H&R BLOCK INC quarterly report, Q1 FY2012

H&R Block, Inc. — Form 10-Q Summary

Reporting period: Three months ended July 31, 2011 (first quarter of fiscal 2012); comparative results are for the three months ended July 31, 2010. Amounts below are in U.S. dollars. The interim financial statements are unaudited. H&R Block notes that its business is highly seasonal, with peak revenue from January through April, so this quarter is not indicative of full-year results.

Key financial results

Metric	Q1 FY2012	Q1 FY2011
Revenue	$267.6 million	$274.5 million
Operating loss	$297.2 million	$210.6 million
Loss from continuing operations	$173.4 million	$127.6 million
Net loss	$175.1 million	$130.7 million
Basic and diluted loss per share	$0.57	$0.41
Net cash used in operating activities	$394.5 million	$348.3 million

• Revenue declined 2.5% year over year. Operating margin was approximately negative 111%, compared with negative 77% a year earlier; the impairment described below materially affected the current quarter.
• Cash and cash equivalents were $1.013 billion at July 31, down from $1.678 billion at April 30. Restricted cash was an additional $44.4 million. Net cash used in investing activities was $14.3 million; net cash used in financing activities was $257.3 million.
• Total assets were $4.308 billion, total liabilities $3.074 billion, and stockholders’ equity $1.234 billion. Current assets were $1.668 billion and current liabilities $1.603 billion.
• Long-term debt was $1.019 billion and current debt $30.9 million; Federal Home Loan Bank borrowings were $25.0 million. The company reported no balance outstanding on its $1.7 billion committed credit facility and compliance with its covenants.
• Quarterly dividends were $0.15 per share, totaling $45.9 million. The effective tax rate on continuing operations was 40.8%, versus 38.4% in the prior-year quarter.

Material changes and segment results

• Business Services recorded a $99.7 million goodwill impairment—$85.4 million related to RSM and $14.3 million to EquiCo—in connection with a proposed RSM asset sale and evaluation of strategic alternatives for EquiCo. The impairment was partly offset by a $9.9 million gain on the sale of an ancillary business. Management reported the combined events resulted in an after-tax charge of $53.2 million, or $0.17 per share.
• Tax Services revenue was essentially flat at $91.4 million. Management said lower U.S. tax return volumes were offset by increased international returns; expenses fell 2.0%, mainly because the prior-year quarter included severance costs, while current-year legal charges increased.
• Business Services revenue decreased 4.3% to $167.3 million. Its pretax loss was $92.5 million, compared with a $0.4 million loss a year earlier, primarily reflecting the goodwill impairment.
• Corporate pretax loss was $31.1 million, broadly consistent with the prior-year $32.3 million loss. Consolidated net loss widened by $44.4 million year over year.
• Average diluted shares were not applicable because the company reported a loss; weighted-average basic shares were 305.5 million, down from 319.7 million, primarily due to prior-year share repurchases.

Outlook, liquidity, risks, and contingencies

• Management said existing capital sources, including the committed credit lines, should be sufficient for operating needs absent unexpected developments. The company expects seasonal operating cash use from May through mid-January. No specific earnings or revenue guidance is provided in the filing.
• In August 2011, the board approved a non-binding letter of intent to sell substantially all RSM Business Services assets to McGladrey & Pullen LLP. Completion depends in part on the buyer securing financing and was expected by calendar year-end. The buyer would assume substantially all related liabilities, including contingent payments and lease obligations; transaction proceeds and tax benefits could vary.
• The proposed $287.5 million acquisition of TaxACT developer 2SS Holdings remained subject to regulatory approval. The Department of Justice filed suit to block the deal, with a preliminary injunction hearing scheduled for September 2011; closing was uncertain.
• Legacy mortgage exposures remain significant. At July 31, the discontinued mortgage business had a $125.8 million liability for estimated repurchase and indemnity losses, with approximately $66 million of claims still under review. Management said reasonably possible losses above the accrual could not be estimated; a hypothetical 1% increase in both assumed claim validity and loss severity would add approximately $16 million in losses.
• The mortgage portfolio was $554.0 million before allowance; 63% consisted of loans purchased from Sand Canyon, with higher delinquency and loss exposure. The allowance was $91.3 million, or 16.5% of the portfolio. Approximately 52% of the portfolio was concentrated in Florida, California, and New York.
• Accrued litigation and indemnification contingencies totaled $86.3 million. For certain wage-and-hour class actions, the estimated range of possible loss was $0–$70 million above amounts accrued, excluding matters for which a range could not be estimated. Other disclosed matters include mortgage-related litigation and a proposed EquiCo class settlement of up to $41.5 million, subject to final court approval.
• Management reported effective disclosure controls and no material changes in internal control over financial reporting. It reported no material changes in risk factors, market risks, or contractual obligations from the prior annual report.

Important facts for investors to verify

• Whether the RSM transaction closes, its final terms, and the resulting proceeds, liabilities assumed, and tax benefits; also whether EquiCo strategic alternatives lead to further impairment or disposal.
• The status and financial effect of the DOJ challenge to the TaxACT acquisition.
• Developments in Sand Canyon repurchase claims, litigation accruals, and the mortgage portfolio’s delinquencies, recoveries, and allowance adequacy.
• Seasonal cash needs, customer deposit movements, available borrowing capacity, and compliance with credit-facility covenants.
• Whether the unusually large quarterly loss and cash use persist beyond the seasonally weak first quarter; interim results are not a reliable full-year indicator.