HRB

Business Context and Reporting Period

Company: H&R Block, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 31, 2007 (First Quarter of Fiscal Year 2008)
Business Overview: H&R Block operates through Tax Services, Business Services, and Consumer Financial Services segments. The quarter was significantly impacted by the classification of its mortgage operations (Option One Mortgage Corporation - OOMC) as discontinued operations due to a pending sale agreement and severe deterioration in the non-prime mortgage market.

Key Financial Metrics

Material Changes vs. Prior Period

• Discontinued Operations Impact: The net loss increased significantly year-over-year, driven primarily by a $192.8 million loss from discontinued operations (OOMC), compared to a $13.5 million loss in the prior year. This includes $157.3 million in loan repurchase reserves and $49.6 million in impairments of residual interests.
• Continuing Operations: Despite the overall loss, the loss from continuing operations narrowed slightly to $109.8 million from $117.8 million, aided by improved performance in Consumer Financial Services (turning a $3.1 million loss into a $6.2 million profit) and reduced corporate expenses.
• Revenue Growth: Total revenues increased 11.2% to $381.2 million, driven by a 45% increase in Consumer Financial Services revenues and growth in Tax Services.
• Cash Flow: Net cash used in operating activities was $432.2 million, a decrease from $476.1 million in the prior year, primarily due to lower income tax payments.

Guidance, Outlook, and Risks

• Mortgage Market Outlook: Management expects loan originations to slow to approximately $200 million per month starting September 2007. They anticipate further impairments to residual interests and loans held for sale in the second quarter, potentially ranging from $150 million to $200 million pretax.
• Sale of OOMC: The company is not currently in compliance with certain closing conditions for the sale of OOMC to Cerberus Capital Management. While they intend to consummate the transaction by December 31, 2007, there is no assurance the deal will close. Failure to close could result in additional significant impairment losses.
• Regulatory Capital: H&R Block Bank (HRB Bank) is subject to a Supervisory Directive from the Office of Thrift Supervision (OTS) requiring a 3% minimum ratio of adjusted tangible capital. The company is currently non-compliant and does not expect to regain compliance until April 30, 2008. Consequently, share repurchases are suspended until Fiscal Year 2009.
• Liquidity: Due to disruptions in the commercial paper market, the company drew $1.2 billion on its committed lines of credit (CLOCs) subsequent to July 31, 2007, to ensure stable funding.
• Legal Proceedings: Significant litigation remains regarding Refund Anticipation Loans (RAL), the Peace of Mind (POM) guarantee program, and Express IRA marketing. The company believes it has meritorious defenses but acknowledges potential material adverse effects if outcomes are unfavorable.

Investor Verification Checklist

• OOMC Sale Status: Verify if the company has obtained waivers for the closing conditions of the OOMC sale or if the transaction is at risk of termination.
• Impairment Estimates: Monitor the second-quarter results for the anticipated $150-$200 million in additional impairments related to the non-prime mortgage portfolio.
• Regulatory Compliance: Track progress toward meeting the OTS 3% adjusted tangible capital requirement by April 30, 2008, and the impact on future capital allocation (dividends/buybacks).
• Liquidity Position: Confirm the company's ability to refinance commercial paper and maintain access to credit lines given the negative outlook on credit ratings.
• Legal Reserves: Review updates on RAL and POM litigation settlements or judgments that could impact future earnings.