H&R Block, Inc. — FY2010 Form 10-K
Reporting period: Fiscal year ended April 30, 2010. The request labels the period “2009 Q4,” but this filing is an annual report, not a quarterly filing; it includes fourth-quarter data.
Business context
H&R Block provides retail, online and software-based tax preparation, retail banking products, and tax and consulting services to middle-market businesses. Tax Services generated 76.8% of continuing-operations revenue; Business Services generated 22.2%. Results are highly seasonal, with most tax-preparation revenue earned during tax season.
Key financial results
| Metric | FY2010 | FY2009 | Change |
|---|---|---|---|
| Revenue | $3.874 billion | $4.084 billion | Down 5.1% |
| Continuing-operations pretax income | $784.1 million | $839.4 million | Down 6.6% |
| Continuing-operations net income | $488.9 million | $513.1 million | Down 4.7% |
| Diluted EPS from continuing operations | $1.46 | $1.53 | Down 4.6% |
| Net income, including discontinued operations | $479.2 million | $485.7 million | Down 1.3% |
| Operating cash flow | $587.5 million | $1.024 billion | Down $437.0 million |
| Capital expenditures | $90.5 million | $97.9 million | Down $7.4 million |
- Margins: Tax Services pretax margin was 29.2%, versus 29.6% in FY2009. Business Services pretax margin was 6.8%, versus 10.7%. Consolidated operating income was $774.8 million.
- Cash and liquidity: Cash and cash equivalents were $1.804 billion at year-end, including cash held by regulated HRB Bank. Of the bank’s $701.0 million cash balance, distributions for general corporate use were subject to regulatory approval. The company reported no short-term borrowings outstanding at April 30, 2010.
- Debt: Long-term debt was $1.035 billion, and Federal Home Loan Bank borrowings totaled $75.0 million. The company had a new $1.7 billion committed credit line, maturing July 2013, with no balance drawn at year-end. It reported compliance with covenants and net worth of $1.4 billion.
- Shareholder returns: Dividends paid were $200.9 million; 12.8 million shares were repurchased and retired for $250.0 million. Dividends declared were $0.75 per share, including a payment declared in April for July 2010.
Material changes versus FY2009
- Worldwide tax returns prepared fell to 23.2 million from 23.9 million; U.S. returns fell to 20.1 million from 21.0 million. The company cited lower IRS filings, high unemployment among its key client segments, office closures and reduced retail volumes. The net average fee per U.S. retail return increased to $189.21 from $187.36.
- Tax Services revenue declined 5.0% and pretax income declined $59.7 million. Revenue from tax-preparation fees fell 7.6%; $49.1 million of gains on sales of tax offices partly offset the decline, compared with $14.9 million in FY2009. Management said gains were not expected to continue at a similar level in FY2011.
- Business Services pretax income declined 38.9%, to $58.7 million. Results reflected weaker core service revenue, a $15.0 million goodwill impairment at RSM EquiCo, and increased legal and arbitration costs.
- Corporate pretax loss narrowed to $141.9 million from $183.8 million, supported by lower loan-loss provisions and gains relating to residual interests and transferred insurance risk. Mortgage-loan interest income declined.
- Operating cash flow decreased primarily because the company paid $359.6 million in income taxes in FY2010, versus net tax refunds received in FY2009.
Outlook, risks and unusual items
- No specific consolidated revenue, earnings or EPS guidance is provided in the supplied filing text. The company said existing capital sources should meet operating needs absent unexpected developments.
- In May 2010, after year-end, the company announced a realignment involving approximately 400 staff reductions and 400 office closures. Approximately $19 million of severance was recorded primarily in the first quarter of FY2011.
- Mortgage credit remains a major exposure. Mortgage loans held for investment had $683.7 million principal outstanding and a $93.5 million allowance at April 30, 2010; the allowance was 13.7% of principal, up from 10.2%. Loans purchased from discontinued mortgage affiliate Sand Canyon Corporation (SCC) represented about 64% of the portfolio and had higher delinquency rates. The company recorded $47.8 million of loan-loss provisions in FY2010.
- SCC’s loan repurchase and indemnification liability was $188.2 million. Future valid claims, declining home values or greater losses could exceed estimates. SCC also faces mortgage-related litigation and investigations.
- Material legal matters include POM class actions; a remaining RAL case; RSM EquiCo litigation involving client fees of approximately $185 million; and claims relating to M&P audit work and discontinued mortgage operations. The company reported $35.5 million of accrued litigation and related contingencies; actual losses could differ materially.
- An Express IRA settlement approved in May 2010 requires a payment between $11.4 million and $25.4 million, depending on claims, with claims due by July 30, 2010. The company said it had previously accrued its best estimate. A separate Mississippi Attorney General case remained pending.
- RSM and M&P renewed their alternative practice structure agreements in February 2010 after termination notices. The relationship remains important to RSM’s business and carries regulatory, litigation and continuity risks. RSM also committed to pay $60.0 million in FY2011 for retirement-plan contributions through 2015.
- Other risks identified include recession and unemployment, competition and free tax-preparation offers, changes to regulation of tax preparers and refund anticipation loans, privacy and cybersecurity, seasonal systems capacity, liquidity access and credit ratings, and regulatory limits on HRB Bank capital distributions.
- The company reported effective disclosure controls and internal control over financial reporting; Deloitte & Touche issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether tax-return volumes, client retention and average fees stabilized after FY2010’s declines, and whether office closures and franchise conversions affect future revenue and margins.
- Whether tax-office sale gains recur; management cautioned that FY2010’s $49.1 million level was not expected to continue similarly.
- Mortgage portfolio delinquency, collateral values, charge-offs and reserve adequacy, particularly for SCC-originated loans; also track repurchase claims against SCC.
- Final costs and developments in the Express IRA settlement and significant POM, RSM EquiCo, SCC and other litigation.
- Availability of HRB Bank cash to the parent, ongoing regulatory capital requirements, and compliance with the credit-line covenants and seasonal clean-down requirement.
- Effects of announced FY2011 workforce and office reductions, including severance, savings and potential client impacts.