H&R Block, Inc. — Form 10-Q Summary
Business context and period. This filing covers the fiscal third quarter and nine months ended January 31, 2010. H&R Block’s principal businesses are Tax Services and Business Services; results are highly seasonal, with peak tax-preparation revenue generally occurring January through April. The company cautions that interim results are not indicative of full-year results.
Financial performance
| Metric | Three months ended Jan. 31, 2010 | Three months ended Jan. 31, 2009 | Nine months ended Jan. 31, 2010 | Nine months ended Jan. 31, 2009 |
|---|---|---|---|---|
| Revenue | $934.9 million | $993.4 million | $1,536.4 million | $1,616.8 million |
| Operating income (loss) | $94.4 million | $100.1 million | $(334.3) million | $(336.9) million |
| Income (loss) from continuing operations | $53.6 million | $66.8 million | $(203.5) million | $(194.8) million |
| Net income (loss), including discontinued operations | $50.6 million | $47.4 million | $(211.6) million | $(221.2) million |
| Diluted EPS | $0.15 | $0.14 | $(0.63) | $(0.67) |
| Operating margin | 10.1% | 10.1% | (21.8)% | (20.8)% |
Cash flow and balance sheet. For the nine months, operating activities used $2.729 billion of cash, compared with $2.424 billion used in the prior year; management attributed the increase primarily to higher income-tax payments. Investing activities provided $71.2 million, versus $13.7 million used. Financing activities provided $2.721 billion, including net short-term borrowing and increased customer deposits. Cash and cash equivalents were $1.728 billion at January 31, 2010, including $85.3 million restricted.
Total assets were $7.410 billion and stockholders’ equity was $936.5 million at January 31, 2010. Short-term borrowings were $1.675 billion; long-term debt was $1.033 billion; and Federal Home Loan Bank borrowings totaled $100.0 million. Customer banking deposits were $2.221 billion. Current liabilities exceeded current assets by approximately $255 million, in the context of the company’s seasonal working-capital needs.
The mortgage-loan portfolio had $732.8 million in principal outstanding and a $97.3 million allowance for loan losses, equal to 13.27% of principal, up from 10.23% at April 30, 2009. Total non-performing assets were $360.4 million. The company reported a $15.0 million goodwill impairment in Business Services. It paid $151.3 million in dividends and repurchased and retired 6.8 million shares for $150.0 million during the nine months/quarter, respectively.
Material changes versus prior comparable periods
- Third-quarter revenue declined 5.9%; continuing-operations net income fell 19.8%, while reported net income rose to $50.6 million because the discontinued-operations loss was smaller than in the prior-year quarter.
- Nine-month revenue declined 5.0%. The continuing-operations loss widened to $203.5 million from $194.8 million, while the total net loss narrowed, mainly reflecting a smaller discontinued-operations loss.
- Tax Services revenue fell 6.2% in the quarter. U.S. retail returns prepared through January declined; management cited office transfers to franchisees, office closures, lower IRS filings, and some shift to do-it-yourself preparation. Net average fee per U.S. retail return increased 1.5%.
- Business Services recorded a quarterly pretax loss of $11.2 million, compared with $10.7 million pretax income a year earlier. The $15.0 million RSM EquiCo goodwill impairment was a significant factor; reduced client demand also affected service revenue.
- Short-term borrowing rose from none at April 30, 2009 to $1.675 billion at January 31, 2010, largely reflecting seasonal funding and RAL-participation financing. The mortgage allowance ratio and reported non-performing assets also increased from April 2009 levels.
Outlook, management commentary, risks, and unusual items
- Management said available liquidity sources were expected to cover operating needs absent unexpected developments. A new $1.7 billion credit facility was entered into on March 4, 2010, after the balance-sheet date; it matures July 31, 2013 and includes a $650 million minimum-net-worth covenant and a requirement to reduce specified short-term debt to $200 million or less for 30 consecutive days during March–June.
- The company expected a fiscal 2010 effective tax rate of approximately 39%. It did not provide a clear full-year revenue, earnings, or EPS forecast in the supplied filing text.
- Through February 28, 2010, tax returns prepared in company-owned and franchise offices were down 9.4% year over year. Management cited difficult economic conditions and high unemployment, while noting that tax-season results remained incomplete.
- Credit and legacy mortgage risks remain material: 63.5% of the mortgage portfolio consisted of loans purchased from Sand Canyon Corporation, with 37.04% at least 30 days past due. The allowance reflects management’s estimate, and actual credit losses may differ.
- Significant contingencies include RAL litigation, Peace of Mind guarantee class actions, Express IRA litigation (proposed settlement range $11.4 million to $25.4 million, subject to approval), RSM EquiCo litigation involving approximately $185 million of client fees, and claims tied to discontinued mortgage operations. The filing says outcomes and potential losses may be difficult to predict.
- RSM and McGladrey & Pullen entered new agreements effective February 3, 2010, withdrawing prior termination notices concerning their alternative practice structure. The company also recorded a $9.5 million quarterly gain from transferring certain retained insurance-risk liabilities to a third party.
- Management reported disclosure controls and procedures were effective at period end and that there were no material changes to internal control over financial reporting. It reported no material changes in risk factors or market-risk disclosures compared with the prior annual report.
Most important facts for investors to verify
- Tax-season return volumes, customer mix, average fees, and whether the reported decline persists through the full filing season.
- Availability, use, and covenant compliance of the new credit facility and seasonal RAL funding, including the short-term-debt clean-down requirement.
- Mortgage delinquencies, non-performing assets, reserve adequacy, and potential further losses on loans purchased from Sand Canyon.
- Developments in the major litigation and the adequacy of recorded reserves, especially the RSM EquiCo and discontinued-mortgage matters.
- Whether cash generation improves as the seasonal tax business reaches peak activity, and the effect of dividends and share repurchases on liquidity and equity.