H&R BLOCK INC annual report, FY2013

Business context and reporting period

H&R Block, Inc. filed this Form 10-K for the fiscal year ended April 30, 2013. The company provides assisted and do-it-yourself tax preparation services in the U.S., Canada and Australia, alongside financial products offered through HRB Bank. Operations are highly seasonal, with most tax-related revenue earned January through April. This is an annual filing, not a standalone fiscal fourth-quarter report.

Financial performance and liquidity

Tax Services generated $2,878.0 million of revenue and $821.1 million of pretax income; its pretax margin rose to 28.5% from 24.6%. Adjusted EBITDA from continuing operations, a non-GAAP measure, was $882.7 million, up 9.3% from $807.5 million. Cash used in investing activities was $110.9 million, versus $351.9 million provided in FY2012; financing activities used $584.5 million. Restricted cash was $117.8 million and is not generally available for corporate use.

The company had no commercial paper outstanding at year-end and no borrowings under its $1.5 billion committed credit line; commercial paper borrowings peaked at $496.7 million during January. Management stated that existing capital sources were sufficient for operating needs absent unexpected developments. The company issued $500 million of 5.50% senior notes due 2022 and redeemed $600 million of 7.875% notes due 2013. It paid $217.2 million in dividends and repurchased $315.0 million of shares during FY2013.

Material changes versus the prior comparable period

• Revenue increased 0.4%, while continuing-operations pretax income rose 21.9% and continuing-operations net income increased 34.5%. Management attributed improved earnings chiefly to cost-saving initiatives; total Tax Services expenses fell 4.7%.
• U.S. returns prepared by and through H&R Block declined 0.7% to 22.2 million. U.S. tax preparation fees fell 2.1%, reflecting lower return volume, partly offset by higher average charges. Online returns increased, while software and Free File Alliance return counts declined.
• Tax Services revenue increased 0.5%. Higher RAC fees, following discontinuation of the prior-year free-RAC promotion, and growth in international and digital services partly offset lower U.S. assisted fees.
• The effective tax rate on continuing operations fell to 33.7% from 39.9%, primarily due to a $33.3 million discrete tax benefit associated with settlement of most issues concerning 1999–2007 federal tax returns.
• Discontinued operations recorded a $31.2 million loss, compared with an $80.0 million loss in FY2012. FY2013 mortgage-operation losses included a $40.0 million provision for SCC representation-and-warranty claims.

Outlook, commentary, risks and unusual items

• The filing provides no specific forward financial guidance. Management describes liquidity as adequate, but cautions that results are seasonal and depend heavily on successful peak-season operations.
• H&R Block was evaluating ways to cease being a savings and loan holding company while continuing to provide financial services. The timing and outcome were uncertain; proposed regulatory capital rules could constrain dividends, repurchases, acquisitions and other investments.
• SCC accrued $158.8 million for estimated mortgage representation-and-warranty losses and estimated reasonably possible additional losses of up to $30 million above the accrual. Separate indemnification exposures tied to mortgage securitizations were not accrued because losses were not deemed probable or reasonably estimable; outcomes could be material.
• Other litigation and related contingencies had an estimated aggregate reasonably possible loss range of $0–$55 million in excess of accrued amounts, approximately 54% relating to discontinued operations. The filing also identifies matters for which a loss range could not be estimated.
• Key business risks include intense competition and free tax-filing alternatives, data security and system interruptions, changes in tax laws or filing processes, vendor dependence, consumer-finance regulation, credit losses and reputational or litigation exposure. Mortgage loans held for investment had a $338.8 million carrying value versus $210.9 million estimated fair value.
• The U.S. Walmart license agreement, covering about 450 offices, expired April 30, 2013 and was not renewed. The company also noted that financial-services revenue and profitability could be affected by any change in its regulatory structure.

Important facts for investors to verify

• Whether earnings growth is sustainable after separating cost reductions and the $33.3 million tax benefit from recurring operating performance.
• Trends in U.S. assisted-return volumes, digital growth, average client charges and RAC/card usage, including the effect of the Walmart agreement ending.
• The final form and impact of bank and holding-company capital rules, and any restrictions on dividends, share repurchases or transfers of HRB Bank capital.
• Developments in SCC representation-and-warranty settlements, indemnification claims and litigation, including whether recorded reserves prove adequate.
• Availability of seasonal liquidity and compliance with credit-line covenants; distinguish unrestricted corporate cash from restricted cash and funds held at HRB Bank or foreign subsidiaries.