H&R Block, Inc. — Form 10-Q
Business context and reporting period: Quarter ended January 31, 2013 (fiscal 2013 third quarter), with nine-month results also presented. H&R Block’s tax preparation business is highly seasonal, with peak revenues from January through April; interim results are not indicative of full-year performance. Unless stated otherwise, amounts below are in millions.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2013 | Prior-year quarter | Nine months ended Jan. 31, 2013 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $472.0 | $663.3 | $705.7 | $893.1 |
| Operating income (loss) | $(92.6) | $(3.7) | $(430.1) | $(414.7) |
| Continuing-operations net income (loss) | $(16.9) | $(3.6) | $(223.8) | $(245.7) |
| Net income (loss), including discontinued operations | $(17.7) | $(3.3) | $(230.4) | $(320.2) |
| Continuing-operations loss per share | $(0.06) | $(0.01) | $(0.82) | $(0.82) |
- Quarter revenue fell 28.8%; management attributed the decline principally to a 28.7% decrease in returns prepared through H&R Block, following the IRS’s delayed opening of filing and processing.
- Quarter operating expenses declined 15.3%, but the lower revenue drove a $92.6 million operating loss. Nine-month revenue declined 21.0%, while the continuing-operations pretax loss widened to $427.8 million from $405.6 million.
- The quarter included a $43.3 million tax benefit from settlement of most issues in the IRS examination of 1999–2007 federal returns, among other discrete tax benefits. The settlement materially affected the relationship between pretax and net loss.
- Operating cash used in the nine months was $1.312 billion, compared with $1.383 billion used in the prior-year period. Investing activities used $180.3 million; financing activities used $33.3 million. Cash and equivalents ended at $418.4 million, down from $1.944 billion at April 30, 2012.
- At January 31, commercial paper borrowings were $425.0 million and long-term debt was $906.0 million (total borrowings approximately $1.332 billion). The company issued $500 million of 5.50% notes due 2022 and redeemed $600 million of notes due January 2013, paying $623 million including premium and accrued interest; the early redemption generated a $5.8 million loss.
- The company had an undrawn $1.5 billion five-year committed credit facility. Management stated that, absent unexpected developments, available capital sources were sufficient for operating needs. Customer deposits were $1.037 billion. HRB Bank cash was $291.2 million, but was not generally available to the parent without regulatory approval.
- Dividends paid were $162.7 million over nine months. The company repurchased and retired 21.3 million shares for $315.0 million; $857.5 million remained under its $2.0 billion authorization.
Material changes and management commentary
- The IRS delayed accepting individual tax returns until January 30, 2013, nearly two weeks later than the prior season; certain forms remained unavailable at January 31. H&R Block deferred $13.2 million of revenue on prepared returns that could not yet be filed. Through February 28, retail returns were down 7.8% and digital returns down 1.8% year over year; management cautioned that these figures might not reflect full-season results.
- Tax Services quarterly revenue declined 29.1% to $464.6 million and the segment recorded a $64.2 million pretax loss, versus $31.7 million pretax income a year earlier. Cost reductions included workforce actions and office closures. Company-owned offices numbered 6,211 versus 6,521 a year earlier.
- Discontinued operations produced a $6.6 million nine-month loss, improved from a $74.4 million loss, which included prior-year business-sale losses and impairment. Discontinued businesses include the former Business Services segment and the exited mortgage business.
- Management was evaluating alternatives to cease being a savings and loan holding company (SLHC), but said the review was at an early stage and its timing and outcome were uncertain. Proposed Federal Reserve capital rules could constrain dividends, repurchases, acquisitions, and other strategic investments; implementation had been postponed to an unspecified date.
Risks, contingencies, and unusual items
- Legacy mortgage exposure remains significant. The discontinued mortgage subsidiary had an $118.8 million accrual for representation-and-warranty claims. Management could not estimate reasonably possible losses beyond that accrual; a hypothetical 1% increase in loss severity and 1% decrease in claim denial assumptions would add approximately $27 million of losses.
- Mortgage loans held for investment were $357.9 million net; 57% of the portfolio was purchased from the former Option One business. Overall, 23.6% of principal was at least 30 days past due, and the allowance was 4.6% of principal. The company noted elevated delinquency and geographic concentration risks.
- The company reported $18.9 million of accrued litigation liabilities and estimated reasonably possible aggregate losses above accruals of $0–$119 million, approximately 78% relating to discontinued operations. It cautioned that some exposures could not be reasonably estimated and unfavorable outcomes could be material.
- Other notable matters include employment, refund anticipation loan/check, compliance-fee, and legacy mortgage litigation; the filing describes outcomes as uncertain. The filing also identifies vendor concentration and potential regulatory restrictions as risks.
- HRB Bank began offering unsecured credit cards in November 2012. At January 31, balances were $20.3 million, with a $4.3 million allowance based on an initial 21% reserve assumption; payment and delinquency experience was not yet established.
Most important facts for investors to verify
- Whether the delayed IRS filing season translated into a recovery in return volumes, deferred revenue recognition, and full-season tax-service results.
- Cash needs through the remainder of tax season, commercial-paper levels, access to the committed facility, and compliance with its financial covenants.
- Developments in SLHC regulation and the company’s proposed alternatives, including any implications for dividends, repurchases, and delivery of banking products.
- Changes in mortgage delinquencies, allowance adequacy, and legacy representation-and-warranty claims and litigation exposures.
- Credit-card repayment and delinquency performance and any revisions to the initial allowance assumptions.