H&R Block, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended October 31, 2009 (fiscal 2010 second quarter). Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise. Interim results are seasonal and are not indicative of full-year results.
Business context and financial results
H&R Block provides tax preparation and related financial services, banking services, and accounting, tax and consulting services to middle-market businesses. The filing presents continuing operations alongside losses from discontinued operations, principally related to its former mortgage business.
| Metric | Three months ended Oct. 31, 2009 | Prior-year quarter | Six months ended Oct. 31, 2009 | Prior-year period |
|---|---|---|---|---|
| Revenue | $326.1 million | $351.5 million | $601.6 million | $623.4 million |
| Operating loss | $214.6 million | $225.3 million | $428.7 million | $436.9 million |
| Net loss | $128.6 million | $135.9 million | $262.2 million | $268.6 million |
| Net loss per share | $0.38 | $0.41 | $0.78 | $0.82 |
| Operating cash flow | Not presented separately | Not presented separately | $(786.2) million | $(665.9) million |
The company reported an income tax benefit of $86.4 million for the quarter and $166.6 million for the six-month period. Consolidated margins were not stated as separate metrics in the filing.
Material changes and segment performance
- Quarterly revenue declined 7.2% year over year; six-month revenue declined 3.5%. Net losses narrowed modestly in both comparisons.
- Tax Services revenue rose 4.4% for the quarter and 5.8% for six months, primarily reflecting higher tax-return volume and the acquisition of a major franchise operator. Segment pretax losses narrowed to $172.2 million for the quarter and $344.2 million for six months.
- Business Services revenue fell 11.3% for the quarter and 5.8% for six months. Management attributed weakness to lower client demand, reduced chargeable hours and a sharp decline in capital-markets transactions. Pretax income fell to $0.2 million for the quarter and $1.5 million for six months.
- Corporate pretax losses improved to $40.8 million for the quarter and $81.1 million for six months, helped by lower interest expense and loan-loss provisions compared with the prior-year periods.
Cash flow, debt and liquidity
- Cash and cash equivalents were $1.432 billion at October 31, 2009, down from $1.655 billion at April 30, 2009. Cash used in operations was $786.2 million for the first six months, up from $665.9 million, primarily because of higher income-tax payments.
- Investing activities provided $43.3 million, compared with $48.8 million used in the prior-year period. Financing activities provided $511.2 million, including a $638.5 million net increase in customer banking deposits; dividends paid were $100.8 million.
- Long-term debt was $1.033 billion, with $3.7 million classified as current; Federal Home Loan Bank borrowings totaled $100 million. Customer banking deposits were $1.494 billion.
- The company had $2.0 billion of revolving credit facilities, with no balance outstanding at quarter-end. A lender in the facilities was not honoring funding requests, reducing effective availability to $1.95 billion. Management stated that existing capital sources were sufficient for operating needs absent unexpected developments.
- H&R Block Bank received $150 million in capital contributions from its parent during the six months and another $85 million in November 2009. Regulatory approval is required for bank capital returns, and future approvals are not assured.
Outlook, risks and unusual items
- Management expected a fiscal 2010 full-year effective tax rate of approximately 40%. The filing does not provide a clear revenue or earnings forecast.
- Mortgage loans held for investment totaled $671.0 million net of a $96.0 million allowance. The allowance was 12.61% of principal, up from 10.23% at April 30. Nonperforming assets increased to $376.0 million from $348.4 million. Approximately 64% of the portfolio was purchased from Sand Canyon Corporation; this pool had a higher delinquency rate and a reserve equal to 18.22% of principal. About 52% of the mortgage portfolio was concentrated in Florida, California and New York.
- The RSM McGladrey–McGladrey & Pullen alternative practice structure faced termination notices and ongoing negotiations following a contractual dispute. The arbitration panel issued a confidential ruling on restrictive covenants. A separation could reduce revenue and earnings or lead to impairment; the company’s interim goodwill assessment relied on assumptions about continued collaboration or replacement attest-firm relationships.
- Significant legal and contingent exposures include mortgage repurchase and indemnification obligations (reserve of $201.2 million), tax-return guarantee and refund-anticipation-loan litigation, Express IRA claims, and a certified RSM EquiCo class action. The RSM EquiCo action involves fees of approximately $185 million and could materially affect results; trial was scheduled for January 2011. Accrued litigation and indemnification losses were $32.9 million.
- The company reported no goodwill impairment in the interim assessment of the RSM reporting unit, but noted that changed assumptions could result in future impairment. It also identified possible impairment risk for $29.3 million of goodwill tied to its capital-markets business if weak financing conditions persisted.
- Management said disclosure controls were effective and reported no material change in internal control over financial reporting. The company’s business is highly seasonal, with peak revenues from January through April.
Key facts for investors to verify
- Whether RSM and McGladrey & Pullen reached an agreement and whether any separation affected clients, revenue, costs or goodwill.
- Mortgage delinquency, nonperforming assets, reserve adequacy, and developments in Sand Canyon repurchase claims and related litigation.
- Liquidity and bank funding, including the availability of revolving facilities, customer deposit trends, and regulatory limits on capital returns.
- Progress in Business Services demand and capital-markets activity, and whether Tax Services’ volume gains continue into the seasonal tax period.
- Developments in material litigation and contingent liabilities, particularly the RSM EquiCo class action, Express IRA cases and mortgage-related claims.