HRB

H&R Block, Inc. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report (Form 10-Q) for H&R Block, Inc. for the period ended October 31, 2006. The company operates through four primary segments: Tax Services, Mortgage Services, Business Services, and Consumer Financial Services (which includes HRB Bank, HRB Financial Advisors, and HRB Mortgage Corporation). The company is a large accelerated filer incorporated in Missouri.

Key Financial Metrics

Amounts in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 6.9% to $563.2 million for the quarter and 9.5% to $1.1 billion for the six months compared to the prior year. This was primarily driven by a significant drop in the Mortgage Services segment.
• Net Loss Expansion: Net loss increased 92.6% to $156.5 million for the quarter and 163.5% to $287.8 million for the six months compared to the prior year.
• Mortgage Segment Performance: Mortgage Services revenues fell 40.4% for the quarter and 42.6% for the six months. This was caused by a 45.7% decline in loan origination volumes and increased loss provisions for loan repurchases due to higher early payment defaults.
• Business Services Growth: Revenues increased 37.3% for the quarter and 47.9% for the six months, largely attributable to the acquisition of American Express Tax and Business Services, Inc. (AmexTBS).
• Derivative Losses: The company recorded a net loss of $29.4 million on derivative instruments for the quarter, compared to a gain of $55.1 million in the prior year, due to declining market interest rates.

Guidance, Outlook, Risks, and Unusual Items

• Restructuring: On November 6, 2006, the company announced an additional restructuring plan for mortgage operations, including the closure of 12 offices and affecting approximately 300 positions. Expected charges are between $10 million and $12 million, to be recorded in the third and fourth quarters.
• Strategic Alternatives: Management is evaluating strategic alternatives for Option One Mortgage Corporation (OOMC), including a possible sale.
• Loan Repurchase Reserves: Due to higher early payment defaults, the company increased its repurchase liability to $84.1 million (from $33.4 million at April 30, 2006). Loss provisions for loan repurchases totaled $138.6 million for the six months ended October 31, 2006.
• Legal Proceedings: Significant litigation remains regarding Refund Anticipation Loans (RALs), the Peace of Mind (POM) guarantee program, and the Express IRA product. The company settled several RAL cases in fiscal 2006 for a combined pretax expense of $70.2 million. A securities class action and shareholder derivative suits are also pending.
• HRB Bank: HRB Bank commenced operations on May 1, 2006, and is categorized as "well capitalized" by regulators.

Investor Verification Checklist

• Mortgage Asset Quality: Verify the adequacy of the $84.1 million repurchase reserve given the rising trend in early payment defaults and the increase in loss severity assumptions to 17%.
• Derivative Exposure: Review the sensitivity of mortgage servicing rights (MSRs) and residual interests to changes in interest rates and prepayment speeds, as these significantly impact earnings.
• Legal Accruals: Assess the potential financial impact of pending RAL, POM, and securities litigation, noting that the company states ultimate liability is difficult to predict.
• Liquidity Position: Confirm the company's ability to refinance $500 million in Senior Notes due in April 2007 and manage the $1.04 billion commercial paper balance.
• Segment Integration: Monitor the integration and profitability of the AmexTBS acquisition within the Business Services segment.