HRB

H&R Block, Inc. 10-Q Summary

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for H&R Block, Inc. for the period ended July 31, 2010. The company operates primarily in tax preparation services (retail, online, software) and business services (RSM McGladrey). The reporting period represents the first quarter of fiscal year 2011, a seasonally off-peak period for the tax services segment.

Key Financial Metrics

Note: The company reported a net loss from continuing operations of $127.6 million and a net loss from discontinued operations of $3.0 million.

Material Changes vs. Prior Period

• Revenues: Total revenues decreased slightly by $1.0 million (0.4%). Tax Services revenues increased $3.7 million (4.2%) due to higher royalties from franchise conversions, while Business Services revenues decreased $2.9 million (1.6%).
• Profitability: The net loss improved by $2.9 million compared to the prior year, driven primarily by a reduction in income tax payments and lower provisions for loan losses.
• Loan Portfolio: The provision for loan losses decreased significantly to $8.0 million from $13.6 million in the prior year. However, the allowance for loan losses remained at 13.7% of the portfolio, with 37.3% of loans purchased from Sand Canyon Corporation (SCC) being 30+ days past due.
• Capital Allocation: The company repurchased and retired 15.5 million shares of common stock at a cost of $235.7 million (with $161.0 million paid in cash during the quarter). This contrasts with only $3.5 million in repurchases during the same period in 2009.
• Acquisitions: The company paid $33.2 million for business acquisitions, primarily a Boston-based accounting firm acquired by the Business Services segment.

Guidance, Outlook, and Risks

• IRS Debt Indicator (DI) Discontinuation: The IRS announced it will no longer furnish the Debt Indicator to tax preparers starting the next tax season. Management estimates this will reduce pretax profitability by approximately $25 million ($0.05 per share) due to lower RAL volumes and higher default risks.
• Effective Tax Rate: The effective tax rate for continuing operations was 38.4%. Management expects the full fiscal year 2011 rate to be approximately 39%.
• Legal Contingencies: Significant litigation risks remain, including:
  • Peace of Mind (POM) Litigation: Class action suits regarding the sale of tax error guarantees; trial set for November 2010.
  • RSM McGladrey Litigation: Class action regarding business valuation services; trial set for January 2011.
  • Discontinued Mortgage Operations: Ongoing claims and investigations related to Sand Canyon Corporation's prior loan origination activities, with a reserve of $188.1 million for repurchase and indemnification obligations.
• Credit Ratings: Moody's revised its outlook to "Negative" in July 2010 and initiated a 90-day review for a potential downgrade. S&P and DBRS maintained "Positive" outlooks.

Investor Verification Checklist

• IRS DI Impact: Verify the accuracy of the $25 million profitability reduction estimate regarding the discontinuation of the IRS Debt Indicator.
• Mortgage Loan Quality: Monitor the delinquency rates of the Sand Canyon Corporation (SCC) loan portfolio, which has a 37.3% delinquency rate (30+ days past due) compared to 10.0% for other loans.
• Litigation Outcomes: Track the status of the POM class action trial (Nov 2010) and RSM McGladrey trial (Jan 2011), as potential liabilities are substantial.
• Share Repurchases: Confirm the settlement of the remaining $74.7 million in share repurchase obligations scheduled for August 2010.
• Regulatory Capital: Review HRB Bank's regulatory capital ratios to ensure continued compliance with "Well Capitalized" standards.