H&R Block, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Three months ended July 31, 2014. H&R Block provides assisted and do-it-yourself tax preparation, along with related financial products. Results are highly seasonal: peak revenue typically occurs from February through April, so this quarter’s results are not indicative of the full year.
Financial results
Amounts are in millions, except per-share data and percentages.
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Revenue | $133.6 | $127.2 |
| Operating loss | $(175.1) | $(179.6) |
| Loss from continuing operations | $(108.9) | $(113.3) |
| Net loss, including discontinued operations | $(116.2) | $(115.2) |
| Loss per share, consolidated | $(0.42) | $(0.42) |
| Operating margin | (131.1%) | (141.2%) |
| Cash used in operating activities | $(381.6) | $(318.7) |
- Revenue rose 5.0%. Tax Services revenue increased $7.4 million to $129.1 million; the company attributed the increase primarily to the Canadian tax season extending to May 5.
- Operating loss narrowed by $4.4 million, while net loss widened by $1.0 million, mainly reflecting a larger loss from discontinued operations. Tax Services’ pretax loss increased to $150.6 million from $144.4 million.
- Management-reported EBITDA from continuing operations was a loss of $128.2 million, versus a loss of $147.2 million. Adjusted EBITDA was a loss of $126.2 million versus $138.7 million; these are non-GAAP measures.
- Cash and cash equivalents were $1.429 billion at July 31, down $755.8 million from April 30. This includes restricted cash of $71.9 million; the filing also notes that some bank-held and foreign cash is not freely available for general corporate use.
- Total debt was approximately $906.4 million: $400.7 million current and $505.7 million long-term. A $400 million, 5.125% note was due in October 2014. The company also had a $1.5 billion committed credit line scheduled to expire in August 2017.
- Total assets were $3.891 billion and total liabilities were $2.494 billion. The quarterly dividend declared was $0.20 per share; dividends paid were $54.9 million.
Material changes and management commentary
- Operating cash outflow increased $62.8 million year over year, primarily due to higher bonus and payroll-tax payments and unfavorable changes in restricted cash balances. Financing cash outflow increased to $348.4 million, principally reflecting deposit-account closures related to the planned bank transaction.
- Tax Services expenses increased $13.6 million. Higher compensation and depreciation and amortization were partly offset by lower other expenses, including lower foreign-currency losses and legal expenses. Corporate pretax loss improved to $25.3 million from $40.1 million, primarily due to lower mortgage-loan loss provisions and lower consulting expenses related to the planned transaction.
- The company had agreed to sell certain H&R Block Bank assets and transfer liabilities, including all deposits, to BofI Federal Bank, subject to regulatory approvals and other closing conditions. Had the transaction closed on July 31, the estimated cash payment to BofI would have been approximately $465 million; actual closing amounts could differ. The company intended to liquidate approximately $404 million of bank-held available-for-sale securities in connection with closing.
- Management expected the related ongoing agreements with BofI to reduce annual earnings by approximately $0.07–$0.09 per share beginning in FY2015, based on then-current fully diluted shares. Actual impact would depend on product sales and closing timing. The filing does not provide broader earnings or revenue guidance.
- Management said existing liquidity sources, including cash and potential borrowing under the credit line or commercial paper, were expected to meet operating and financing needs absent unexpected developments. The company typically uses cash and short-term borrowing to fund off-season needs.
Risks, contingencies, and unusual items
- Sand Canyon Corporation, the discontinued mortgage business, had accrued $193.8 million for estimated representation-and-warranty losses, including a $10.0 million provision in the quarter. Management said estimates rely on significant judgment and may change. Additional indemnification claims tied to mortgage securitizations were not accrued because loss was not concluded to be probable or reasonably estimable; the company could not estimate a range for these claims.
- The filing describes numerous ongoing lawsuits and claims, including mortgage-related matters and tax-product class actions. Accrued liabilities for litigation and other contingencies were $23.7 million. The company stated that the aggregate reasonably possible losses in excess of accruals for estimable matters were not material, while noting that some exposures could not be estimated and outcomes were uncertain.
- Mortgage loans held for investment totaled $259.7 million net of a $10.6 million allowance; 51% of the portfolio was concentrated in Florida, California, and New York. The estimated fair value of the loans was $193.9 million, below carrying value.
- Unrecognized tax benefits were $128.1 million. Management said approximately $21 million could potentially decrease within 12 months, mainly from statute expirations and expected settlements. The company’s first-quarter tax benefit reflects its estimate of the annual effective tax rate and may not indicate the full-year rate.
- The bank divestiture was not assured: it remained subject to regulatory approval and other conditions, and the timing and terms could change. The company also noted that regulatory supervision could constrain share repurchases.
Important facts for investors to verify
- Whether and when the BofI transaction closed, the final cash payment and deposit liabilities transferred, and the realized impact of the replacement financial-product arrangements.
- Repayment or refinancing of the $400 million note due in October 2014 and the availability and terms of other liquidity sources.
- Subsequent cash flows through the off-season and the availability of cash held by the bank and foreign subsidiaries.
- Changes in the $193.8 million mortgage representation-and-warranty accrual, litigation provisions, and any developments in unaccrued indemnification claims.
- Mortgage-loan delinquencies, valuation and allowance adequacy, particularly given the portfolio’s geographic concentration and the gap between carrying amount and estimated fair value.
- Full-year performance against the seasonal pattern; the filing cautions that first-quarter results are not representative of the full fiscal year.