H&R Block, Inc. — FY2011 Form 10-K
Reporting period: Fiscal year ended April 30, 2011, compared with fiscal 2010. Although the request metadata says “2010 Q4,” this is an annual filing, not a stand-alone quarterly report. Unless stated otherwise, amounts below are U.S. dollars.
Business context
H&R Block provides retail, online and software-based tax preparation, related banking services, and tax, consulting and accounting services to middle-market businesses. Tax Services contributed 77.2% of continuing-operations revenue; Business Services contributed 22.0%. The tax business is highly seasonal, with most revenue earned from January through April.
Financial performance
| Metric | FY2011 | FY2010 | Change |
|---|---|---|---|
| Revenue | $3.774 billion | $3.874 billion | Down 2.6% |
| Operating income | $665.6 million | $774.8 million | Down 14.1% |
| Continuing-operations pretax income | $677.0 million | $784.1 million | Down 13.7% |
| Continuing-operations net income | $419.4 million | $488.9 million | Down 14.2% |
| Net income | $406.1 million | $479.2 million | Down 15.3% |
| Diluted EPS, continuing operations | $1.35 | $1.46 | Down 7.5% |
| Diluted EPS, total | $1.31 | $1.43 | Down 8.4% |
| Net cash from operating activities | $512.5 million | $587.5 million | Down $75.0 million |
- Operating margin was approximately 17.6%, versus 20.0% in FY2010. The continuing-operations effective tax rate rose to 38.1% from 37.6%.
- Tax Services revenue fell 2.1% to $2.912 billion and pretax income fell 11.5% to $767.5 million; segment pretax margin declined to 26.4% from 29.2%.
- Business Services revenue fell 3.6% to $829.8 million and pretax income fell 16.5% to $49.0 million; segment pretax margin declined to 5.9% from 6.8%.
- Cash and cash equivalents were $1.678 billion at year-end, down from $1.804 billion. Investing activities used $110.2 million and financing activities used $534.4 million.
- Long-term debt was $1.050 billion; total reported debt including current maturities and capital leases was $1.053 billion. HRB Bank also had $25.0 million of Federal Home Loan Bank borrowings. No commercial paper or committed-line borrowings were outstanding at year-end.
Material changes and unusual items
- HSBC terminated its RAL contract in December 2010, and H&R Block did not offer refund anticipation loans in its retail offices during the 2011 tax season. Tax Services loan-participation revenue fell to $17.2 million from $146.2 million. RAC fees rose to $181.7 million from $87.5 million, partly offsetting the decline.
- Worldwide returns prepared increased to 24.5 million from 23.2 million; U.S. returns rose 6.5% to 21.4 million. The filing attributes growth partly to a free Federal 1040 EZ offer and improved online results. U.S. retail average fees declined.
- Tax Services pretax income was pressured by a $34.3 million increase in bad-debt expense, a $22.7 million goodwill impairment and $15.0 million in litigation charges. The company also recorded $29.6 million of severance costs following planned organizational reductions.
- Business Services results included higher litigation expense, while Caturano acquisition-related activity contributed to tax-services revenue. The company recorded a $45.1 million gain from sales of tax offices to franchisees.
- Discontinued mortgage operations generated a $13.3 million net loss, compared with losses of $9.7 million in FY2010 and $27.4 million in FY2009.
- The company repurchased and retired 19.0 million shares for $279.9 million and paid $186.8 million in dividends during FY2011.
Liquidity, outlook and risks
Management said existing capital sources, including the $1.7 billion committed line of credit maturing July 2013, were sufficient for operating needs absent unexpected developments. The company was in compliance with line covenants at year-end. However, $615.1 million of HRB Bank cash was subject to regulatory restrictions and was not generally available for corporate purposes. Commercial paper borrowings peaked at $674.7 million during the year, reflecting seasonal funding needs.
The filing provides no specific forward earnings or revenue guidance. Management identified significant uncertainties including RAL availability and related client retention, intense competition and free tax-preparation offers, economic conditions, evolving tax-preparer and banking regulation, and the impact of Dodd-Frank implementation.
- Mortgage exposures: HRB Bank held $573.0 million of mortgage loans before allowance; the allowance was 16.1% of the portfolio. Loans purchased from discontinued Sand Canyon Corporation represented 62% of the portfolio and had higher delinquency rates. The portfolio was concentrated in Florida, California, New York and Wisconsin.
- Mortgage repurchase claims: Sand Canyon’s recorded representation-and-warranty liability was $126.3 million. Management could not reasonably estimate possible losses beyond the accrual; a hypothetical 1% increase in both assumed claim-validity rates and loss severities would add approximately $16 million of losses beyond it.
- Litigation: Accrued litigation and related contingencies totaled $70.6 million. For certain wage-and-hour class actions, estimated possible losses were $0–$70 million above the accrued liability, and this range was not the maximum exposure. Other claims, including mortgage-related litigation, could not be reliably estimated.
- TaxACT transaction: The proposed $287.5 million acquisition of 2SS Holdings was challenged by the DOJ in May 2011. The agreement was amended in June 2011, but closing remained uncertain.
Most important facts for investors to verify
- Whether loss of RALs continues to affect tax-return volumes, client retention and earnings, and whether RAC and other products offset that impact.
- Whether bad-debt expense and HRB Bank mortgage credit quality improve or require additional provisions, particularly for Sand Canyon-originated loans.
- The eventual cash cost of mortgage repurchase claims and litigation, including wage-and-hour cases and discontinued-mortgage matters.
- The outcome and financial implications of the DOJ challenge to the TaxACT acquisition.
- Seasonal funding needs, access to commercial-paper markets and compliance with committed-line covenants; also distinguish restricted HRB Bank cash from cash available to the parent company.
- That audited financial statements received an unqualified opinion and management and the auditor reported effective internal control over financial reporting as of April 30, 2011.