
$ | 113,855 | $ | 115,406 | ||||||
9
The following table summarizes certain of our other contractual
obligations and commitments:
(in 000s) | ||||||||||
As of | July 31, 2008 | April 30, 2008 | ||||||||
Commitment to fund Franchise Equity
Lines of Credit |
$ | 78,915 | $ | 79,134 | ||||||
Contingent business acquisition obligations
|
24,214 | 24,288 | ||||||||
Media advertising purchase obligation
|
19,043 | 19,043 | ||||||||
We routinely enter into contracts that include embedded
indemnifications that have characteristics similar to
guarantees. Other guarantees and indemnifications of the Company
and its subsidiaries include obligations to protect
counterparties from losses arising from the following:
(1) tax, legal and other risks related to the purchase or
disposition of businesses; (2) penalties and interest
assessed by federal and state taxing authorities in connection
with tax returns prepared for clients; (3) indemnification
of our directors and officers; and (4) third-party claims
relating to various arrangements in the normal course of
business. Typically, there is no stated maximum payment related
to these indemnifications, and the terms of the indemnities may
vary and in many cases is limited only by the applicable statute
of limitations. The likelihood of any claims being asserted
against us and the ultimate liability related to any such
claims, if any, is difficult to predict. While we cannot provide
assurance we will ultimately prevail in the event any such
claims are asserted, we believe the fair value of these
guarantees and indemnifications is not material as of
July 31, 2008.
Mortgage Loan
Repurchase Liability
Sand Canyon Corporation (SCC), formerly Option One Mortgage
Corporation, maintains recourse with respect to loans previously
sold or securitized under indemnification of loss provisions
relating to breach of representations and warranties made to
purchasers or insurers. As a result, SCC may be required to
repurchase loans or otherwise indemnify third-parties for
losses. These representations and warranties and corresponding
repurchase obligations generally are not subject to stated
limits or a stated term and, therefore, may continue for the
foreseeable future. SCC has established a liability related to
potential losses under these indemnifications and monitors the
adequacy of the repurchase liability on an ongoing basis. To the
extent that future claim volumes differ from current estimates,
or the value of mortgage loans and residential home prices
change, future losses may be different than these estimates and
those differences may be significant. The following table
summarizes SCCs loan repurchase activity:
(in 000s) | ||||||||||||||
Three Months Ended |
Year Ended |
|||||||||||||
July 31, 2008 | July 31, 2007 | April 30, 2008 | ||||||||||||
Loan repurchase liability at end of period
|
$ | 238,123 | $ | 72,199 | $ | 243,066 | ||||||||
Loans repurchased and indemnification payments during the period
|
6,913 | 193,640 | 515,370 | |||||||||||
Repurchase reserves added during the period
|
- | 157,296 | 582,373 | |||||||||||
9. | Litigation and Related Contingencies |
We are party to investigations, legal claims and lawsuits
arising out of our business operations. We accrue our best
estimate of the probable loss upon resolution of investigations,
legal claims and lawsuits, which totaled $10.5 million and
$11.5 million at July 31, 2008 and April 30,
2008, respectively. With respect to most of the matters
described below, we have concluded that a loss is not probable
and therefore no liability has been recorded.
RAL Litigation
We have been named as a defendant in numerous lawsuits
throughout the country regarding our refund anticipation loan
programs (collectively, RAL Cases). The RAL Cases
have involved a variety of legal theories asserted by
plaintiffs. These theories include allegations that, among other
things: disclosures in the RAL applications were inadequate,
misleading and untimely; the RAL interest rates were usurious
and unconscionable; we did not disclose that we would receive
part of the finance charges paid by the
10
customer for such loans; untrue, misleading or deceptive
statements in marketing RALs; breach of state laws on credit
service organizations; breach of contract, unjust enrichment,
unfair and deceptive acts or practices; violations of the
federal Racketeer Influenced and Corrupt Organizations Act;
violations of the federal Fair Debt Collection Practices Act and
unfair competition regarding debt collection activities; and
that we owe, and breached, a fiduciary duty to our customers in
connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial
in some instances, with one settlement resulting in a pretax
expense of $43.5 million in fiscal year 2003 (the
Texas RAL Settlement) and other settlements
resulting in a combined pretax expense in fiscal year 2006 of
$70.2 million.
We believe we have meritorious defenses to the remaining RAL
Cases and we intend to defend them vigorously. There can be no
assurances, however, as to the outcome of the pending RAL Cases
individually or in the aggregate or regarding the impact of the
RAL Cases on our financial statements. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of the currently pending RAL
Cases. There were no significant developments regarding the RAL
Cases during the three months ended July 31, 2008.
Peace of Mind
Litigation
We are defendants in lawsuits regarding our Peace of Mind
program (collectively, the POM Cases). The POM Cases
are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services,
Inc., et al., Case
No. 08-CV-591
in the U.S. District Court for the Southern District of
Illinois, is a class action case originally filed in the Circuit
Court of Madison County, Illinois on January 18, 2002, in
which class certification was granted on August 27, 2003.
Plaintiffs claims consist of five counts relating to the
POM program under which the applicable tax return preparation
subsidiary assumes liability for additional tax assessments
attributable to tax return preparation error. The plaintiffs
allege that the sale of POM guarantees constitutes
(1) statutory fraud by selling insurance without a license,
(2) an unfair trade practice, by omission and by
cramming (i.e., charging customers for the guarantee
even though they did not request it or want it), and (3) a
breach of fiduciary duty. In August 2003, the court certified
the plaintiff classes consisting of all persons who from
January 1, 1997 to final judgment (1) were charged a
separate fee for POM by H&R Block or a
defendant H&R Block class member; (2) reside in
certain class states and were charged a separate fee for POM by
H&R Block or a defendant H&R Block class
member not licensed to sell insurance; and (3) had an
unsolicited charge for POM posted to their bills by
H&R Block or a defendant H&R Block class
member. Persons who received the POM guarantee through an
H&R Block Premium office and persons who reside in Alabama
and Texas were excluded from the plaintiff class. The court also
certified a defendant class consisting of any entity with names
that include H&R Block or HRB, or
are otherwise affiliated or associated with H&R Block Tax
Services, Inc., and that sold or sells the POM product. On
August 5, 2008, the court decertified the defendant class
and reduced the geographical scope of the plaintiff classes from
48 states to 13 states. On August 19, 2008, we
removed the case from state court in Madison County, Illinois to
the U.S. District Court for the Southern District of
Illinois. No trial date has been set.
There is one other putative class action pending against us in
Texas that involves the POM guarantee. This case is pending
before the same judge that presided over the Texas RAL
Settlement, involves the same plaintiffs attorneys that
are involved in the Marshall litigation in Illinois, and
contains similar allegations. No class has been certified in
this case.
We believe the claims in the POM Cases are without merit, and we
intend to defend them vigorously. The amounts claimed in the POM
Cases are substantial, however, and there can be no assurances
as to the outcome of these pending actions individually or in
the aggregate. We are unable to determine an estimate of the
possible loss or range of loss, if any, in light of the early
stages of the POM Cases.
Electronic Filing
Litigation
We are a defendant in a class action filed on August 30,
2002 and entitled Erin M. McNulty and
Brian J. Erzar v. H&R Block, Inc., et
al., Case
No. 02-CIV-4654
in the Court of Common Pleas of Lackawanna County, Pennsylvania,
in which the plaintiffs allege that the defendants deceptively
portray electronic filing fees as a necessary and required
component of standard tax preparation services and do not inform
tax preparation clients that they may (1) file tax returns
free of charge by mailing the returns, (2) electronically
file tax returns from personal computers either free of charge
or at significantly lower
11
fees and (3) be eligible to electronically file tax returns
free of charge via telephone. The plaintiffs seek unspecified
damages and disgorgement of all electronic filing, tax
preparation and related fees collected during the applicable
class period. Class certification was granted in this case on
September 5, 2007. In March 2008, we reached a tentative
agreement to settle this case for an amount not to exceed
$2.5 million and have accrued $1.5 million,
representing our best estimate of ultimate loss. The settlement
was preliminarily approved on June 27, 2008, with a final
fairness hearing scheduled for September 2008.
Express IRA
Litigation
On March 15, 2006, the New York Attorney General filed a
lawsuit in the Supreme Court of the State of New York, County of
New York (Index No. 06/401110) entitled The People of
New York v. H&R Block, Inc. and H&R Block
Financial Advisors, Inc. et al. The complaint alleged
fraudulent business practices, deceptive acts and practices,
common law fraud and breach of fiduciary duty with respect to
the Express IRA product and sought equitable relief,
disgorgement of profits, damages and restitution, civil
penalties and punitive damages. On July 12, 2007, the
Supreme Court of the State of New York issued a ruling that
dismissed all defendants other than HRBFA and the claims of
common law fraud. Both the New York Attorney General and HRBFA
have appealed the adverse portions of the trial courts
ruling. We believe the claims in this case are without merit,
and we intend to defend this case vigorously, but there are no
assurances as to its outcome.
On January 2, 2008, the Mississippi Attorney General filed
a lawsuit in the Chancery Court of Hinds County, Mississippi
First Judicial District (Case No. G 2008 6 S
2) entitled Jim Hood, Attorney for the State of
Mississippi v. H&R Block, Inc., et al. The
complaint alleged fraudulent business practices, deceptive acts
and practices, common law fraud and breach of fiduciary duty
with respect to the Express IRA product and sought equitable
relief, disgorgement of profits, damages and restitution, civil
penalties and punitive damages. The defendants have filed a
motion to dismiss. We believe the claims in this case are
without merit, and we intend to defend this case vigorously, but
there are no assurances as to its outcome.
In addition to the New York and Mississippi Attorney General
actions, a number of civil actions were filed against us
concerning the Express IRA product, the first of which was filed
on March 17, 2006. Except for two cases pending in state
court, all of the civil actions have been consolidated by the
panel for Multi-District Litigation into a single action styled
In re H&R Block, Inc. Express IRA Marketing Litigation
in the United States District Court for the Western District
of Missouri. We believe the claims in these cases are without
merit, and we intend to defend these cases vigorously, but there
are no assurances as to their outcome.
We are unable to determine an estimate of the possible loss or
range of loss, if any, in light of the early stages of the
Express IRA litigation.
Securities Litigation
On April 6, 2007, a putative class action styled In re
H&R Block Securities Litigation was filed against the
Company and certain of its officers in the United States
District Court for the Western District of Missouri. The
complaint alleged, among other things, deceptive, material and
misleading financial statements, failure to prepare financial
statements in accordance with generally accepted accounting
principles and concealment of the potential for lawsuits
stemming from the allegedly fraudulent nature of the
Companys operations. The complaint sought unspecified
damages and equitable relief. On October 5, 2007, the court
dismissed the complaint and granted the plaintiffs leave to
re-file the portion of the complaint pertaining to the
Companys financial statements. On November 19, 2007,
the plaintiffs re-filed the complaint, alleging, among other
things, deceptive, material and misleading financial statements
and failure to prepare financial statements in accordance with
generally accepted accounting principles. The court dismissed
the re-filed complaint on February 19, 2008. On
March 11, 2008, the plaintiffs appealed the dismissal. In
addition, plaintiffs in a shareholder derivative action that was
consolidated into the securities litigation filed a separate
appeal on March 18, 2008, contending that the derivative
action was improperly consolidated. The derivative action is
Iron Workers Local 16 Pension Fund v. H&R Block, et
al., in the United States District Court for the Western
District of Missouri, Case
No. 06-cv-00466-ODS
(instituted on June 8, 2006) and was brought against
certain of our directors and officers purportedly on behalf of
the Company. The derivative action alleges breach of fiduciary
duty, abuse of control, gross mismanagement, waste, and unjust
enrichment pertaining to (1) our restatement of financial
results in
12
fiscal year 2006 due to errors in determining our state
effective income tax rate and (2) certain of our products
and business activities. We believe the claims in these cases
are without merit and intend to defend this litigation
vigorously. We currently do not believe that we will incur a
material loss with respect to this litigation.
RSM McGladrey
Litigation
RSM EquiCo, Inc., a subsidiary of RSM McGladrey, Inc. (RSM), is
a party to a putative class action filed on July 11, 2006
and entitled Do Rights Plant Growers, et al. v.
RSM EquiCo, Inc., et al. Case No. 06 CC00137, in the
California Superior Court, Orange County. The complaint contains
allegations regarding business valuation services provided by
RSM EquiCo, Inc., including fraud, negligent misrepresentation,
breach of contract, breach of implied covenant of good faith and
fair dealing, breach of fiduciary duty and unfair competition
and seeks unspecified damages, restitution and equitable relief.
We intend to defend this case vigorously. The amount claimed in
this action is substantial and there can be no assurance
regarding the outcome and resolution of this matter. It is
reasonably possible that we could incur losses with respect to
this litigation, although an estimate of such losses cannot be
made in light of the early stage of the litigation.
RSM has a relationship with certain public accounting firms
(collectively, the Attest Firms) pursuant to which
(1) some RSM employees are also partners or employees of
the Attest Firms, (2) many clients of the Attest Firms are
also RSM clients, and (3) our RSM McGladrey brand is
closely linked to the Attest Firms. The Attest Firms are parties
to claims and lawsuits (collectively, Attest Firm
Claims). Judgments or settlements arising from Attest Firm
Claims, which exceed the Attest Firms insurance coverage,
could have a direct adverse effect on Attest Firm operations,
and could impair RSMs ability to attract and retain
clients and quality professionals. Accordingly, although RSM is
not a direct party to significant Attest Firm Claims, such
Attest Firm Claims could have a material adverse effect on
RSMs operations and impair the value of our investment in
RSM. There is no assurance regarding the outcome of the Attest
Firm Claims.
Litigation and
Claims Pertaining to Discontinued Mortgage Operations
Although mortgage loan origination activities were terminated
and the loan servicing business was sold during fiscal year
2008, SCC remains subject to investigations, claims and lawsuits
pertaining to its loan origination and servicing activities that
occurred prior to such termination and sale. These
investigations, claims and lawsuits include actions by state
attorneys general, other state regulators, municipalities,
individual plaintiffs, and cases in which plaintiffs seek to
represent a class of others alleged to be similarly situated.
Among other things, these investigations, claims and lawsuits
allege discriminatory or unfair and deceptive loan origination
and servicing practices, public nuisance, fraud, and violations
of the Truth in Lending Act, Equal Credit Opportunity Act and
the Fair Housing Act. In the current non-prime mortgage
environment, the number of these investigations, claims and
lawsuits has increased over historical experience and is likely
to continue at increased levels. The amounts claimed in these
investigations, claims and lawsuits are substantial in some
instances, and the ultimate resulting liability is difficult to
predict. In the event of unfavorable outcomes, the amounts SCC
may be required to pay in the discharge of liabilities or
settlements could be substantial and, because SCCs
operating results are included in our consolidated financial
statements, could have a material adverse impact on our
consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a
lawsuit in the Superior Court of Suffolk County, Massachusetts
(Case
No. 08-2474-BLS)
entitled Commonwealth of Massachusetts v. H&R
Block, Inc., et al., alleging unfair, deceptive and
discriminatory origination and servicing of mortgage loans and
seeks equitable relief, disgorgement of profits, restitution and
statutory penalties. We believe the claims in this case are
without merit, and we intend to defend this case vigorously, but
there are no assurances as to its outcome. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of this litigation.
SCC also remains subject to potential claims for indemnification
and loan repurchases pertaining to loans previously sold. In the
current non-prime mortgage environment, it is likely that the
frequency of repurchase and indemnification claims may increase
over historical experience and give rise to additional
litigation. In some instances, H&R Block, Inc. was required
to guarantee SCCs obligations. The amounts involved in
these potential claims may be substantial, and the ultimate
resulting liability is difficult to
13
predict. In the event of unfavorable outcomes, the amounts SCC
may be required to pay in the discharge or settlement of these
claims could be substantial and, because SCCs operating
results are included in our consolidated financial statements,
could have a material adverse impact on our consolidated results
of operations.
Other Claims and
Litigation
We have from time to time been party to investigations, claims
and lawsuits not discussed herein arising out of our business
operations. These investigations, claims and lawsuits include
actions by state attorneys general, other state regulators,
individual plaintiffs, and cases in which plaintiffs seek to
represent a class of others similarly situated. Some of these
investigations, claims and lawsuits pertain to RALs, the
electronic filing of customers income tax returns, the POM
guarantee program, wage and hour claims and investment products.
We believe we have meritorious defenses to each of these claims,
and we are defending or intend to defend them vigorously. The
amounts claimed in these claims and lawsuits are substantial in
some instances, however the ultimate liability with respect to
such litigation and claims is difficult to predict. In the event
of an unfavorable outcome, the amounts we may be required to pay
in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are parties
to claims and lawsuits that we consider to be ordinary, routine
litigation incidental to our business, including claims and
lawsuits (collectively, Other Claims) concerning
investment products, the preparation of customers income
tax returns, the fees charged customers for various products and
services, losses incurred by customers with respect to their
investment accounts, relationships with franchisees,
intellectual property disputes, employment matters and contract
disputes. While we cannot provide assurance that we will
ultimately prevail in each instance, we believe the amount, if
any, we are required to pay in the discharge of liabilities or
settlements in these Other Claims will not have a material
adverse effect on our consolidated operating results or
financial position.
10. | Segment Information |
Information concerning our operations by reportable operating
segment is as follows:
(in 000s) | ||||||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||||
Revenues:
|
||||||||||
Tax Services
|
$ | 75,265 | $ | 69,863 | ||||||
Business Services
|
174,651 | 192,823 | ||||||||
Consumer Financial Services
|
86,679 | 114,372 | ||||||||
Corporate
|
3,043 | 4,151 | ||||||||
$ | 339,638 | $ | 381,209 | |||||||
Pretax income (loss):
|
||||||||||
Tax Services
|
$ | (163,923 | ) | $ | (172,289 | ) | ||||
Business Services
|
(295 | ) | (1,906 | ) | ||||||
Consumer Financial Services
|
(17,736 | ) | 6,206 | |||||||
Corporate
|
(32,662 | ) | (15,591 | ) | ||||||
Loss from continuing
operations before tax benefit |
$ | (214,616 | ) | $ | (183,580 | ) | ||||
11. | Accounting Pronouncements |
In June 2008, FASB Staff Position on
EITF 03-6-1,
Determining Whether Instruments Granted in Share-Based
Payment Transactions are Participating Securities
(FSP 03-6-1)
was issued.
FSP 03-6-1
addresses whether instruments granted in share-based payment
transactions are participating securities prior to vesting and,
therefore, should be included in the process of allocating
earnings for purposes of computing earnings per share. This
guidance is effective for financial statements issued for fiscal
years and interim periods beginning after December 15,
2008. Early application is not permitted. We are currently
evaluating what effect
FSP 03-6-1
will have on our consolidated financial statements.
14
In December 2007, Statement of Financial Accounting Standards
No. 141(R), Business Combinations,
(SFAS 141R), and Statement of Financial Accounting
Standards No. 160, Non-Controlling Interests in
Consolidated Financial Statements An Amendment of
ARB No. 51 (SFAS 160) were issued. These
standards will require an acquiring entity to recognize all the
assets acquired and liabilities assumed in a transaction,
including non-controlling interests, at the acquisition-date
fair value with limited exceptions. The provisions of these
standards are effective as of the beginning of our fiscal year
2010. We are currently evaluating what effect the adoption of
SFAS 141R and SFAS 160 will have on our consolidated
financial statements.
As discussed in note 6, we adopted SFAS 157 and
SFAS 159 as of May 1, 2008.
12. | Discontinued Operations |
During fiscal year 2008, we exited the mortgage business
operated through a subsidiary and sold the related loan
servicing business. Our discontinued operations reflect the
wind-down of our mortgage origination business and, as a result,
our discontinued operations reported a net loss of
$3.4 million for the three months ended July 31, 2008
compared to $192.8 million in the prior year.
The financial results of discontinued operations are as follows:
(in 000s) | ||||||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||||
Net revenue
|
$ | 1,137 | $ | (123,390 | ) | |||||
Loss from operations before income tax benefit
|
(3,957 | ) | (312,168 | ) | ||||||
Impairment related to the disposition of businesses
|
- | (23,229 | ) | |||||||
Pretax loss
|
(3,957 | ) | (335,397 | ) | ||||||
Income tax benefit
|
(607 | ) | (142,640 | ) | ||||||
Net loss from discontinued operations
|
$ | (3,350 | ) | $ | (192,757 | ) | ||||
Restructuring Charge
During fiscal year 2006, our mortgage business initiated a
restructuring plan to reduce costs. Restructuring activities
continued into the current year, including our previously
announced closure of all mortgage origination activities and
sale of servicing operations. We did not incur any charges
during the three months ended July 31, 2008, compared to
$16.1 million in the prior year. Changes in our
restructuring charge liability during the three months ended
July 31, 2008 are as follows:
(in 000s) | ||||||||||||||||||
Accrual Balance as
of |
Cash |
Other |
Accrual Balance as
of |
|||||||||||||||
April 30, 2008 | Payments | Adjustments | July 31, 2008 | |||||||||||||||
Employee severance costs
|
$ | 4,807 | $ | (2,453 | ) | $ | 1,219 | $ | 3,573 | |||||||||
Contract termination costs
|
23,113 | (3,931 | ) | 157 | 19,339 | |||||||||||||
$ | 27,920 | $ | (6,384 | ) | $ | 1,376 | $ | 22,912 | ||||||||||
The remaining liability related to this restructuring charge is
included in accounts payable, accrued expenses and other current
liabilities and accrued salaries, wages and payroll taxes on our
consolidated balance sheet and primarily relates to lease
obligations for vacant space resulting from branch office
closings and employee severance costs, respectively.
Contract termination costs include estimates regarding the
length of time required to sublease vacant space and expected
recovery rates. Actual results could vary from these estimates.
13. | Subsequent Events |
On August 12, 2008, we announced the signing of a
definitive agreement to sell HRBFA to Ameriprise Financial, Inc.
The transaction is subject to customary regulatory approvals,
and is expected to close in three to six months. The purchase
price is $315 million in cash, subject to working capital
and advisor retention adjustments at closing. The transaction is
not expected to result in a material gain or loss for financial
reporting purposes. The transaction involves the sale of all
outstanding common stock of HRB
15
Financial Corporation, HRBFAs direct parent, and is
expected to result in a capital loss for income tax purposes. We
currently do not expect to be able to realize a benefit for this
capital loss.
This business will be presented as
held-for-sale
and as discontinued operations beginning with our quarter ending
October 31, 2008. Major classes of assets and liabilities
of HRB Financial Corporation as of July 31, 2008 are as
follows:
(in 000s) | ||||
Cash and cash equivalents
|
$ | 110,535 | ||
Cash and cash equivalents restricted
|
219,000 | |||
Accounts receivable from customers, brokers and dealers
|
401,859 | |||
Prepaid expenses and other assets
|
73,699 | |||
Goodwill
|
173,954 | |||
Total assets
|
$ | 979,047 | ||
Accounts payable to customers, brokers and dealers
|
$ | 592,688 | ||
Accounts payable, accrued expenses and deposits
|
38,486 | |||
Other liabilities
|
52,268 | |||
Total liabilities
|
$ | 683,422 | ||
Had HRBFA been reported as discontinued operations as of
July 31, 2008, revenues of $67.7 million and
$87.2 million for the three months ended July 31, 2008
and 2007, respectively, and a pretax loss of $1.8 million
and pretax income of $3.9 million, respectively, would have
been included in discontinued operations on our consolidated
statements of operations. Overhead costs of a continuing nature
which would have previously been allocated to HRBFA totaled
$1.8 million and $2.5 million for the three months
ended July 31, 2008 and 2007, respectively, and will be
included in continuing operations.
On September 3, 2008 we announced the signing of a
definitive agreement to acquire our last major independent
franchise operator for approximately $278 million. This
franchise includes a network of over 600 tax offices, nearly
two-thirds
of which will convert to
company-owned
offices upon the closing of the transaction. The remaining
offices are currently operated by
sub-franchisees
and, as a result, will become our direct franchises. The
transaction is expected to close by the end of our second fiscal
quarter.
16
14. | Condensed Consolidating Financial Statements |
Block Financial LLC (BFC) is an indirect, wholly-owned
consolidated subsidiary of the Company. BFC is the Issuer and
the Company is the Guarantor of the $500.0 million credit
facility entered into in April 2007, the Senior Notes issued on
January 11, 2008 and October 26, 2004, our unsecured
committed lines of credit (CLOCs) and other indebtedness issued
from time to time. These condensed consolidating financial
statements have been prepared using the equity method of
accounting. Earnings of subsidiaries are, therefore, reflected
in the Companys investment in subsidiaries account. The
elimination entries eliminate investments in subsidiaries,
related stockholders equity and other intercompany
balances and transactions.
Condensed Consolidating Income Statements | (in 000s) | |||||||||||||||||||
Three
Months Ended |
H&R
Block, Inc. |
BFC |
Other |
Consolidated |
||||||||||||||||
July 31, 2008 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Total revenues
|
$ | - | $ | 88,504 | $ | 252,572 | $ | (1,438 | ) | $ | 339,638 | |||||||||
Cost of services
|
- | 52,033 | 317,569 | 4 | 369,606 | |||||||||||||||
Cost of other revenues
|
- | 39,620 | 3,203 | - | 42,823 | |||||||||||||||
Selling, general and administrative
|
- | 37,829 | 104,083 | (1,442 | ) | 140,470 | ||||||||||||||
Total expenses
|
- | 129,482 | 424,855 | (1,438 | ) | 552,899 | ||||||||||||||
Operating loss
|
- | (40,978 | ) | (172,283 | ) | - | (213,261 | ) | ||||||||||||
Other income, net
|
(214,616 | ) | (4,350 | ) | 2,995 | 214,616 | (1,355 | ) | ||||||||||||
Loss from continuing operations
before tax benefit |
(214,616 | ) | (45,328 | ) | (169,288 | ) | 214,616 | (214,616 | ) | |||||||||||
Income tax benefit
|
(85,247 | ) | (17,712 | ) | (67,535 | ) | 85,247 | (85,247 | ) | |||||||||||
Net loss from continuing operations
|
(129,369 | ) | (27,616 | ) | (101,753 | ) | 129,369 | (129,369 | ) | |||||||||||
Net loss from discontinued operations
|
(3,350 | ) | (3,350 | ) | - | 3,350 | (3,350 | ) | ||||||||||||
Net loss
|
$ | (132,719 | ) | $ | (30,966 | ) | $ | (101,753 | ) | $ | 132,719 | $ | (132,719 | ) | ||||||
Three
Months Ended |
H&R
Block, Inc. |
BFC |
Other |
Consolidated |
||||||||||||||||
July 31, 2007 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Total revenues
|
$ | - | $ | 189,100 | $ | 194,355 | $ | (2,246 | ) | $ | 381,209 | |||||||||
Cost of services
|
- | 63,529 | 321,553 | 33 | 385,115 | |||||||||||||||
Cost of other revenues
|
- | 37,637 | 5,892 | - | 43,529 | |||||||||||||||
Selling, general and administrative
|
- | 45,469 | 100,535 | (1,895 | ) | 144,109 | ||||||||||||||
Total expenses
|
- | 146,635 | 427,980 | (1,862 | ) | 572,753 | ||||||||||||||
Operating income (loss)
|
- | 42,465 | (233,625 | ) | (384 | ) | (191,544 | ) | ||||||||||||
Other income, net
|
(183,580 | ) | (5 | ) | 7,969 | 183,580 | 7,964 | |||||||||||||
Income (loss) from continuing operations before tax (benefit)
|
(183,580 | ) | 42,460 | (225,656 | ) | 183,196 | (183,580 | ) | ||||||||||||
Income tax (benefit)
|
(73,757 | ) | 14,622 | (88,225 | ) | 73,603 | (73,757 | ) | ||||||||||||
Net income (loss) from continuing operations
|
(109,823 | ) | 27,838 | (137,431 | ) | 109,593 | (109,823 | ) | ||||||||||||
Net loss from discontinued operations
|
(192,757 | ) | (190,143 | ) | (2,923 | ) | 193,066 | (192,757 | ) | |||||||||||
Net loss
|
$ | (302,580 | ) | $ | (162,305 | ) | $ | (140,354 | ) | $ | 302,659 | $ | (302,580 | ) | ||||||
17
Condensed Consolidating Balance Sheets | (in 000s) | |||||||||||||||||||
H&R Block,
Inc. |
BFC |
Other |
Consolidated |
|||||||||||||||||
July 31, 2008 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Cash & cash equivalents
|
$ | - | $ | 148,374 | $ | 208,102 | $ | (478 | ) | $ | 355,998 | |||||||||
Cash & cash equivalents restricted
|
- | 220,516 | 822 | - | 221,338 | |||||||||||||||
Receivables from customers, brokers and dealers, net
|
- | 401,859 | - | - | 401,859 | |||||||||||||||
Receivables, net
|
3,346 | 116,914 | 262,964 | - | 383,224 | |||||||||||||||
Mortgage loans held for investment
|
- | 868,603 | - | - | 868,603 | |||||||||||||||
Intangible assets and goodwill, net
|
- | 173,954 | 974,786 | - | 1,148,740 | |||||||||||||||
Investments in subsidiaries
|
3,987,649 | - | 352 | (3,987,649 | ) | 352 | ||||||||||||||
Other assets
|
- | 568,663 | 954,694 | 11 | 1,523,368 | |||||||||||||||
Total assets
|
$ | 3,990,995 | $ | 2,498,883 | $ | 2,401,720 | $ | (3,988,116 | ) | $ | 4,903,482 | |||||||||
Accts. payable to customers, brokers and dealers
|
$ | - | $ | 592,688 | $ | - | $ | - | $ | 592,688 | ||||||||||
Customer deposits
|
- | 777,558 | - | (478 | ) | 777,080 | ||||||||||||||
Long-term debt
|
- | 1,101,975 | 40,981 | - | 1,142,956 | |||||||||||||||
Other liabilities
|
2 | 501,563 | 1,052,419 | 52 | 1,554,036 | |||||||||||||||
Net intercompany advances
|
3,154,271 | (683,051 | ) | (2,471,179 | ) | (41 | ) | - | ||||||||||||
Stockholders equity
|
836,722 | 208,150 | 3,779,499 | (3,987,649 | ) | 836,722 | ||||||||||||||
Total liabilities and stockholders equity
|
$ | 3,990,995 | $ | 2,498,883 | $ | 2,401,720 | $ | (3,988,116 | ) | $ | 4,903,482 | |||||||||
H&R Block,
Inc. |
BFC |
Other |
Consolidated |
|||||||||||||||||
April 30, 2008 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Cash & cash equivalents
|
$ | - | $ | 96,559 | $ | 630,933 | $ | (647 | ) | $ | 726,845 | |||||||||
Cash & cash equivalents restricted
|
- | 218,214 | 817 | - | 219,031 | |||||||||||||||
Receivables from customers, brokers and dealers, net
|
- | 438,899 | - | - | 438,899 | |||||||||||||||
Receivables, net
|
139 | 141,398 | 411,334 | - | 552,871 | |||||||||||||||
Mortgage loans held for investment
|
- | 966,301 | - | - | 966,301 | |||||||||||||||
Intangible assets and goodwill, net
|
- | 173,954 | 978,682 | - | 1,152,636 | |||||||||||||||
Investments in subsidiaries
|
4,131,345 | - | 322 | (4,131,345 | ) | 322 | ||||||||||||||
Other assets
|
- | 596,612 | 969,896 | 12 | 1,566,520 | |||||||||||||||
Total assets
|
$ | 4,131,484 | $ | 2,631,937 | $ | 2,991,984 | $ | (4,131,980 | ) | $ | 5,623,425 | |||||||||
Short-term borrowings
|
$ | - | $ | 25,000 | $ | - | $ | - | $ | 25,000 | ||||||||||
Customer deposits
|
- | 786,271 | - | (647 | ) | 785,624 | ||||||||||||||
Accts. payable to customers, brokers and dealers
|
- | 559,658 | - | - | 559,658 | |||||||||||||||
Long-term debt
|
- | 1,101,885 | 41,185 | - | 1,143,070 | |||||||||||||||
Other liabilities
|
2 | 551,024 | 1,571,178 | 51 | 2,122,255 | |||||||||||||||
Net intercompany advances
|
3,143,664 | (632,522 | ) | (2,511,103 | ) | (39 | ) | - | ||||||||||||
Stockholders equity
|
987,818 | 240,621 | 3,890,724 | (4,131,345 | ) | 987,818 | ||||||||||||||
Total liabilities and stockholders equity
|
$ | 4,131,484 | $ | 2,631,937 | $ | 2,991,984 | $ | (4,131,980 | ) | $ | 5,623,425 | |||||||||
18
Condensed Consolidating Statements of Cash Flows | (in 000s) | |||||||||||||||||||
Three
Months Ended |
H&R
Block, Inc. |
BFC |
Other |
Consolidated |
||||||||||||||||
July 31, 2008 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Net cash provided by (used in) operating activities:
|
$ | (11,615 | ) | $ | 107,012 | $ | (411,733 | ) | $ | - | $ | (316,336 | ) | |||||||
Cash flows from investing:
|
||||||||||||||||||||
Mortgage loans originated for investment, net
|
- | 31,619 | - | - | 31,619 | |||||||||||||||
Purchase property & equipment
|
- | (1,727 | ) | (14,462 | ) | - | (16,189 | ) | ||||||||||||
Payments for business acquisitions
|
- | - | (2,251 | ) | - | (2,251 | ) | |||||||||||||
Net intercompany advances
|
29,630 | - | - | (29,630 | ) | - | ||||||||||||||
Other, net
|
- | 2,906 | (15 | ) | - | 2,891 | ||||||||||||||
Net cash provided by (used in) investing activities
|
29,630 | 32,798 | (16,728 | ) | (29,630 | ) | 16,070 | |||||||||||||
Cash flows from financing:
|
||||||||||||||||||||
Repayments of short-term borrowings
|
- | (40,000 | ) | - | - | (40,000 | ) | |||||||||||||
Proceeds from short-term borrowings
|
- | 15,000 | - | - | 15,000 | |||||||||||||||
Customer deposits
|
- | (8,964 | ) | - | 169 | (8,795 | ) | |||||||||||||
Dividends paid
|
(46,790 | ) | - | - | - | (46,790 | ) | |||||||||||||
Proceeds from stock options
|
20,520 | - | - | - | 20,520 | |||||||||||||||
Net intercompany advances
|
- | (50,203 | ) | 20,573 | 29,630 | - | ||||||||||||||
Other, net
|
8,255 | (3,828 | ) | (14,943 | ) | - | (10,516 | ) | ||||||||||||
Net cash provided by (used in) financing activities
|
(18,015 | ) | (87,995 | ) | 5,630 | 29,799 | (70,581 | ) | ||||||||||||
Net increase (decrease) in cash
|
- | 51,815 | (422,831 | ) | 169 | (370,847 | ) | |||||||||||||
Cash beginning of period
|
- | 96,559 | 630,933 | (647 | ) | 726,845 | ||||||||||||||
Cash end of period
|
$ | - | $ | 148,374 | $ | 208,102 | $ | (478 | ) | $ | 355,998 | |||||||||
Three
Months Ended |
H&R
Block, Inc. |
BFC |
Other |
Consolidated |
||||||||||||||||
July 31, 2007 | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||
Net cash provided by (used in) operating activities:
|
$ | 8,194 | $ | (10,196 | ) | $ | (333,344 | ) | $ | - | $ | (335,346 | ) | |||||||
Cash flows from investing:
|
||||||||||||||||||||
Mortgage loans originated for investment, net
|
- | 14,327 | - | - | 14,327 | |||||||||||||||
Purchase property & equipment
|
- | (5,124 | ) | (9,373 | ) | - | (14,497 | ) | ||||||||||||
Payments for business acquisitions
|
- | - | (20,887 | ) | - | (20,887 | ) | |||||||||||||
Net intercompany advances
|
24,566 | - | - | (24,566 | ) | - | ||||||||||||||
Investing cash flows from discontinued operations
|
- | (557 | ) | 3,625 | - | 3,068 | ||||||||||||||
Other, net
|
- | (295 | ) | 6,994 | - | 6,699 | ||||||||||||||
Net cash provided by (used in) investing activities
|
24,566 | 8,351 | (19,641 | ) | (24,566 | ) | (11,290 | ) | ||||||||||||
Cash flows from financing:
|
||||||||||||||||||||
Repayments of commercial paper
|
- | (3,463,719 | ) | - | - | (3,463,719 | ) | |||||||||||||
Proceeds from commercial paper
|
- | 3,622,874 | - | - | 3,622,874 | |||||||||||||||
Repayments of short-term borrowings
|
- | (560,000 | ) | - | - | (560,000 | ) | |||||||||||||
Proceeds from short-term borrowings
|
- | 485,000 | - | - | 485,000 | |||||||||||||||
Customer deposits
|
- | (90,378 | ) | - | - | (90,378 | ) | |||||||||||||
Dividends paid
|
(43,937 | ) | - | - | - | (43,937 | ) | |||||||||||||
Proceeds from issuance of common stock
|
9,788 | - | - | - | 9,788 | |||||||||||||||
Net intercompany advances
|
- | 44,132 | (68,698 | ) | 24,566 | - | ||||||||||||||
Financing cash flows from discontinued operations
|
- | (47,535 | ) | - | - | (47,535 | ) | |||||||||||||
Other, net
|
1,389 | (9,495 | ) | (41,518 | ) | - | (49,624 | ) | ||||||||||||
Net cash used in financing activities
|
(32,760 | ) | (19,121 | ) | (110,216 | ) | 24,566 | (137,531 | ) | |||||||||||
Net decrease in cash
|
- | (20,966 | ) | (463,201 | ) | - | (484,167 | ) | ||||||||||||
Cash beginning of period
|
- | 165,118 | 756,720 | - | 921,838 | |||||||||||||||
Cash end of period
|
$ | - | $ | 144,152 | $ | 293,519 | $ | - | $ | 437,671 | ||||||||||
19
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
RESULTS OF
OPERATIONS
H&R Block provides tax services, certain financial and
banking services, and business and consulting services. Our Tax
Services segment provides income tax return preparation
services, electronic filing services and other services and
products related to income tax return preparation to the general
public primarily in the United States, Canada and Australia. RSM
McGladrey, Inc. (RSM) is a national accounting, tax and business
consulting firm primarily serving midsized businesses. Our
Consumer Financial Services segment offers investment services
through H&R Block Financial Advisors, Inc. (HRBFA) and
retail banking through H&R Block Bank (HRB Bank).
On August 12, 2008, we announced the signing of a
definitive agreement to sell HRBFA to Ameriprise Financial, Inc.
See additional discussion in note 13 to our condensed
consolidated financial statements.
TAX
SERVICES
This segment primarily consists of our income tax preparation
businesses retail, online and software.
Additionally, this segment includes commercial tax businesses,
which provide tax preparation software to CPAs and other tax
preparers.
Tax Services Operating Results | (in 000s) | |||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||
Service revenues:
|
||||||||
Tax preparation fees
|
$ | 29,432 | $ | 24,924 | ||||
Other services
|
38,783 | 37,349 | ||||||
68,215 | 62,273 | |||||||
Royalties
|
3,684 | 2,842 | ||||||
Other
|
3,366 | 4,748 | ||||||
Total revenues
|
75,265 | 69,863 | ||||||
Cost of services:
|
||||||||
Compensation and benefits
|
44,197 | 46,140 | ||||||
Occupancy
|
79,350 | 74,960 | ||||||
Depreciation
|
8,019 | 8,160 | ||||||
Other
|
47,677 | 55,165 | ||||||
179,243 | 184,425 | |||||||
Cost of other revenues, selling,
general and administrative |
59,945 | 57,727 | ||||||
Total expenses
|
239,188 | 242,152 | ||||||
Pretax loss
|
$ | (163,923 | ) | $ | (172,289 | ) | ||
Three months
ended July 31, 2008 compared to July 31,
2007
Tax Services revenues increased $5.4 million, or
7.7%, for the three months ended July 31, 2008 compared to
the prior year. Tax preparation fees increased
$4.5 million, or 18.1%, primarily due to an increase of
14.2% in our U.S. retail clients served in company-owned
offices.
Total expenses decreased $3.0 million, or 1.2%, for the
three months ended July 31, 2008. Cost of services
decreased $5.2 million, or 2.8%, from the prior year, as
lower corporate shared services were partially offset by higher
occupancy expenses. Occupancy expenses increased
$4.4 million, or 5.9%, primarily as a result of higher rent
expenses due to a 1.9% increase in company-owned offices under
lease and a 2.7% increase in the average rent. Other cost of
services decreased $7.5 million, or 13.6%, due primarily to
a $5.4 million reduction in corporate shared services,
primarily related to fewer information technology projects.
The pretax loss for the three months ended July 31, 2008
was $163.9 million, compared to a loss of
$172.3 million in the prior year.
20
BUSINESS
SERVICES
This segment offers accounting, tax and consulting services to
middle-market companies.
Business Services Operating Statistics | ||||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||
Accounting, tax and business consulting:
|
||||||||
Chargeable hours
|
960,300 | 1,039,190 | ||||||
Chargeable hours per person
|
284 | 274 | ||||||
Net billed rate per hour
|
$ | 140 | $ | 144 | ||||
Average margin per person
|
$ | 18,564 | $ | 19,225 | ||||
Business Services Operating Results | (in 000s) | |||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||
Tax services
|
$ | 76,301 | $ | 75,172 | ||||
Business consulting
|
50,757 | 51,248 | ||||||
Accounting services
|
12,960 | 14,925 | ||||||
Capital markets
|
5,818 | 10,734 | ||||||
Leased employee revenue
|
18 | 11,371 | ||||||
Reimbursed expenses
|
4,205 | 5,848 | ||||||
Other
|
24,592 | 23,525 | ||||||
Total revenues
|
174,651 | 192,823 | ||||||
Compensation and benefits
|
97,757 | 114,655 | ||||||
Occupancy
|
18,660 | 17,862 | ||||||
Other
|
15,166 | 18,648 | ||||||
Cost of revenues
|
131,583 | 151,165 | ||||||
Amortization of intangible assets
|
3,419 | 3,626 | ||||||
Selling, general and administrative
|
39,944 | 39,938 | ||||||
Total expenses
|
174,946 | 194,729 | ||||||
Pretax loss
|
$ | (295 | ) | $ | (1,906 | ) | ||
Three months
ended July 31, 2008 compared to July 31,
2007
Business Services revenues for the three months ended
July 31, 2008 declined $18.2 million, or 9.4% from the
prior year.
Leased employee revenue decreased primarily due to a change in
organizational structure between the businesses we acquired from
American Express Tax and Business Services, Inc. (AmexTBS) and
the attest firms that, while not affiliates of our company, also
serve our clients. Employees we previously leased to the attest
firms have now been transferred to the separate attest
practices. As a result, we no longer record the revenues and
expenses associated with leasing these employees.
Capital markets revenues decreased $4.9 million, primarily
due to a 38.0% decrease in revenue per transaction.
Total expenses decreased $19.8 million, or 10.2%, from the
prior year. Compensation and benefits decreased primarily due to
the change in organizational structure with AmexTBS as discussed
above. Other expenses declined $3.5 million, or 18.7%, as a
result of a $1.6 million decline in reimbursed expenses.
The pretax loss for the three months ended July 31, 2008
was $0.3 million compared to a loss of $1.9 million in
the prior year.
21
CONSUMER
FINANCIAL SERVICES
This segment is engaged in offering brokerage services, along
with investment planning and related financial advice through
HRBFA and retail banking through HRB Bank.
HRBFA offers traditional brokerage services, as well as
annuities, insurance, fee-based accounts, online account access,
equity research and focus lists, model portfolios, asset
allocation strategies, and other investment tools and
information. On August 12, 2008, we announced the signing
of a definitive agreement to sell HRBFA to Ameriprise Financial,
Inc. See additional discussion in note 13 to our condensed
consolidated financial statements.
HRB Bank offers traditional banking services including checking
and savings accounts, lines of credit, individual retirement
accounts, certificates of deposit and prepaid debit card
accounts. HRBFA utilizes HRB Bank for certain FDIC-insured
deposits for its clients.
Consumer Financial Services Operating Statistics | ||||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||
Broker-dealer:
|
||||||||
Traditional brokerage
accounts(1)
|
370,054 | 383,229 | ||||||
New traditional brokerage accounts funded by tax clients
|
3,299 | 3,311 | ||||||
Cross-service revenue as a percent of total production
revenue(2)
|
19.3% | 18.1% | ||||||
Average assets per traditional brokerage account
|
$ | 81,194 | $ | 84,775 | ||||
Average margin balances (millions)
|
$ | 401 | $ | 357 | ||||
Average customer payable balances (millions)
|
$ | 482 | $ | 560 | ||||
Number of advisors
|
976 | 936 | ||||||
Banking:
|
||||||||
Efficiency
ratio(3)
|
88% | 37% | ||||||
Annualized net interest
margin(4)
|
3.57% | 2.11% | ||||||
Annualized pretax return on average
assets(5)
|
(5.27)% | 1.34% | ||||||
Total assets (thousands)
|
$ | 1,039,397 | $ | 1,336,705 | ||||
Mortgage loans held for investment:
|
||||||||
Loan loss reserve as a % of mortgage loans
|
5.12% | 0.37% | ||||||
Delinquency rate
|
9.60% | 3.43% | ||||||
(1) | Includes only accounts with a positive balance. | |
(2) | Defined as revenue generated from referred customers divided by total production revenue. | |
(3) | Defined as non-interest expense divided by revenue net of interest expense. See Reconciliation of Non-GAAP Financial Information at the end of Part I, Item 2. | |
(4) | Defined as annualized net interest revenue divided by average bank earning assets. See Reconciliation of Non-GAAP Financial Information at the end of Part I, Item 2. | |
(5) | Defined as annualized pretax banking income divided by average bank assets. See Reconciliation of Non-GAAP Financial Information at the end of Part I, Item 2. |
22
Consumer Financial Services Operating Results | (in 000s) | |||||||
Three Months Ended July 31, | 2008 | 2007 | ||||||
Service revenues:
|
||||||||
Financial advisor production
revenue |
$ | 51,381 | $ | 58,296 | ||||
Other
|
14,118 | 18,067 | ||||||
65,499 | 76,363 | |||||||
Net interest income:
|
||||||||
Margin lending
|
7,133 | 12,272 | ||||||
Banking activities
|
9,161 | 7,503 | ||||||
16,294 | 19,775 | |||||||
Provision for loan loss reserves
|
(14,991 | ) | (2,084 | ) | ||||
Other
|
(742 | ) | 40 | |||||
Total
revenues(1)
|
66,060 | 94,094 | ||||||
Cost of services:
|
||||||||
Compensation and benefits
|
39,530 | 41,207 | ||||||
Occupancy
|
6,927 | 6,894 | ||||||
Other
|
11,914 | 4,810 | ||||||
58,371 | 52,911 | |||||||
Amortization of intangible assets
|
- | 9,156 | ||||||
Selling, general and administrative
|
25,425 | 25,821 | ||||||
Total expenses
|
83,796 | 87,888 | ||||||
Pretax income (loss)
|
$ | (17,736 | ) | $ | 6,206 | |||
Supplemental information
|
||||||||
Revenues:(1)
|
||||||||
Broker-dealer
|
$ | 67,472 | $ | 85,128 | ||||
Bank
|
(1,412 | ) | 8,966 | |||||
$ | 66,060 | $ | 94,094 | |||||
Pretax income (loss):
|
||||||||
Broker-dealer
|
$ | (3,619 | ) | $ | 1,364 | |||
Bank
|
(14,117 | ) | 4,842 | |||||
$ | (17,736 | ) | $ | 6,206 | ||||
(1) | Total revenues, less loan loss reserves on mortgage loans held for investment and interest expense. |
Three months
ended July 31, 2008 compared to July 31,
2007
Consumer Financial Services revenues, net of interest
expense and provision for loan loss reserves, for the three
months ended July 31, 2008 decreased $28.0 million, or
29.8%, over the prior year.
Financial advisor production revenue, which consists primarily
of fees earned on assets under administration and commissions on
client trades, declined $6.9 million, or 11.9%, from the
prior year due to lower closed-end fund revenues. The following
table summarizes the key drivers of production revenue:
Three Months Ended July 31, | 2008 | 2007 | ||||||||
Client trades
|
232,180 | 242,087 | ||||||||
Average revenue per trade
|
$ | 118.81 | $ | 136.53 | ||||||
Ending balance of assets under administration (billions)
|
$ | 30.0 | $ | 32.5 | ||||||
Annualized productivity per advisor
|
$ | 209,000 | $ | 253,000 | ||||||
Net interest income on margin lending activities declined
$5.1 million, or 41.9%, due to declining interest rates.
The Federal Funds rate declined by a total of 325 basis
points since the second quarter of last year. As this rate
declines, we reduce the rates on margin and other asset
balances, and therefore, net interest income is reduced.
23
Net interest income on banking activities increased
$1.7 million from the prior year primarily due to a
$10.2 million decline in interest expense on deposits,
partially offset by a $9.2 million decline in interest
income on mortgage loans held for investment. Interest expense
and interest income are both declining due to lower interest
rates and lower average balances in the corresponding liability
or asset. Interest income is also declining due to an increase
in non-accrual loans from $20.4 million at July 31,
2007 to $119.5 million at July 31, 2008. The following
table summarizes the key drivers of net interest revenue on
banking activities:
(dollars in 000s) | ||||||||||||||||
Average Balance | Average Rate Earned (Paid) | |||||||||||||||
Three Months Ended July 31, | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Loans
|
$ | 994,301 | $ | 1,339,049 | 5.50% | 6.72% | ||||||||||
Investments
|
79,154 | 85,235 | 2.62% | 5.35% | ||||||||||||
Deposits
|
802,285 | 1,105,125 | (2.00%) | (5.11%) | ||||||||||||
Detail of our mortgage loans held for investment and the related
allowance at July 31, 2008 and April 30, 2008 is as
follows:
(dollars in 000s) | ||||||||||||||||||||||||
As of | July 31, 2008 | April 30, 2008 | ||||||||||||||||||||||
Outstanding |
Loan Loss |
% 30-Days |
Outstanding |
Loan Loss |
% 30-Days |
|||||||||||||||||||
Principal Balance | Allowance | Past Due | Principal Balance | Allowance | Past Due | |||||||||||||||||||
Purchased from affiliates
|
$ | 643,360 | 13.05 | % | $ | 734,658 | 16.30 | % | ||||||||||||||||
Purchased from third-parties
|
265,383 | 1.04 | % | 269,982 | 1.90 | % | ||||||||||||||||||
$ | 908,743 | $ | 46,853 | 9.60 | % | $ | 1,004,640 | $ | 45,401 | 11.71 | % | |||||||||||||
We recorded a provision for loan losses on our mortgage loans
held for investment of $15.0 million during the current
quarter, compared to $2.1 million in the prior year. Our
loan loss provision increased significantly as a result of
declining residential home prices, and increasing delinquencies
occurring in our portfolio. Our loan loss reserve as a percent
of mortgage loans was 5.12%, or $46.9 million, at
July 31, 2008, compared to 4.49%, or $45.4 million, at
April 30, 2008.
In estimating our loan loss allowance, we stratify the loan
portfolio based on our view of risk associated with various
elements of the pool and assign estimated loss rates based on
those risks. Loss rates are based primarily on historical
experience and our assessment of economic and market conditions.
Loss rates consider both the rate at which loans will become
delinquent (frequency) and the amount of loss that will
ultimately be realized upon occurrence of a liquidation of
collateral (severity). At July 31, 2008 and April 30,
2008 our weighted average frequency assumption was 14%. Our
weighted average severity assumption was approximately 30% at
July 31, 2008 and 22% at April 30, 2008, and increased
due to declining collateral values during the quarter. Loss
severity assumptions are based on the principal balance of the
mortgage loan and, because the average loan to value ratio for
our portfolio was 76.3%, imply a greater decline in actual
property values.
Mortgage loans held for investment includes loans originated by
affiliates and purchased by HRB Bank. Those loans have
experienced higher rates of delinquency than other loans in our
portfolio and expose us to a higher risk of potential credit
loss. Residential real estate markets are experiencing
significant declines in property values and mortgage default
rates are increasing. If adverse market trends continue,
including trends within our portfolio specifically, we may be
required to record additional loan loss provisions, and those
losses may be significant.
When mortgage loans become 180 days delinquent we account
for those loans as in-substance foreclosures and
classify the outstanding principal balance as other real estate
owned rather than mortgage loans held for investment and record
them at fair value. Mortgage loans with a principal balance of
$65.8 million and a corresponding allowance balance of
$12.3 million, were transferred to other real estate owned
during the quarter ended July 31, 2008. During the quarter
we recorded an additional impairment charge on these balances
totaling $5.4 million reflecting declining collateral
values.
Total expenses declined $4.1 million, or 4.7%, from the
prior year. Other cost of services increased $7.1 million
primarily due to higher expenses associated with the H&R
Block Prepaid Emerald
MasterCard®
program.
24
Amortization of intangible assets decreased $9.2 million as
the related intangible assets were fully amortized in November
2007.
The pretax loss for the three months ended July 31, 2008
was $17.7 million compared to prior year income of
$6.2 million.
CORPORATE,
ELIMINATIONS AND INCOME TAXES ON CONTINUING OPERATIONS
The pretax loss recorded in our corporate operations for the
three months ended July 31, 2008 was $32.7 million
compared to $15.6 million in the prior year. The increased
loss is primarily due to $7.2 million in incremental
interest expense resulting from our corporate operations
absorbing current year financing costs for all long-term debt.
In the prior year, financing costs were primarily related to
borrowings incurred to cover losses of our mortgage business,
and were therefore reported in discontinued operations. We also
recorded $5.0 million in net impairments of residual
interests in securitizations in the current year, and a
$4.5 million decline in investment income.
Our effective tax rate for continuing operations was 39.7% and
40.2% for the three months ended July 31, 2008 and 2007,
respectively. Our effective tax rate decreased primarily due to
changes in our estimated state tax rate.
DISCONTINUED
OPERATIONS
Discontinued operations includes mortgage businesses
historically engaged in the origination of non-prime and prime
mortgage loans, the sale and securitization of mortgage loans
and residual interests, and the servicing of non-prime loans.
During fiscal year 2008, we terminated all origination
activities and sold the loan servicing operations. Our current
year discontinued operations reflect the wind-down of our
mortgage loan origination business. Also included in the prior
year are the results of three smaller lines of business
previously reported in our Business Services segment. We will
begin reporting operating results of HRBFA as discontinued
during our quarter ending October 31, 2008.
The pretax loss of our discontinued operations for the three
months ended July 31, 2008 was $4.0 million compared
to a loss of $335.4 million in the prior year. The loss
from discontinued operations for the prior year period included
impairments of residual interests of $49.6 million, losses
relating to loan repurchase obligations of $157.3 million,
and losses on the sale of mortgage loans totaling
$57.4 million.
FINANCIAL
CONDITION
These comments should be read in conjunction with the condensed
consolidated balance sheets and condensed consolidated
statements of cash flows found on pages 1 and 3, respectively.
CAPITAL
RESOURCES & LIQUIDITY BY SEGMENT
Our sources of capital include cash from operations, issuances
of common stock and debt. We use capital primarily to fund
working capital, pay dividends, repurchase treasury shares and
acquire businesses. Our Tax Services and Business Services
segments are highly seasonal and therefore generally require the
use of cash to fund operating losses during the period May
through December.
Given the likely availability of a number of liquidity options,
we believe, that in the absence of any unexpected developments,
our existing sources of capital at July 31, 2008 are
sufficient to meet our operating needs.
Cash From
Operations. Cash used in operating activities for the
first three months of fiscal year 2009 totaled
$316.3 million, compared with $335.3 million for the
same period last year. The change was due primarily to lower
losses and reduced working capital requirements of our
discontinued mortgage businesses.
Debt.
We borrow under our unsecured committed lines of credit (CLOCs)
to support working capital requirements primarily arising from
off-season operating losses in our Tax Services and Business
Services segments. We had no balance outstanding under our CLOCs
at July 31, 2008, although we drew on the CLOCs in August
2008. See additional discussion in Borrowings.
Issuance of
Common Stock. We issue shares of common stock, in
accordance with our stock-based compensation plans, out of
treasury shares. Proceeds from the issuance of common stock
totaled $28.5 million and $15.3 million for the three
months ended July 31, 2008 and 2007, respectively.
25
Dividends.
Dividends paid totaled $46.8 million and $43.9 million
for the three months ended July 31, 2008 and 2007,
respectively.
Share
Repurchases. In June 2008, our Board of Directors
rescinded the previous authorizations to repurchase shares of
our common stock, and approved an authorization to purchase up
to $2.0 billion of our common stock over the next four
years. We did not repurchase shares during the three months
ended July 31, 2008, and do not expect to repurchase shares
prior to our fourth quarter.
Restricted
Cash. We hold certain cash balances that are
restricted as to use. Cash and cash equivalents
restricted totaled $221.3 million at July 31, 2008
compared to $219.0 million at April 30, 2008. At
July 31, 2008, Consumer Financial Services held
$219.0 million of this total segregated in a special
reserve account for the exclusive benefit of its broker-dealer
clients.
Segment Cash
Flows. A condensed consolidating statement of cash
flows by segment for the three months ended July 31, 2008
is as follows:
(in 000s) | ||||||||||||||||||||
Consumer |
||||||||||||||||||||
Tax |
Business |
Financial |
Consolidated |
|||||||||||||||||
Services | Services | Services | Corporate | H&R Block | ||||||||||||||||
Cash provided by (used in):
|
||||||||||||||||||||
Operations
|
$ | (257,431 | ) | $ | 46,255 | $ | 77,641 | $ | (182,801 | ) | $ | (316,336 | ) | |||||||
Investing
|
(9,062 | ) | (7,376 | ) | 32,044 | 464 | 16,070 | |||||||||||||
Financing
|
(17,782 | ) | 3,738 | (38,057 | ) | (18,480 | ) | (70,581 | ) | |||||||||||
Net intercompany
|
287,564 | (57,430 | ) | (4,638 | ) | (225,496 | ) | - | ||||||||||||
Tax
Services. Tax Services has historically been our
largest provider of annual operating cash flows. The seasonal
nature of Tax Services generally results in a large positive
operating cash flow in our fourth quarter. Tax Services used
$257.4 million in its current three-month operations to
cover off-season costs and working capital requirements. This
segment used $9.1 million in investing activities primarily
related to capital expenditures, and used $17.8 million in
financing activities related to book overdrafts.
Business
Services. Business Services funding requirements are
largely related to receivables for completed work and work
in process. We provide funding sufficient to cover their
working capital needs. This segment provided $46.3 million
in operating cash flows during the first three months of the
year, primarily due to collections on receivables. Business
Services used $7.4 million in investing activities
primarily related to capital expenditures.
Consumer
Financial Services. In the first three months of
fiscal year 2009, Consumer Financial Services provided
$77.6 million in cash from its operating activities
primarily due to the timing of cash deposits that are restricted
for the benefit of its broker-dealer clients. The segment
provided $32.0 million in investing activities primarily
from principal payments received on mortgage loans held for
investment and used $38.1 million in financing activities
due to the repayment of $25.0 million in Federal Home Loan
Bank (FHLB) advances.
HRB Bank is a member of the FHLB of Des Moines, which extends
credit to member banks based on eligible collateral. At
July 31, 2008, HRB Bank had FHLB advance capacity of
$373.5 million, and there was $104.0 million
outstanding on this facility. Mortgage loans held for investment
of $917.3 million were pledged as collateral on these
advances.
BORROWINGS
The following chart provides the debt ratings for Block
Financial LLC (BFC) as of July 31, 2008 and April 30,
2008:
July 31,
2008 |
April 30,
2008 |
|||||||||||||||||||||||
Short-term | Long-term | Outlook | Short-term | Long-term | Outlook | |||||||||||||||||||
Fitch
|
F2 | BBB | Stable | F3 | BBB | Negative | ||||||||||||||||||
Moodys
|
P2 | Baa1 | Negative | P2 | Baa1 | Negative | ||||||||||||||||||
S&P
|
A2 | BBB | Positive | A3 | BBB- | Negative | ||||||||||||||||||
DBRS
|
R-2(high | ) | BBB (high | ) | Stable | R-2(high | ) | BBB(high | ) | Negative | ||||||||||||||
26
At July 31, 2008, we maintained $2.0 billion in
revolving credit facilities to support issuance of commercial
paper and for general corporate purposes. These CLOCs, and
borrowings thereunder, have a maturity date of August 2010 and
an annual facility fee in a range of six to fifteen basis points
per annum, based on our credit ratings. We had no balance
outstanding as of July 31, 2008, although we did draw on
the CLOCs in August 2008 to support working capital requirements
primarily arising from off-season operating losses. The CLOCs,
among other things, require we maintain at least
$650.0 million of net worth on the last day of any fiscal
quarter. We had net worth of $836.7 million at
July 31, 2008.
Other than the changes outlined above, there have been no
material changes in our borrowings from those reported at
April 30, 2008 in our Annual Report on
Form 10-K.
CONTRACTUAL
OBLIGATIONS AND COMMERCIAL COMMITMENTS
There have been no material changes in our contractual
obligations and commercial commitments from those reported at
April 30, 2008 in our Annual Report on
Form 10-K.
REGULATORY
ENVIRONMENT
HRBFA is subject to regulatory requirements intended to ensure
the general financial soundness and liquidity of broker-dealers.
At July 31, 2008, HRBFAs net capital of
$60.4 million, which was 14.4% of aggregate debit items,
exceeded its minimum required net capital of $8.4 million
by $52.0 million.
Other than the items discussed above, there have been no
material changes in our regulatory environment from those
reported at April 30, 2008 in our Annual Report on
Form 10-K.
FORWARD-LOOKING
INFORMATION
This report and other documents filed with the Securities and
Exchange Commission (SEC) may contain forward-looking
statements. In addition, our senior management may make
forward-looking statements orally to analysts, investors, the
media and others. Forward-looking statements can be identified
by the fact that they do not relate strictly to historical or
current facts. They often include words such as
expects, anticipates,
intends, plans, believes,
seeks, estimates, will,
would, should, could or
may. Forward-looking statements provide
managements current expectations or predictions of future
conditions, events or results. They may include projections of
revenues, income, earnings per share, capital expenditures,
dividends, liquidity, capital structure or other financial
items, descriptions of managements plans or objectives for
future operations, products or services, or descriptions of
assumptions underlying any of the above. They are not guarantees
of future performance. By their nature, forward-looking
statements are subject to risks and uncertainties. These
statements speak only as of the date made and management does
not undertake to update them to reflect changes or events
occurring after that date except as required by federal
securities laws.
27
RECONCILIATION OF
NON-GAAP FINANCIAL INFORMATION
We report our
financial results in accordance with generally accepted
accounting principles (GAAP). However, we believe certain
non-GAAP performance measures and ratios used in managing the
business may provide additional meaningful comparisons between
current year results and prior periods. Reconciliations to GAAP
financial measures are provided below. These non-GAAP financial
measures should be viewed in addition to, not as an alternative
for, our reported GAAP results.
Banking Ratios | (dollars in 000s) |
Three Months Ended July 31, | 2008 | 2007 | ||||
Efficiency Ratio:
|
||||||
Total Consumer Financial Services expenses
|
$ | 104,415 | $ | 108,166 | ||
Less: Interest and non-banking expenses
|
(91,594) | (104,043) | ||||
Non-interest banking expenses
|
$ | 12,821 | $ | 4,123 | ||
Total Consumer Financial Services revenues
|
$ | 86,679 | $ | 114,372 | ||
Less: Non-banking revenues and interest expense
|
(72,033) | (103,323) | ||||
Banking revenue net of interest expense
|
$ | 14,646 | $ | 11,049 | ||
88% | 37% | |||||
Net Interest Margin (annualized):
|
||||||
Net banking interest income
|
$ | 9,161 | $ | 7,503 | ||
Net banking interest income (annualized)
|
$ | 36,644 | $ | 30,012 | ||
Divided by average bank earning assets
|
$ | 1,026,809 | $ | 1,419,223 | ||
3.57% | 2.11% | |||||
Return on Average Assets (annualized):
|
||||||
Pretax banking income (loss)
|
$ | (14,117) | $ | 4,842 | ||
Pretax banking income (loss), annualized
|
$ | (56,468) | $ | 19,368 | ||
Divided by average bank assets
|
$ | 1,071,044 | $ | 1,442,299 | ||
(5.27%) | 1.34% |
28
Item 7A of our Annual Report on
Form 10-K
for fiscal year 2008 presents discussions of market risks that
may impact our future results. The following should be read in
conjunction with that discussion.
Sensitivity
Analysis. The sensitivities of certain financial
instruments to changes in interest rates as of July 31,
2008 are presented below. The following table represents
hypothetical instantaneous and sustained parallel shifts in
interest rates and should not be relied on as an indicator of
future expected results.
(in 000s) | ||||||||||||||||||||||||||||||||
Carrying
Value at |
Basis Point Change | |||||||||||||||||||||||||||||||
July 31, 2008 | -300 | -200 | -100 | +100 | +200 | +300 | ||||||||||||||||||||||||||
Mortgage loans held for investment
|
$ | 868,603 | $ | 37,057 | $ | 27,088 | $ | 19,077 | $ | (20,764 | ) | $ | (40,581 | ) | $ | (58,717 | ) | |||||||||||||||
Residual interests in securitizations
|
8,466 | 5,916 | 3,782 | 1,698 | (1,545 | ) | (2,489 | ) | (3,207 | ) |
There have been no other material changes in our market risks
from those reported at April 30, 2008 in our Annual Report
on
Form 10-K.
EVALUATION OF
DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this
Form 10-Q,
we evaluated the effectiveness of the design and operation of
our disclosure controls and procedures. The controls evaluation
was done under the supervision and with the participation of
management, including our Chief Executive Officer and Chief
Financial Officer. Based on this evaluation, we have concluded
that our disclosure controls and procedures were effective as of
the end of the period covered by this Quarterly Report on
Form 10-Q.
CHANGES IN
INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes that materially affected, or are
reasonably likely to materially affect, our internal control
over financial reporting.
29
The information below should be read in conjunction with the
information included in note 9 to our condensed
consolidated financial statements.
RAL
Litigation. We reported in our Annual Report on
Form 10-K
for the year ended April 30, 2008, certain events and
information pertaining to lawsuits regarding our refund
anticipation loan programs (collectively, RAL
Cases). The RAL Cases have involved a variety of legal
theories asserted by plaintiffs. These theories include
allegations that, among other things: disclosures in the RAL
applications were inadequate, misleading and untimely; the RAL
interest rates were usurious and unconscionable; we did not
disclose that we would receive part of the finance charges paid
by the customer for such loans; untrue, misleading or deceptive
statements in marketing RALs; breach of state laws on credit
service organizations; breach of contract, unjust enrichment,
unfair and deceptive acts or practices; violations of the
federal Racketeer Influenced and Corrupt Organizations Act;
violations of the federal Fair Debt Collection Practices Act and
unfair competition regarding debt collection activities; and
that we owe, and breached, a fiduciary duty to our customers in
connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial
in some instances, with one settlement resulting in a pretax
expense of $43.5 million in fiscal year 2003 (the
Texas RAL Settlement) and other settlements
resulting in a combined pretax expense in fiscal year 2006 of
$70.2 million.
We believe we have meritorious defenses to the remaining RAL
Cases and we intend to defend them vigorously. There can be no
assurances, however, as to the outcome of the pending RAL Cases
individually or in the aggregate or regarding the impact of the
RAL Cases on our financial statements. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of the currently pending RAL
Cases. There were no significant developments regarding the RAL
Cases during the three months ended July 31, 2008.
Peace of Mind
Litigation.
We are defendants in lawsuits regarding our Peace of Mind
program (collectively, the POM Cases). The POM Cases
are described below.
Lorie J.
Marshall, et al. v. H&R Block Tax Services, Inc., et
al., Case
No. 08-CV-591
in the U.S. District Court for the Southern District of
Illinois, is a class action case originally filed in the Circuit
Court of Madison County, Illinois on January 18, 2002, in
which class certification was granted on August 27, 2003.
Plaintiffs claims consist of five counts relating to the
POM program under which the applicable tax return preparation
subsidiary assumes liability for additional tax assessments
attributable to tax return preparation error. The plaintiffs
allege that the sale of POM guarantees constitutes
(1) statutory fraud by selling insurance without a license,
(2) an unfair trade practice, by omission and by
cramming (i.e., charging customers for the guarantee
even though they did not request it or want it), and (3) a
breach of fiduciary duty. In August 2003, the court certified
the plaintiff classes consisting of all persons who from
January 1, 1997 to final judgment (1) were charged a
separate fee for POM by H&R Block or a
defendant H&R Block class member; (2) reside in
certain class states and were charged a separate fee for POM by
H&R Block or a defendant H&R Block class
member not licensed to sell insurance; and (3) had an
unsolicited charge for POM posted to their bills by
H&R Block or a defendant H&R Block class
member. Persons who received the POM guarantee through an
H&R Block Premium office and persons who reside in Alabama
and Texas were excluded from the plaintiff class. The court also
certified a defendant class consisting of any entity with names
that include H&R Block or HRB, or
are otherwise affiliated or associated with H&R Block Tax
Services, Inc., and that sold or sells the POM product. On
August 5, 2008, the court decertified the defendant class
and reduced the geographical scope of the plaintiff classes from
48 states to 13 states. On August 19, 2008, we
removed the case from state court in Madison County, Illinois to
the U.S. District Court for the Southern District of
Illinois. No trial date has been set.
There is one other putative class action pending against us in
Texas that involves the POM guarantee. This case is pending
before the same judge that presided over the Texas RAL
Settlement, involves the same plaintiffs attorneys that
are involved in the Marshall litigation in Illinois, and
contains similar allegations. No class has been certified in
this case.
30
We believe the claims in the POM Cases are without merit, and we
intend to defend them vigorously. The amounts claimed in the POM
Cases are substantial, however, and there can be no assurances
as to the outcome of these pending actions individually or in
the aggregate. We are unable to determine an estimate of the
possible loss or range of loss, if any, in light of the early
stages of the POM Cases.
Electronic Filing
Litigation.
We are a defendant in a class action filed on
August 30, 2002 and entitled Erin M. McNulty and Brian
J. Erzar v. H&R Block, Inc., et al., Case
No. 02-CIV-4654
in the Court of Common Pleas of Lackawanna County, Pennsylvania,
in which the plaintiffs allege that the defendants deceptively
portray electronic filing fees as a necessary and required
component of standard tax preparation services and do not inform
tax preparation clients that they may (1) file tax returns
free of charge by mailing the returns, (2) electronically
file tax returns from personal computers either free of charge
or at significantly lower fees and (3) be eligible to
electronically file tax returns free of charge via telephone.
The plaintiffs seek unspecified damages and disgorgement of all
electronic filing, tax preparation and related fees collected
during the applicable class period. Class certification was
granted in this case on September 5, 2007. In March 2008,
we reached a tentative agreement to settle this case for an
amount not to exceed $2.5 million and have accrued
$1.5 million, representing our best estimate of ultimate
loss. The settlement was preliminarily approved on June 27,
2008, with a final fairness hearing scheduled for September 2008.
Express IRA
Litigation. On March 15, 2006, the New York
Attorney General filed a lawsuit in the Supreme Court of the
State of New York, County of New York (Index No. 06/401110)
entitled The People of New York v. H&R Block, Inc.
and H&R Block Financial Advisors, Inc. et al. The
complaint alleged fraudulent business practices, deceptive acts
and practices, common law fraud and breach of fiduciary duty
with respect to the Express IRA product and sought equitable
relief, disgorgement of profits, damages and restitution, civil
penalties and punitive damages. On July 12, 2007, the
Supreme Court of the State of New York issued a ruling that
dismissed all defendants other than HRBFA and the claims of
common law fraud. Both the New York Attorney General and HRBFA
have appealed the adverse portions of the trial courts
ruling. We believe the claims in this case are without merit,
and we intend to defend this case vigorously, but there are no
assurances as to its outcome.
On January 2, 2008, the Mississippi Attorney General filed
a lawsuit in the Chancery Court of Hinds County, Mississippi
First Judicial District (Case No. G 2008 6 S
2) entitled Jim Hood, Attorney for the State of
Mississippi v. H&R Block, Inc., et al. The
complaint alleged fraudulent business practices, deceptive acts
and practices, common law fraud and breach of fiduciary duty
with respect to the Express IRA product and sought equitable
relief, disgorgement of profits, damages and restitution, civil
penalties and punitive damages. The defendants have filed a
motion to dismiss. We believe the claims in this case are
without merit, and we intend to defend this case vigorously, but
there are no assurances as to its outcome.
In addition to the New York and Mississippi Attorney General
actions, a number of civil actions were filed against us
concerning the Express IRA product, the first of which was filed
on March 17, 2006. Except for two cases pending in state
court, all of the civil actions have been consolidated by the
panel for Multi-District Litigation into a single action styled
In re H&R Block, Inc. Express IRA Marketing Litigation
in the United States District Court for the Western District
of Missouri. We believe the claims in these cases are without
merit, and we intend to defend these cases vigorously, but there
are no assurances as to their outcome.
We are unable to determine an estimate of the possible loss or
range of loss, if any, in light of the early stages of the
Express IRA litigation.
Securities
Litigation. On April 6, 2007, a putative class
action styled In re H&R Block Securities Litigation
was filed against the Company and certain of its officers in
the United States District Court for the Western District of
Missouri. The complaint alleged, among other things, deceptive,
material and misleading financial statements, failure to prepare
financial statements in accordance with generally accepted
accounting principles and concealment of the potential for
lawsuits stemming from the allegedly fraudulent nature of the
Companys operations. The complaint sought unspecified
damages and equitable relief. On October 5, 2007, the court
dismissed the complaint and granted the plaintiffs leave to
re-file the portion of the complaint pertaining to the
Companys financial statements. On November 19, 2007,
the plaintiffs re-filed the complaint, alleging, among other
things, deceptive, material and misleading financial statements
and failure to prepare financial statements in accordance with
generally accepted accounting principles. The court dismissed
the re-filed complaint on February 19, 2008. On
March 11, 2008, the plaintiffs appealed the dismissal. In
addition, plaintiffs in a shareholder derivative action that was
consolidated into the securities litigation filed a separate
31
appeal on March 18, 2008, contending that the derivative
action was improperly consolidated. The derivative action is
Iron Workers Local 16 Pension Fund v. H&R Block, et
al., in the United States District Court for the Western
District of Missouri, Case
No. 06-cv-00466-ODS
(instituted on June 8, 2006) and was brought against
certain of our directors and officers purportedly on behalf of
the Company. The derivative action alleges breach of fiduciary
duty, abuse of control, gross mismanagement, waste, and unjust
enrichment pertaining to (1) our restatement of financial
results in fiscal year 2006 due to errors in determining our
state effective income tax rate and (2) certain of our
products and business activities. We believe the claims in these
cases are without merit and intend to defend this litigation
vigorously. We currently do not believe that we will incur a
material loss with respect to this litigation.
RSM McGladrey
Litigation. RSM EquiCo, Inc., a subsidiary of RSM
McGladrey, Inc. (RSM), is a party to a putative class action
filed on July 11, 2006 and entitled Do Rights
Plant Growers, et al. v. RSM EquiCo, Inc., et al. Case
No. 06 CC00137, in the California Superior Court, Orange
County. The complaint contains allegations regarding business
valuation services provided by RSM EquiCo, Inc., including
fraud, negligent misrepresentation, breach of contract, breach
of implied covenant of good faith and fair dealing, breach of
fiduciary duty and unfair competition and seeks unspecified
damages, restitution and equitable relief. We intend to defend
this case vigorously. The amount claimed in this action is
substantial and there can be no assurance regarding the outcome
and resolution of this matter. It is reasonably possible that we
could incur losses with respect to this litigation, although an
estimate of such losses cannot be made in light of the early
stage of the litigation.
RSM has a relationship with certain public accounting firms
(collectively, the Attest Firms) pursuant to which
(1) some RSM employees are also partners or employees of
the Attest Firms, (2) many clients of the Attest Firms are
also RSM clients, and (3) our RSM McGladrey brand is
closely linked to the Attest Firms. The Attest Firms are parties
to claims and lawsuits (collectively, Attest Firm
Claims). Judgments or settlements arising from Attest Firm
Claims, which exceed the Attest Firms insurance coverage,
could have a direct adverse effect on Attest Firm operations,
and could impair RSMs ability to attract and retain
clients and quality professionals. Accordingly, although RSM is
not a direct party to significant Attest Firm Claims, such
Attest Firm Claims could have a material adverse effect on
RSMs operations and impair the value of our investment in
RSM. There is no assurance regarding the outcome of the Attest
Firm Claims.
Litigation and
Claims Pertaining to Discontinued Mortgage
Operations. Although SCC terminated its mortgage loan
origination activities and sold its loan servicing business
during fiscal year 2008, it remains subject to investigations,
claims and lawsuits pertaining to its loan origination and
servicing activities that occurred prior to such termination and
sale. These investigations, claims and lawsuits include actions
by state attorneys general, other state regulators,
municipalities, individual plaintiffs, and cases in which
plaintiffs seek to represent a class of others alleged to be
similarly situated. Among other things, these investigations,
claims and lawsuits allege discriminatory or unfair and
deceptive loan origination and servicing practices, public
nuisance, fraud, and violations of the Truth in Lending Act,
Equal Credit Opportunity Act and the Fair Housing Act. In the
current non-prime mortgage environment, the number of these
investigations, claims and lawsuits has increased over
historical experience and is likely to continue at increased
levels. The amounts claimed in these investigations, claims and
lawsuits are substantial in some instances, and the ultimate
resulting liability is difficult to predict. In the event of
unfavorable outcomes, the amounts SCC may be required to pay in
the discharge of liabilities or settlements could be substantial
and, because SCCs operating results are included in our
consolidated financial statements, could have a material adverse
impact on our consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a
lawsuit in the Superior Court of Suffolk County, Massachusetts
(Case
No. 08-2474-BLS)
entitled Commonwealth of Massachusetts v. H&R
Block, Inc., et al., alleging unfair, deceptive and
discriminatory origination and servicing of mortgage loans and
seeks equitable relief, disgorgement of profits, restitution and
statutory penalties. We believe the claims in this case are
without merit, and we intend to defend this case vigorously, but
there are no assurances as to its outcome. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of this litigation.
SCC also remains subject to potential claims for indemnification
and loan repurchases pertaining to loans previously sold. In the
current non-prime mortgage environment, it is likely that the
frequency of repurchase and indemnification claims may increase
over historical experience and give rise to additional
litigation. In some instances, H&R Block, Inc. was required
to guarantee SCCs obligations. The amounts involved in
these potential claims may be substantial, and the ultimate
resulting liability is difficult to predict. In the event of
32
unfavorable outcomes, the amounts SCC may be required to pay in
the discharge or settlement of these claims could be substantial
and, because SCCs operating results are included in our
consolidated financial statements, could have a material adverse
impact on our consolidated results of operations.
Other Claims and
Litigation. We have from time to time been party to
investigations, claims and lawsuits not discussed herein arising
out of our business operations. These investigations, claims and
lawsuits include actions by state attorneys general, other state
regulators, individual plaintiffs, and cases in which plaintiffs
seek to represent a class of others similarly situated. Some of
these investigations, claims and lawsuits pertain to RALs, the
electronic filing of customers income tax returns, the POM
guarantee program, wage and hour claims and investment products.
We believe we have meritorious defenses to each of these claims,
and we are defending or intend to defend them vigorously. The
amounts claimed in these claims and lawsuits are substantial in
some instances, however the ultimate liability with respect to
such litigation and claims is difficult to predict. In the event
of an unfavorable outcome, the amounts we may be required to pay
in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are parties
to claims and lawsuits that we consider to be ordinary, routine
litigation incidental to our business, including claims and
lawsuits (collectively, Other Claims) concerning
investment products, the preparation of customers income
tax returns, the fees charged customers for various products and
services, losses incurred by customers with respect to their
investment accounts, relationships with franchisees,
intellectual property disputes, employment matters and contract
disputes. While we cannot provide assurance that we will
ultimately prevail in each instance, we believe the amount, if
any, we are required to pay in the discharge of liabilities or
settlements in these Other Claims will not have a material
adverse effect on our consolidated operating results or
financial position.
There have been no material changes in our risk factors from
those reported at April 30, 2008 in our Annual Report on
Form 10-K.
A summary of our purchases of H&R Block common stock during
the first quarter of fiscal year 2009 is as follows:
(in 000s, except per share amounts) | ||||||||||||
Total Number of
Shares |
Maximum $ Value |
|||||||||||
Total |
Average |
Purchased as Part
of |
of Shares that
May |
|||||||||
Number of Shares |
Price Paid |
Publicly
Announced |
Be Purchased
Under |
|||||||||
Purchased(1) | per Share | Plans or Programs(2) | the Plans or Programs(2) | |||||||||
May 1 May 31
|
6 | $ | 22.85 | - | $ | 2,000,000 | ||||||
June 1 June 30
|
10 | $ | 22.65 | - | $ | 2,000,000 | ||||||
July 1 July 31
|
174 | $ | 21.53 | - | $ | 2,000,000 |
(1) | We purchased 190,301 shares in connection with the funding of employee income tax withholding obligations arising upon the exercise of stock options or the lapse of restrictions on nonvested shares. | |
(2) | In June 2008, our Board of Directors rescinded previous authorizations to repurchase shares of our common stock, and approved an authorization to purchase up to $2.0 billion of our common stock over the next four years. |
3 | .1 | Amended and Restated Bylaws of H&R Block, Inc., as amended and restated as of June 11, 2008. | ||
10 | .1 | Employment Agreement dated July 19, 2008 between H&R Block Management LLC and Russell P. Smyth. | ||
31 | .1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31 | .2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32 | .1 | Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32 | .2 | Certification by Chief Financial Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. |
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
H&R BLOCK,
INC.
/s/ Russell
P. Smyth
Russell
P. Smyth
President and Chief
Executive Officer
September 3,
2008
/s/ Becky
S.
Shulman
Becky
S. Shulman
Senior Vice
President, Treasurer and
Chief Financial
Officer
September 3,
2008
/s/ Jeffrey
T. Brown
Jeffrey
T. Brown
Vice
President and
Corporate
Controller
September 3,
2008
34