H&R BLOCK INC - Quarter Report: 2009 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

FORM 10-Q

 

 

 

Commission file number 1-6089

 

 

H&R Block, Inc.

(Exact name of registrant as specified in its charter)

 

 

One H&R Block Way

Kansas City, Missouri 64105

(Address of principal executive offices, including zip code)

 

(816) 854-3000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes   Ö    No        

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   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) :

 

 

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 registrant’s Common Stock, without par value, at the close of business on November 30, 2009 was 335,541,241 shares.

 

 

Form 10-Q for the Period Ended October 31, 2009

 

 

Table of Contents

 

 

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS (amounts in 000s, except share and per share amounts)

 

 

See Notes to Condensed Consolidated Financial Statements

 

 

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

 

 

Basis of Presentation

The condensed consolidated balance sheet as of October 31, 2009, the condensed consolidated statements of operations and comprehensive income (loss) for the three and six months ended October 31, 2009 and 2008, and the condensed consolidated statements of cash flows for the six months ended October 31, 2009 and 2008 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows at October 31, 2009 and for all periods presented have been made.

“H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.

Certain reclassifications have been made to prior year amounts to conform to the current year presentation. In addition, we realigned our segments as discussed in note 12, and accordingly restated segment disclosures for prior periods. These changes 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, 2009 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of April 30, 2009 or for the year then ended, are derived from our April 30, 2009 Annual Report to Shareholders on Form 10-K.

We have evaluated subsequent events through December 9, 2009, the date of issuance of our condensed consolidated financial statements.

 

Management Estimates

The preparation of financial statements in conformity with 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. Significant estimates, assumptions and judgments are applied in the determination of our allowance for loan losses, potential losses from loan repurchase and indemnity obligations associated with our discontinued mortgage business, contingent losses associated with pending litigation, fair value of reporting units, reserves for uncertain tax positions and related matters. We revise our estimates when facts and circumstances dictate. However, future events and their effects cannot be determined with absolute certainty. As such, actual results could differ materially from those estimates.

 

Seasonality of Business

Our operating revenues are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.

 

Concentrations of Risk

Our mortgage loans held for investment include concentrations of loans to borrowers in certain states, which may result in increased exposure to loss as a result of changes in real estate values and underlying economic or market conditions related to a particular geographical location. Approximately 52% of our mortgage loan portfolio consists of loans to borrowers located in the states of Florida, California and New York.

 

RSM McGladrey, Inc. (RSM) and McGladrey & Pullen LLP (M&P), an independent registered public accounting firm, collaborate to provide accounting, tax and consulting services to clients under an

 

alternative practice structure. RSM and M&P also share in certain common overhead costs through an administrative services agreement. These services are provided by, and coordinated through, RSM, for which RSM receives a management fee.

On July 21, 2009, M&P provided 210 days notice of its intent to terminate the administrative services agreement. The effect of the notice will be to terminate the alternative practice structure on February 16, 2010, unless revoked or modified prior to that time. As a protective measure, on September 15, 2009, RSM provided notice of its intent to terminate the administrative services agreement. Absent revocation or modification by RSM, the effect of RSM’s notice will be to terminate the alternative practice structure on April 13, 2010 even in the event M&P revokes or modifies the M&P notice. Since July 23, 2009, RSM and M&P have been engaged in arbitration to resolve various disputes regarding their contractual relationship, including the scope and enforceability of restrictive covenants agreed to by M&P. On November 24, 2009, the arbitration panel issued a final and binding ruling regarding the enforceability of the covenants. The ruling is confidential. RSM and M&P are continuing negotiations to determine if there are mutually agreeable changes to the current arrangements that would allow the alternative practice structure with M&P to continue. There are no assurances as to the outcome of these negotiations.

 

Basic and diluted loss per share is computed using the two-class method. See note 13 for additional information on our adoption of the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income from continuing operations attributable to common shareholders by the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share except in those periods with a loss from continuing operations. Diluted earnings per share excludes the impact of shares of common stock issuable upon the lapse of certain restrictions or the exercise of options to purchase 19.3 million shares for the three and six months ended October 31, 2009, and 23.7 million shares for the three and six months ended October 31, 2008, as the effect would be antidilutive due to the net loss from continuing operations during each period.

The computations of basic and diluted loss per share from continuing operations are as follows:

 

(in 000s, except per share amounts)
		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2008				2009				2008
Net loss from continuing operations attributable to shareholders		$	(126,472	)		$	(133,161	)		$	(257,089	)		$	(261,584	)
Amounts allocated to participating securities (nonvested shares)			(27	)			248				340				447
Net loss from continuing operations attributable to common shareholders		$	(126,445	)		$	(133,409	)		$	(257,429	)		$	(262,031	)
Basic weighted average common shares			335,346				329,810				334,939				328,475
Potential dilutive shares from stock options and nonvested shares			-				-				-				-
Convertible preferred stock			-				-				-				-
Dilutive weighted average common shares			335,346				329,810				334,939				328,475
Earnings (loss) per share from continuing operations attributable to common shareholders:
Basic		$	(0.38	)		$	(0.40	)		$	(0.77	)		$	(0.80	)
Diluted			(0.38	)			(0.40	)			(0.77	)			(0.80	)

The weighted average shares outstanding for the three and six months ended October 31, 2009 increased to 335.3 million and 334.9 million, respectively, from 329.8 million and 328.5 million for the three and six months ended October 31, 2008, respectively, primarily due to the issuance of shares of our common stock in October 2008.

 

During the six months ended October 31, 2009 and 2008, we issued 1.6 million and 4.5 million shares of common stock, respectively, due to the exercise of stock options, employee stock purchases and vesting of nonvested shares.

During the six months ended October 31, 2009, we acquired 0.2 million shares of our common stock at an aggregate cost of $3.8 million, and during the six months ended October 31, 2008, we acquired 0.2 million shares at an aggregate cost of $4.5 million. Shares acquired during these periods represented shares swapped or surrendered to us in connection with the vesting of nonvested shares and the exercise of stock options.

During the six months ended October 31, 2009, we granted 4.6 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 $3.27 for management options and $2.70 for options granted to our seasonal associates. Stock-based compensation expense totaled $4.8 million and $12.1 million for the three and six months ended October 31, 2009, respectively, and $8.5 million and $13.0 million for the three and six months ended October 31, 2008, respectively. At October 31, 2009, unrecognized compensation cost for options totaled $17.1 million, and for nonvested shares and units totaled $23.4 million.

 

The composition of our mortgage loan portfolio as of October 31, 2009 and April 30, 2009 is as follows:

 

														(dollars in 000s)
		October 31, 2009								April 30, 2009
As of		Amount				% of Total				Amount				% of Total
Adjustable-rate loans		$	472,292				62	%		$	534,943				65	%
Fixed-rate loans			288,824				38	%			286,894				35	%
			761,116				100	%			821,837				100	%
Unamortized deferred fees and costs			5,926								7,135
Less: Allowance for loan losses			(95,993	)							(84,073	)
		$	671,049							$	744,899

Activity in the allowance for loan losses for the six months ended October 31, 2009 and 2008 is as follows:

(in 000s)

Six Months Ended October 31,		2009				2008
Balance, beginning of the period		$	84,073			$	45,401
Provision			27,000				38,083
Recoveries			29				3
Charge-offs			(15,109	)			(19,835	)
Balance, end of the period		$	95,993			$	63,652

Our loan loss reserve as a percent of mortgage loans was 12.61% at October 31, 2009, compared to 10.23% at April 30, 2009.

 

In cases where we modify a loan and in so doing grant a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (TDR). TDR loans totaled $159.9 million and $160.7 million at October 31, 2009 and April 30, 2009, respectively. The principal balance of impaired loans and real estate owned as of October 31, 2009 and April 30, 2009 is as follows:

(in 000s)

As of		October 31, 2009				April 30, 2009
Impaired loans:
60 – 89 days		$	19,976			$	21,415
90+ days, non-accrual			157,282				121,685
TDR loans, accrual			98,547				60,044
TDR loans, non-accrual			61,318				100,697
			337,123				303,841
Real estate owned(1)			38,895				44,533
Total non-performing assets		$	376,018			$	348,374

Activity related to our real estate owned is as follows:

(in 000s)

Six Months Ended October 31,		2009				2008
Balance, beginning of the period		$	44,533			$	350
Additions			9,212				62,578
Sales			(10,055	)			(3,787	)
Impairments			(4,795	)			(5,938	)
Balance, end of the period		$	38,895			$	53,203

 

Changes in the carrying amount of goodwill for the six months ended October 31, 2009 consist of the following:

(in 000s)

		April 30, 2009				Additions				Impairment				Other				October 31, 2009
Tax Services		$	447,591			$	6,227			$	-			$	1,862			$	455,680
Business Services			402,639				-				-				(1,439	)			401,200
Total		$	850,230			$	6,227			$	-			$	423			$	856,880

We test goodwill for impairment annually at the beginning of our fourth quarter, or more frequently if events occur which could, more likely than not, reduce the fair value of a reporting unit’s net assets below its carrying value.

We considered the July 21, 2009 notice by M&P of its intent to terminate the administrative services agreement with RSM to represent a significant change in circumstances requiring an interim evaluation of the fair value of our RSM reporting unit. Goodwill of this reporting unit totaled $371.9 million at October 31, 2009. The net carrying value of other intangible assets of RSM totaled $92.4 million at October 31, 2009, including $50.8 million for an indefinite-lived trade name asset. We have concluded that, as of October 31, 2009, the fair value of this reporting unit exceeds its carrying value and also that the net carrying value of other intangible assets is recoverable.

Our conclusion is based on our current assumptions, including, but not limited to, those listed below.

 

It is difficult to predict the outcome of the above matters, including the outcome of mitigating factors that we are currently pursuing. Therefore, it is possible that changes in our assumptions, based on future events or circumstances, could result in changes in our fair value estimates and corresponding impairment charges.

RSM’s subsidiary, RSM EquiCo, Inc. (RSM EquiCo), which assists clients with capital markets transactions, has experienced declining revenues in the current economic environment. If availability of financing for acquisitions in the middle-market remains limited, revenues may continue to fall below our expectations, which could lead us to consider impairment of the $29.3 million carrying value of goodwill related to our capital markets business.

Intangible assets consist of the following:

 

																						(in 000s)
As of		October 31, 2009												April 30, 2009
		Gross												Gross
		Carrying				Accumulated								Carrying				Accumulated
		Amount				Amortization				Net				Amount				Amortization				Net
Tax Services:
Customer relationships		$	61,475			$	(29,237	)		$	32,238			$	54,655			$	(25,267	)		$	29,388
Noncompete agreements			22,537				(20,808	)			1,729				23,263				(20,941	)			2,322
Reacquired franchise rights			229,438				(4,045	)			225,393				229,438				(1,838	)			227,600
Franchise agreements			19,201				(1,173	)			18,028				19,201				(533	)			18,668
Purchased technology			12,500				(5,219	)			7,281				12,500				(4,240	)			8,260
Trade name			1,325				(300	)			1,025				1,025				(217	)			808
Business Services:
Customer relationships			145,177				(115,558	)			29,619				146,040				(111,017	)			35,023
Noncompete agreements			33,061				(21,031	)			12,030				33,068				(19,908	)			13,160
Trade name – amortizing			2,600				(2,600	)			-				2,600				(2,600	)			-
Trade name – non-amortizing			55,637				(4,868	)			50,769				55,637				(4,868	)			50,769
		$	582,951			$	(204,839	)		$	378,112			$	577,427			$	(191,429	)		$	385,998

Amortization of intangible assets for the three and six months ended October 31, 2009 was $7.5 million and $14.4 million, respectively, and $8.0 million and $13.6 million, for the three and six months ended October 31, 2008, respectively. Estimated amortization of intangible assets for fiscal years 2010 through 2014 is $29.7 million, $27.1 million, $24.1 million, $19.8 million and $16.4 million, respectively.

 

We file a consolidated federal income tax return in the United States and file tax returns in various state and foreign jurisdictions. Consolidated tax returns for the years 1999 through 2007 are currently under examination by the Internal Revenue Service. 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 six months ended October 31, 2009, we accrued an additional $0.8 million for interest and penalties related to our uncertain tax positions. We had unrecognized tax benefits of $121.9 million and $124.6 million at October 31, 2009 and April 30, 2009, respectively. The unrecognized tax benefits decreased $2.7 million in the current year, due primarily to positions related to prior years. Except as noted below, we have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at October 31, 2009, which is included in other noncurrent liabilities on the condensed consolidated balance sheets.

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 reserves for previously unrecognized tax benefits may decrease by approximately $16 million within twelve months of October 31, 2009. This portion of our liability for unrecognized tax benefits has been classified as current and is

 

included in accounts payable, accrued expenses and other current liabilities on the condensed consolidated balance sheets.

 

The following table shows the components of interest income and expense of our continuing operations:

 

		(in 000s)
		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2008				2009				2008
Interest income:
Mortgage loans		$	8,072			$	12,098			$	15,968			$	25,363
Other			4,041				4,949				8,432				9,531
		$	12,113			$	17,047			$	24,400			$	34,894
Interest expense:
Borrowings		$	18,514			$	21,054			$	37,471			$	39,226
Deposits			2,284				3,884				4,333				7,927
FHLB advances			508				1,327				1,017				2,655
		$	21,306			$	26,265			$	42,821			$	49,808

 

The following table presents for each hierarchy level the financial assets that are measured at fair value on both a recurring and non-recurring basis at October 31, 2009:

 

		(dollars in 000s)
		Total				Level 1				Level 2				Level 3
Recurring:
Available-for-sale securities		$	40,702			$	-			$	40,702			$	-
Non-recurring:
Impaired mortgage loans held for investment			252,351				-				-				252,351
		$	293,053			$	-			$	40,702			$	252,351
As a percentage of total assets			5.9%				-%				0.8%				5.1%

There were no significant changes to the unobservable inputs used in determining the fair values of our level 2 and level 3 financial assets.

The carrying amounts and estimated fair values of our financial instruments at October 31, 2009 are as follows:

 

(in 000s)

		Carrying				Estimated
		Amount				Fair Value
Mortgage loans held for investment		$	671,049			$	506,622
IRAs and other time deposits			732,355				732,245
Long-term debt			1,032,562				1,106,878

 

H&R Block Bank (HRB Bank) files its regulatory Thrift Financial Report (TFR) on a calendar quarter basis with the Office of Thrift Supervision (OTS). The following table sets forth HRB Bank’s regulatory capital requirements at September 30, 2009, as calculated in the most recently filed TFR:

 

(dollars in 000s)
																		To Be Well Capitalized
										For Capital Adequacy								Under Prompt Corrective
		Actual								Purposes								Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio(1)		$	287,082				50.1%			$	45,883				8.0%			$	57,354				10.0%
Tier 1 risk-based capital ratio(2)		$	279,460				48.7%				N/A				N/A			$	34,412				6.0%
Tier 1 capital ratio (leverage)(3)		$	279,460				19.4%			$	172,746				12.0%			$	71,977				5.0%
Tangible equity ratio(4)		$	279,460				19.4%			$	21,593				1.5%				N/A				N/A

Block Financial LLC (BFC) typically makes capital contributions to HRB Bank to help it meet its capital requirements. Capital contributions totaling $245.0 million were made by BFC during the fiscal year ended April 30, 2009. BFC made capital contributions to HRB Bank of $150.0 million during the six months ended October 31, 2009 and, in November 2009, BFC made an additional capital contribution to HRB Bank of $85.0 million. As of October 31, 2009, HRB Bank’s leverage ratio was 14.6%.

 

Changes in deferred revenue balances 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)
Six Months Ended October 31,		2009				2008
Balance, beginning of period		$	146,807			$	140,583
Amounts deferred for new guarantees issued			1,351				1,148
Revenue recognized on previous deferrals			(47,044)				(45,826)
Balance, end of period		$	101,114			$	95,905

The following table summarizes certain of our other contractual obligations and commitments:

 

						(in 000s)
As of		October 31, 2009				April 30, 2009
Franchise Equity Lines of Credit – undrawn commitment		$	29,286			$	38,055
Contingent business acquisition obligations			24,973				24,165
Media advertising purchase obligation			45,768				45,768

We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. 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 are 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 guarantees and indemnifications relating to our continuing operations is not material as of October 31, 2009.

 

Discontinued Operations

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. At October 31, 2009 and April 30, 2009, our loan repurchase reserve totaled $201.2 million and $206.6 million, respectively. This liability is included in accounts payable, accrued expenses and other current liabilities on our condensed consolidated balance sheets.

 

We are party to investigations, legal claims and lawsuits arising out of our business operations. As required, we accrue our best estimate of loss contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss. Amounts accrued, including obligations under indemnifications, totaled $32.9 million and $27.9 million at October 31, 2009 and April 30, 2009, respectively. Litigation is inherently unpredictable and it is difficult to predict the outcome of particular matters with reasonable certainty and, therefore, the actual amount of any loss may prove to be larger or smaller than the amounts reflected in our consolidated financial statements.

 

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 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 have settled all but one of the RAL Cases. The sole remaining RAL Case is a putative class action entitled Sandra J. Basile, et al. v. H&R Block, Inc., et al., April Term 1992 Civil Action No. 3246 in the Court of Common Pleas, First Judicial District Court of Pennsylvania, Philadelphia County, instituted on April 23, 1993. The plaintiffs seek unspecified actual and punitive damages, injunctive relief, attorneys’ fees and costs. A Pennsylvania class was certified, but later decertified by the trial court in December 2003. The trial court’s decertification decision is currently on appeal. We believe we have meritorious defenses to this case and intend to defend it vigorously. There can be no assurances, however, as to the outcome of this case or its impact on our consolidated results of operations.

 

Peace of Mind Litigation

We are defendants in lawsuits regarding our Peace of Mind program (collectively, the “POM Cases”), under which our applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. 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 putative class action case originally filed in the Circuit Court of Madison County, Illinois on January 18, 2002. 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. The plaintiffs seek unspecified damages, attorneys’ fees and costs. The Madison County court ultimately certified a class consisting of all persons residing in 13 states who from January 1, 1997 to final judgment (1) were charged a separate fee for POM by “H&R Block;” (2) were charged a separate fee for POM by an “H&R Block” entity not licensed to sell insurance; or (3) had an unsolicited charge for POM posted to their bills by “H&R Block.” Persons who

 

received the POM guarantee through an H&R Block Premium office were excluded from the class. We subsequently removed the case to federal court in the Southern District of Illinois, where it is now pending. In November 2009, the federal court issued an order effectively vacating the state court’s class certification ruling and allowing plaintiffs time to file a renewed motion for class certification under the federal rules.

There is one other putative class action pending against us in Texas that involves the POM guarantee. This case, styled Desiri L. Soliz v. H&R Block, et al. (Cause No. 03-032-D), was filed on January 23, 2003 in the District Court of Kleberg County, Texas and 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 allegations similar to those in the Marshall case. The plaintiff seeks actual and treble damages, equitable relief, attorney fees and costs. No class has been certified in this case.

We believe we have meritorious defenses to the claims in the POM Cases, 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 or their impact on our consolidated results of operations individually or in the aggregate.

 

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 asserts nationwide jurisdiction and alleges fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and seeks equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. In July 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than H&R Block Financial Advisors, Inc. (HRBFA) and the claims of common law fraud. The intermediate appellate court reversed this ruling in January 2009. The amount claimed in this case is substantial. We believe we have meritorious defenses to the claims in this case and intend to defend this case vigorously. There can be no assurances, however, as to the outcome of this case or its impact on our consolidated results of operations.

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 alleges fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and seeks equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. The defendants have filed a motion to dismiss. We believe we have meritorious defenses to the claims in this case, and we intend to defend this case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated results of operations.

In addition to the New York and Mississippi Attorney General actions, a number of civil actions were filed against HRBFA and us concerning the Express IRA product, the first of which was filed on March 15, 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 (Case No. 06-1786-MD-RED) in the United States District Court for the Western District of Missouri. The amounts claimed in these cases are substantial. We believe we have meritorious defenses to the claims in these cases and intend to defend these cases vigorously, but there can be no assurances as to their outcome or their impact on our consolidated results of operations.

Although we sold HRBFA effective November 1, 2008, we remain responsible for any liabilities relating to the Express IRA litigation through an indemnification agreement.

 

Securities and Shareholder Litigation

On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation (Case No. 06-0236-CV-W-ODS) 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 and failure to prepare financial statements in accordance with generally accepted accounting principles. The complaint sought unspecified damages and equitable relief. The court dismissed the complaint in February 2008, and the plaintiffs appealed the dismissal in March 2008.

 

In addition, plaintiffs in a shareholder derivative action that was consolidated into the securities litigation filed a separate appeal in March 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 alleged 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. In September 2009, the appellate court affirmed the dismissal of the securities fraud class action, but reversed the dismissal of the shareholder derivative action. We believe we have meritorious defenses to the claims in the shareholder derivative action and intend to defend the action vigorously. There can be no assurances, however, as to its outcome.

 

RSM McGladrey Litigation

RSM EquiCo, its parent and certain of its subsidiaries and affiliates, are parties to a class action filed on July 11, 2006 and entitled Do Right’s 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 relating to business valuation services provided by RSM EquiCo, including allegations of fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition. Plaintiffs seek unspecified actual and punitive damages, in addition to pre-judgment interest and attorneys’ fees. On March 17, 2009, the court granted plaintiffs’ motion for class certification on all claims. The defendants filed two requests for interlocutory review of the decision, the last of which was denied by the Supreme Court of California on September 30, 2009. A trial date has been set for January 2011.

The certified class consists of all RSM EquiCo U.S. clients who signed platform agreements and for whom RSM EquiCo did not ultimately market their business for sale. The fees paid to RSM EquiCo in connection with these agreements total approximately $185 million, a number which substantially exceeds the equity of RSM EquiCo. We intend to defend this case vigorously. The amount claimed in this action is substantial and could have a material adverse impact on our consolidated results of operations. There can be no assurance regarding the outcome of this matter.

On December 7, 2009, a lawsuit was filed in the Circuit Court of Cook County, Illinois (2009-L-014920) against M&P, RSM and H&R Block entitled Ronald R. Peterson ex rel. Lancelot Investors Fund, L.P., et al. v. McGladrey & Pullen LLP, et al. The complaint, which was filed by the trustee for certain bankrupt investment funds, seeks unspecified damages and asserts claims against M&P for failure to meet generally accepted auditing standards and failure to detect fraud in financial statement audits. The complaint also asserts claims for vicarious liability and alter ego liability against RSM, and for equitable restitution against H&R Block. We are evaluating the claims asserted and have not yet formed an opinion about the case or its materiality.

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”) arising in the normal course of business. Judgments or settlements arising from Attest Firm Claims exceeding the Attest Firms’ insurance coverage could have a direct adverse effect on Attest Firm operations and could impair RSM’s ability to attract and retain clients and quality professionals. For example, accounting and auditing firms (including one of the Attest Firms) have become subject to claims based on losses their clients suffered from investments in investment funds managed by third parties. Although RSM may not have a direct liability for significant Attest Firm Claims, such Attest Firm Claims could have a material adverse effect on RSM’s operations and impair the value of our investment in RSM. There is no assurance regarding the outcome of the Attest Firm Claims.

See note 2 for discussion of the arbitration proceeding between RSM and M&P.

 

 

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 SCC’s 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 seeking equitable relief, disgorgement of profits, restitution and statutory penalties. In November 2008, the court granted a preliminary injunction limiting the ability of the owner of SCC’s former loan servicing business to initiate or advance foreclosure actions against certain loans originated by SCC or its subsidiaries without (1) advance notice to the Massachusetts Attorney General and (2) if the Attorney General objects to foreclosure, approval by the court. The preliminary injunction generally applies to loans meeting all of the following four characteristics: (1) adjustable rate mortgages with an introductory period of three years or less; (2) the borrower has a debt-to-income ratio generally exceeding 50 percent; (3) an introductory interest rate at least 2 percent lower than the fully indexed rate (unless the debt-to-income ratio is 55% or greater); and (4) loan-to-value ratio of 97 percent or certain prepayment penalties. We have appealed this preliminary injunction. We believe the claims in this case are without merit, and we intend to defend this case vigorously. There can be no assurances, however, as to its outcome or its impact on our consolidated results of operations.

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 SCC’s obligations. The amounts involved in these potential claims may be substantial, and the ultimate resulting liability is difficult to predict. Because SCC’s operating results are included in our consolidated financial statements, the amounts SCC may be required to pay in the discharge or settlement of these claims in the event of unfavorable outcomes could have a material adverse impact on our consolidated results of operations.

 

Other Claims and Litigation

We are from time to time 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 investigations, claims and lawsuits, and we are defending or intend to defend them vigorously. The amounts claimed in these matters are substantial in some instances, however the ultimate liability with respect to such matters 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 have a material adverse impact on our consolidated results of operations.

In addition to the aforementioned types of matters, we are party to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (collectively,

 

“Other Claims”) concerning the preparation of customers’ income tax returns, the fees charged customers for various products and services, 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.

 

Results of our continuing operations by reportable operating segment are as follows:

 

Effective May 1, 2009, we realigned certain segments of our business to reflect a new management reporting structure. The operations of HRB Bank, which was previously reported as the Consumer Financial Services segment, have now been reclassified, with activities that support our retail tax network included in the Tax Services segment, and the net interest margin and gains and losses relating to our portfolio of mortgage loans held for investment and related assets included in corporate. Presentation of prior period results reflects the new segment reporting structure.

These segment changes also resulted in the reclassification of assets between segments. Identifiable assets by reportable segment at October 31, 2009 are as follows:

 

 

In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2009-13, “Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements” (ASU 2009-13). This guidance amends the criteria for separating consideration in multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (1) vendor-specific objective evidence; (2) third-party evidence; or (3) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. This guidance is effective prospectively for revenue arrangements entered into or materially modified beginning with our fiscal year 2012. We are currently evaluating the effect of this statement on our consolidated financial statements.

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (SFAS 167). SFAS 167 changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting or similar rights should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. SFAS 167 will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. SFAS 167 will be effective for our fiscal year 2011. We are currently evaluating the effect of this statement on our consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets” (SFAS 166). SFAS 166 is a revision to FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” and will require more disclosure about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a qualifying special purpose entity and changes the requirements for derecognizing financial assets. SFAS 166 will be effective at the beginning of our fiscal year 2011. We are currently evaluating the effect of this statement on our consolidated financial statements.

In May 2009, the FASB issued guidance, under Topic 855 – Subsequent Events, to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance is effective for fiscal years and interim periods ending after June 15, 2009 and is applied prospectively. We adopted the new disclosure requirements in our condensed consolidated financial statements effective July 31, 2009.

In December 2007, the FASB issued guidance, under Topic 805 – Business Combinations, requiring 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. This guidance will require acquisition-related expenses to be expensed and will generally require contingent consideration to be recorded as a liability at the time of acquisition. Under this guidance, subsequent changes to deferred tax valuation allowances relating to acquired businesses and acquired liabilities for uncertain tax positions will no longer be applied to goodwill but will instead be typically recognized as an adjustment to income tax expense. We adopted the provisions of this guidance as of May 1, 2009. The adoption did not have a material impact on our consolidated financial statements.

In June 2008, the FASB issued guidance, under Topic 260 – Earnings Per Share, addressing 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. We adopted the provisions of this guidance as of May 1, 2009. The adoption and retrospective application of this guidance did not change the current year or prior period earnings per share amounts for the fiscal quarter. The adoption of this accounting guidance will reduce earnings per share as previously reported for fiscal year 2009 by $0.01. See additional discussion in note 3.

 

BFC is an indirect, wholly-owned consolidated subsidiary of the Company. BFC is the Issuer and the Company is the Guarantor of 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 Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions.

 

 

 

 

 

 

Six Months Ended		H&R Block, Inc.				BFC				Other								Consolidated
October 31, 2008		(Guarantor)				(Issuer)				Subsidiaries				Elims				H&R Block
Total revenues		$	-			$	39,101			$	587,006			$	(2,729	)		$	623,378
Cost of revenues			-				92,444				712,656				(15	)			805,085
Selling, general and administrative			-				30,544				224,878				(182	)			255,240
Total expenses			-				122,988				937,534				(197	)			1,060,325
Operating loss			-				(83,887	)			(350,528	)			(2,532	)			(436,947	)
Other income (expense), net			(440,423	)			(3,890	)			414				440,423				(3,476	)
Loss from continuing operations before tax benefit			(440,423	)			(87,777	)			(350,114	)			437,891				(440,423	)
Income tax benefit			(178,839	)			(34,540	)			(143,271	)			177,811				(178,839	)
Net loss from continuing operations			(261,584	)			(53,237	)			(206,843	)			260,080				(261,584	)
Net loss from discontinued operations			(7,009	)			(8,464	)			-				8,464				(7,009	)
Net loss		$	(268,593	)		$	(61,701	)		$	(206,843	)		$	268,544			$	(268,593	)