HRB

Business Context and Reporting Period

Company: H&R Block, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: April 30, 2007
Business Overview: H&R Block is a financial services company operating primarily through three continuing segments: Tax Services (retail, online, and software tax preparation), Business Services (accounting and consulting via RSM McGladrey), and Consumer Financial Services (brokerage and banking via HRBFA and HRB Bank). The company also reported significant results from Discontinued Operations, primarily its mortgage lending business (Option One Mortgage Corporation), which was in the process of being sold.

Key Financial Metrics

Material Changes vs. Prior Period

• Discontinued Operations Impact: The most significant change was the shift from a net income of $490.4 million in 2006 to a net loss of $433.7 million in 2007. This was driven entirely by a $1.2 billion pretax loss in discontinued operations (mortgage business), compared to a $316.9 million pretax profit in the prior year. This loss included $388.7 million in loan repurchase reserves, $168.9 million in residual interest impairments, and $345.8 million in asset impairments related to the planned sale of Option One Mortgage Corporation (OOMC).
• Continuing Operations Growth: Excluding discontinued operations, the company performed well. Net income from continuing operations increased 26% to $374.3 million. Revenues grew 12.5% to $4.02 billion.
• Segment Performance:
  • Tax Services: Revenues increased 9.6% to $2.69 billion, driven by higher average fees and growth in digital solutions. Pretax income rose 19.5% to $705.2 million.
  • Business Services: Revenues increased 12.6% to $932.4 million, largely due to the American Express Tax and Business Services acquisition. Pretax income decreased slightly to $57.7 million.
  • Consumer Financial Services: Revenues increased 34.8% to $388.1 million, turning a pretax loss of $32.8 million in 2006 into a profit of $19.8 million in 2007, aided by the launch of HRB Bank.

Guidance, Outlook, Risks, and Contingencies

• Mortgage Sale Transaction: On April 19, 2007, the company entered an agreement to sell OOMC. The sale price is based on the fair value of adjusted tangible net assets less $300 million. The transaction is subject to closing conditions, including maintaining specific warehouse facility capacities. If the sale does not close by December 31, 2007, the agreement may be terminated.
• Regulatory Capital Compliance: The company fell below the 3% minimum ratio of adjusted tangible capital to adjusted total assets required by the Office of Thrift Supervision (OTS) for its savings and loan holding company status. A Supervisory Directive was issued in May 2007 requiring a revised capital plan to regain compliance by April 30, 2008. Failure to comply could restrict share repurchases and dividends.
• Litigation: Significant pending litigation includes class actions regarding Refund Anticipation Loans (RALs), the Peace of Mind (POM) guarantee program, and Express IRA marketing practices. While the company believes it has meritorious defenses, adverse outcomes could result in substantial damages.
• Market Risks: The mortgage operations faced deteriorating secondary market conditions, reduced investor demand, and higher loss estimates, leading to significant impairments. The company noted that if home appreciation continues to decline, future results could be negatively impacted.

Key Facts for Investor Verification

• Discontinued Operations Loss: Verify the magnitude of the $1.2 billion pretax loss in discontinued operations and the specific components (repurchase reserves, impairments) driving this figure.
• OTS Capital Plan: Confirm the status of the revised capital plan submitted to the OTS and the company's ability to meet the 3% tangible capital requirement by April 30, 2008.
• OOMC Sale Closing: Monitor the progress of the OOMC sale transaction, specifically the satisfaction of closing conditions regarding warehouse facility capacity and regulatory approvals.
• Litigation Reserves: Review the adequacy of reserves for pending RAL, POM, and Express IRA litigation, as outcomes remain uncertain.
• Continuing Operations Margins: Assess the sustainability of the improved profitability in continuing operations, particularly in the Tax Services segment, independent of the mortgage business.