HRB

H&R Block, Inc. 2005 Form 10-K Summary

Business Context and Reporting Period

This report covers the fiscal year ended April 30, 2005. H&R Block is a diversified financial services company operating through four primary segments: Tax Services (retail, online, and software), Mortgage Services (non-prime and prime origination and servicing), Business Services (accounting, tax, and consulting for mid-sized businesses), and Investment Services (brokerage and financial planning). The company serves approximately 21.4 million clients globally.

Restatement Notice: On June 7, 2005, the company restated its financial statements for fiscal years 2004 and 2003, as well as interim periods, due to errors in accounting for income taxes, gain on sale of residual interests, incentive compensation, lease accounting, and acquisition accounting.

Key Financial Metrics (Fiscal Year 2005)

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 4.1% to $4.42 billion, driven by growth in Tax Services (+7.6%) and Business Services (+14.8%), partially offset by a decline in Mortgage Services revenues (-5.9%).
• Profitability Decline: Net income decreased 10.3% to $635.9 million. Diluted earnings per share fell 3.8% to $3.77, primarily due to margin compression in the Mortgage Services segment.
• Mortgage Segment Performance: While loan origination volumes reached record levels of $31.0 billion, gains on sales of mortgage assets declined 10.5% to $822.1 million due to increased price competition and lower execution prices in the secondary market. Net margin dropped to 1.12% from 2.22%.
• Tax Segment Performance: Despite serving fewer clients (21.4 million vs. 21.6 million), revenue grew due to higher average fees and increased return complexity. Pretax income increased 3.9% to $663.5 million.
• Investment Segment: Continued to report a pretax loss of $75.4 million, consistent with the prior year's loss of $75.6 million.

Guidance, Outlook, and Risks

• Outlook: Management expects Tax Services revenue growth of less than 10% in fiscal 2006, with continued office expansion (500-700 new offices) expected to incur incremental pretax losses initially. Mortgage Services expects loan origination growth of at least 15% with net margins between 1.00% and 1.25%. Business Services pretax income is expected to increase by approximately 30%.
• Dividends and Buybacks: The Board approved a dividend increase to $0.25 per share (from $0.22) and a two-for-one stock split effective August 2005. The company repurchased 11.2 million shares in fiscal 2005.
• Material Weakness in Internal Controls: The company identified a material weakness in internal controls over financial reporting related to income tax accounting. This resulted in the restatement of prior periods. KPMG issued an adverse opinion on the effectiveness of internal controls as of April 30, 2005.
• Legal Contingencies: Significant litigation remains regarding Refund Anticipation Loans (RALs) and the Peace of Mind (POM) guarantee. A proposed $360 million settlement in the Carnegie RAL case was denied by the court in May 2005; the case is scheduled for trial in October 2005.
• Regulatory Risks: The company faces ongoing regulatory scrutiny regarding RALs, mortgage lending practices (predatory lending laws), and the potential consolidation of Qualifying Special Purpose Entities (QSPEs) under proposed FASB rules, which could impact the balance sheet.

Investor Verification Checklist

• Restatement Impact: Verify the specific adjustments made to prior year financials regarding income taxes and mortgage gain-on-sale accounting to understand the true trend in profitability.
• Internal Control Remediation: Monitor the company's progress in remedying the material weakness in tax accounting controls to ensure future financial statement reliability.
• RAL Litigation Exposure: Assess the potential financial impact of the pending Carnegie RAL trial and other class actions, given the denial of the previous settlement.
• Mortgage Margin Sustainability: Evaluate whether the compressed mortgage margins (1.12%) are sustainable given the competitive landscape and interest rate environment.
• QSPE Accounting Changes: Review the potential impact of proposed FASB rules on the consolidation of mortgage trusts, which could significantly alter the company's reported leverage and asset base.