H&R Block, Inc. — Form 10-Q summary
Reporting period: Quarter and nine months ended January 31, 2011. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions. H&R Block’s business is highly seasonal, with peak revenue generally occurring January through April, so interim results are not necessarily indicative of the full year.
Financial performance
| Metric | Quarter ended Jan. 31, 2011 | Prior-year quarter | Nine months ended Jan. 31, 2011 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $851.5 million | $934.9 million | $1,448.8 million | $1,536.4 million |
| Operating income (loss) | $(19.5) million | $94.4 million | $(409.1) million | $(334.3) million |
| Net income (loss) | $(12.7) million | $50.6 million | $(252.5) million | $(211.6) million |
| Diluted EPS | $(0.04) | $0.15 | $(0.81) | $(0.63) |
| Operating margin | (2.3)% | 10.1% | (28.2)% | (21.8)% |
Revenue fell 8.9% in the quarter and 5.7% for the nine-month period. Quarterly operating results deteriorated sharply, while the nine-month operating and net losses widened. Approximate gross margin, calculated as revenue less cost of revenues divided by revenue, was 25.4% for the quarter versus 30.9%; for nine months it was 3.6% versus 6.1%.
- Tax Services: Revenue was $672.8 million for the quarter, down 10.0%; nine-month revenue was $875.4 million, down 7.4%. Segment pretax income fell to $4.1 million from $131.2 million in the quarter; the nine-month pretax loss widened to $324.9 million from $213.0 million.
- Business Services: Quarterly revenue declined 4.0% to $171.3 million, while pretax results improved to income of $8.6 million from a loss of $11.2 million. Nine-month revenue declined 2.4% to $549.4 million; pretax income was $16.6 million versus a $9.7 million loss.
- Cash flow: Operating cash use was $1.505 billion for nine months, compared with $2.649 billion. Investing cash use was $36.1 million versus $8.9 million; financing provided $1.199 billion versus $2.721 billion. Cash declined $338.4 million to $1.466 billion.
- Balance sheet and liquidity: Total assets were $5.803 billion and stockholders’ equity $827.7 million at January 31, 2011. Current assets were $3.274 billion versus current liabilities of $3.463 billion. Customer deposits totaled $1.855 billion. Commercial paper was $632.6 million; long-term debt was $1.049 billion and FHLB borrowings were $75.0 million. The company had a $1.7 billion committed credit facility with no amount drawn and reported covenant compliance; $151.2 million of FHLB capacity remained available.
Material changes and unusual items
- HSBC terminated its RAL contract in December 2010 following regulatory restrictions. RALs were not offered in H&R Block’s retail offices this tax season. RAC fees rose as clients used refund anticipation checks instead; current-quarter revenue also included $16.3 million of accelerated deferred HSBC fees.
- U.S. retail tax returns prepared through January 31 declined 5.8% year over year, but were up 3.2% through February 28. Average fees per return declined, reflecting client mix and promotions. Revenue of $17.4 million for prepared returns that could not yet be filed because of IRS processing delays was deferred to the fourth quarter.
- Tax Services recorded a $22.7 million goodwill impairment after lower-than-expected settlement-product revenue. It also reported increased bad debt expense, associated in part with higher EA and RAC volumes, and $17.5 million of incremental legal accruals in the quarter.
- H&R Block repurchased and retired 19.0 million shares for $279.9 million during the nine months. Dividends paid were $140.9 million; dividends per share remained $0.45 for the nine-month period.
- The company acquired Caturano for an aggregate purchase price of approximately $40.2 million. It also signed an agreement to acquire TaxACT developer 2SS Holdings for $287.5 million in cash, subject to customary closing conditions, including regulatory approval.
- The 2010 comparative cash flow statement was restated to classify franchisee loans and related receipts as investing, rather than operating, cash flows.
Outlook, risks and contingencies
- Management expected full-year fiscal 2011 tax returns prepared to increase 0.5%–1.5% and average fee per return to decline 2%–4% from fiscal 2010. It expected a full-year effective tax rate of approximately 39%. Management cautioned that third-quarter tax results are not indicative of full-year results.
- Management said existing capital sources were expected to meet operating needs absent unexpected developments. Seasonal funding needs, access to commercial paper and the credit facility, and the facility’s requirement to reduce short-term debt to $200 million or less for 30 consecutive days between March 1 and June 30 are important liquidity considerations.
- Discontinued mortgage operations remain exposed to repurchase and indemnity claims. The recorded representation-and-warranty liability was approximately $155.0 million; management estimated that a 1% increase in both assumed claim validity and loss severity could add about $21 million above the accrual. It expected the remaining $24.2 million under a separate indemnity agreement to be paid in the fourth quarter.
- Mortgage credit remains a risk: about 63% of the mortgage loan portfolio was purchased from Sand Canyon Corporation, and 41.5% of that segment was at least 30 days past due. Overall mortgage loans held for investment were $513.2 million net of an $87.9 million allowance; approximately 51% of the portfolio was concentrated in Florida, California and New York.
- Other material exposures include pending litigation and investigations. Accrued litigation and related contingencies were $43.9 million. The filing describes claims whose potential losses are not reasonably estimable, including a certified wage-and-hour class action and litigation related to discontinued mortgage operations; adverse outcomes could materially affect results.
- Management highlighted uncertainty from the loss of RAL availability and the potential effects of the Dodd-Frank Act, including future regulatory requirements for HRB Bank and possible limits on payment-card interchange fees. The filing reported no material changes in market risk and stated disclosure controls were effective.
Key facts for investors to verify
- Whether the improved return-preparation trend after January 31 continued through the remainder of tax season, and whether management’s full-year volume and average-fee expectations were achieved.
- The effects of the discontinued HSBC RAL program on client retention, RAC and other settlement-product revenue, and credit losses.
- Collections, delinquencies and reserve adequacy for Emerald Advance receivables and the legacy mortgage portfolio, particularly Sand Canyon-originated loans.
- Progress in resolving mortgage repurchase claims and significant litigation, including the adequacy of the $155.0 million repurchase liability and $43.9 million litigation accrual.
- Completion, financing and expected contribution of the proposed TaxACT acquisition, and the impact of share repurchases and debt on liquidity and financial flexibility.