H&R Block, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2012, ended January 31, 2012. The interim financial statements are unaudited. Tax-preparation activity is highly seasonal, with peak revenues from January through April; interim results are not necessarily indicative of full-year results.
Financial results and liquidity
Amounts below are in millions, except per-share data and where noted.
| Metric | Three months ended Jan. 31, 2012 | Prior-year quarter | Nine months ended Jan. 31, 2012 | Prior-year period |
|---|---|---|---|---|
| Revenue from continuing operations | $663.3 | $680.3 | $893.1 | $899.7 |
| Operating loss | $(3.7) | $(27.9) | $(414.7) | $(425.7) |
| Net loss from continuing operations | $(3.6) | $(11.0) | $(245.7) | $(250.3) |
| Net income (loss) from discontinued operations | $0.2 | $(1.7) | $(74.4) | $(2.2) |
| Net loss | $(3.3) | $(12.7) | $(320.2) | $(252.5) |
| Basic and diluted loss per share | $(0.01) | $(0.04) | $(1.07) | $(0.81) |
Quarterly operating loss improved year over year; the nine-month net loss worsened primarily because of losses on the sales of discontinued businesses and increased mortgage-related legal and representation-and-warranty provisions. The filing reports no consolidated gross-margin measure. Operating margin, calculated as operating loss divided by continuing-operations revenue, was approximately negative 0.6% for the quarter and negative 46.4% for the nine-month period.
- Cash flow: Operating activities used $1,382.8 million in the first nine months, versus $1,505.4 million a year earlier. Investing activities provided $323.5 million, including $533.1 million in net business-sale proceeds; financing activities provided $603.8 million. Cash and cash equivalents fell $458.9 million to $1,219.0 million.
- Balance sheet and debt: At January 31, cash was $1,219.0 million, total assets $4,852.8 million, total liabilities $4,046.3 million and stockholders’ equity $806.4 million. Commercial paper was $230.9 million; long-term debt was $1,040.2 million, including $631.0 million classified as current, principally the $600 million Senior Notes due January 2013. Federal Home Loan Bank borrowings were $25.0 million.
- Liquidity: The company had a $1.7 billion committed credit line, with no amount outstanding, and reported compliance with its covenants at January 31. The minimum-equity covenant was subsequently reduced from $650 million to $500 million, effective March 2, 2012. Management said available capital sources were sufficient for operating needs absent unexpected developments. HRB Bank held $1.1 billion of cash, but distribution to the parent requires regulatory approval and the funds were not currently available for general corporate purposes.
- Capital returns: The quarterly dividend increased from $0.15 to $0.20 per share. The company repurchased and retired 13.0 million shares for $177.5 million during the nine-month period.
Material changes and operating commentary
- H&R Block sold substantially all RSM McGladrey assets in November 2011, receiving $495.6 million in net cash proceeds, a $32.3 million short-term note and a $54.0 million long-term note. The reported after-tax sale loss was $37.1 million. It also sold McGladrey Capital Markets assets for $1.0 million and plans to wind down the remaining EquiCo businesses; the reported after-tax loss on that sale was $12.4 million. These businesses are presented as discontinued operations.
- Tax Services quarterly revenue declined 2.5% to $655.7 million, while pretax income rose to $31.7 million from $4.1 million. Tax-preparation fees and royalties increased, but RAC fees and Emerald Advance interest income fell. Management attributed lower RAC fees partly to a promotion waiving the fee for clients choosing Emerald Card direct deposit; the offer ended February 4, 2012. Lower Emerald Advance volumes, principally following tighter underwriting, reduced interest income and bad-debt expense.
- U.S. returns prepared through January 31 rose to 5.676 million from 5.138 million, including growth in retail and digital channels. Through February 28, returns prepared in company-owned and franchise offices were up 1.6% year over year, according to management. The company expanded television and online marketing.
- The nine-month continuing-operations loss remained substantial despite modest improvement from the prior year. The filing attributes part of the seasonal loss to the company’s off-season operating pattern. No quantified full-year earnings or revenue guidance is provided in the supplied filing text.
Risks, contingencies and unusual items
- Mortgage-related exposure: SCC’s liability for estimated representation-and-warranty losses was $142.9 million. It received $35 million of claims in the quarter; approximately $399 million of claims remained under review at January 31. Management states outcomes and future claims are difficult to estimate; a hypothetical 1% increase in both assumed claim validity and loss severity would imply about $22 million of losses beyond the accrual.
- Mortgage portfolio credit risk: Mortgage loans held for investment totaled $430.2 million net of an $89.9 million allowance. The allowance was 17.4% of gross loans. About 63% of the portfolio had been purchased from SCC; 47.1% of that segment was 30 or more days past due. Approximately 52% of the portfolio was concentrated in Florida, California and New York.
- Litigation: Accrued litigation and related contingencies were $89.0 million. For matters where an estimate was possible, reasonably possible losses above accrued amounts were estimated at $0–$61 million; other matters could not be reasonably estimated. The filing describes wage-and-hour class actions, RAL/RAC litigation, mortgage-related proceedings and other claims. A proposed settlement of the Lemus wage case had a maximum payment of $35 million and received preliminary court approval in February 2012; final approval remained pending.
- Other items: Gross unrecognized tax benefits were $199.2 million, with federal tax years 1999–2010 under examination. The company recorded a $4.3 million goodwill impairment related to discontinuing its ExpressTax brand. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Progress on refinancing or repaying the $600 million Senior Notes due January 2013 and continued compliance with credit-line covenants.
- Actual outcomes and cash costs of SCC representation-and-warranty claims, including the validity and severity of claims still under review.
- Mortgage delinquency trends, allowance adequacy and the performance of the SCC-originated portion of the retained loan portfolio.
- Final court approval and realized cost of the Lemus settlement, and developments in other material litigation and regulatory matters.
- Collection of the $32.3 million and $54.0 million notes from the RSM buyer, and remaining liabilities or indemnification obligations after the business disposals.
- Tax-season performance after January 31 and the effect of RAC promotions, underwriting changes, return volumes and marketing costs; the filing provides no quantified full-year guidance.