H&R Block 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 1-6089
(Exact name of registrant as specified in its charter)
One H&R Block Way, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
Common Stock, without par value
(Title of Class)
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the registrants Common Stock (all voting stock) held by non-affiliates of the registrant, computed by reference to the price at which the stock was sold on October 31, 2008, was $6,539,980,861.
Number of shares of the registrants Common Stock, without par value, outstanding on May 31, 2009: 334,140,455.
The definitive proxy statement for the registrants Annual Meeting of Shareholders, to be held September 10, 2009, is incorporated by reference in Part III to the extent described therein.
2009 FORM 10-K AND ANNUAL REPORT
Specified portions of our proxy statement, which will be filed in July 2009, are listed as incorporated by reference in response to certain items. Our proxy statement will be made available to shareholders in July 2009, and will also be available on our website at www.hrblock.com.
This report and other documents filed with the Securities and Exchange Commission (SEC) may contain forward-looking statements. In addition, our senior management may make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as expects, anticipates, intends, plans, believes, seeks, estimates, will, would, should, could or may. Forward-looking statements provide managements current expectations or predictions of future conditions, events or results. They may include projections of revenues, income, earnings per share, capital expenditures, dividends, liquidity, capital structure or other financial items, descriptions of managements plans or objectives for future operations, products or services, or descriptions of assumptions underlying any of the above. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date they are made and management does not undertake to update them to reflect changes or events occurring after that date except as required by federal securities laws.
ITEM 1. BUSINESS
H&R Block, Inc. has subsidiaries that provide tax, retail banking, accounting and business consulting services and products. Our Tax Services segment primarily consists of our income tax preparation businesses retail, online and software. These businesses serve the general public in the United States (U.S.), Canada and Australia. Additionally, this segment includes commercial tax businesses, which provide tax preparation software to certified public accountants (CPAs) and other tax preparers in the U.S. Our Business Services segment consists of a national accounting, tax and business consulting firm primarily serving middle-market companies under the RSM McGladrey, Inc. (RSM) brand. Our Consumer Financial Services segment is engaged in retail banking through H&R Block Bank (HRB Bank).
H&R Block, Inc. was organized as a corporation in 1955 under the laws of the State of Missouri. H&R Block, the Company, we, our and us are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context. A complete list of our subsidiaries can be found in Exhibit 21.
DISCONTINUED OPERATIONS Effective November 1, 2008, we sold H&R Block Financial Advisors, Inc. (HRBFA) to Ameriprise Financial, Inc. (Ameriprise). We received cash proceeds, net of selling costs, of $304.0 million and repayment of $46.6 million in intercompany liabilities. At April 30, 2009, HRBFA and its direct corporate parent are presented as discontinued operations in the consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. See additional discussion in Item 8, note 19 to our consolidated financial statements.
Our discontinued operations also include the wind-down of our mortgage loan origination business and the sale of our mortgage loan servicing business in the prior year. Also included in the prior years are the results of three smaller lines of business previously reported in our Business Services segment.
ISSUANCE OF COMMON STOCK In October 2008, we sold 8.3 million shares of our common stock, without par value, at a price of $17.50 per share in a registered direct offering through subscription agreements with selected institutional investors. We received net proceeds of $141.4 million, after deducting placement agent fees and other offering expenses. The purpose of the equity offering was to ensure we maintained adequate equity levels, as a condition of certain borrowings, during our off-season. Proceeds were used for general corporate purposes.
See discussion below and in Item 8, note 20 to our consolidated financial statements.
DESCRIPTION OF BUSINESS
GENERAL Our Tax Services segment is primarily engaged in providing tax return preparation and related services and products in the U.S. and its territories, Canada and Australia. Major revenue sources include fees earned for tax preparation services performed at company-owned retail tax offices, royalties from franchise retail tax offices, sales of tax-related services, sales of tax preparation and other software, online tax preparation fees,
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participation in refund anticipation loans (RALs) and Emerald Advance lines of credit. Segment revenues constituted 74.3% of our consolidated revenues from continuing operations for fiscal year 2009, 73.1% for 2008 and 72.4% for 2007.
Retail income tax return preparation and related services are provided by tax professionals via a system of retail offices operated directly by us or by franchisees. We also offer our services through seasonal offices located inside major retailers.
TAX RETURNS PREPARED We, together with our franchisees, prepared approximately 24.0 million tax returns worldwide during fiscal year 2009, compared to 24.6 million in 2008 and 24.0 million in 2007. We prepared 21.1 million tax returns in the U.S. during fiscal year 2009, down from 21.8 million in 2008 and 21.5 million in 2007. Our U.S. tax returns prepared, including those prepared and filed at no charge, for the 2009 tax season constituted 15.8% of an Internal Revenue Service (IRS) estimate of total individual income tax returns filed during the fiscal year 2009 tax season. This compares to 16.2% in the 2008 tax season, excluding tax returns filed as a result of the Economic Stimulus Act of 2008 (Stimulus Act), and 16.5% in 2007.
FRANCHISES We offer franchises as a way to expand our presence in the market. Our franchise arrangements provide us with certain rights designed to protect our brand. Most of our franchisees receive use of our software, access to product offerings and expertise, signs, specialized forms, local advertising, initial training and supervisory services, and pay us a percentage, typically approximately 30%, of gross tax return preparation and related service revenues as a franchise royalty.
From time to time, we have acquired the territories of existing franchisees and other tax return preparation businesses, and may continue to do so if future conditions warrant and satisfactory terms can be negotiated. During fiscal year 2009, we acquired the assets and franchise rights of our last major independent franchise operator for an aggregate purchase price of $279.2 million. Results of the acquisition are included in our consolidated financial statements at April 30, 2009. See Item 8, note 2 to our consolidated financial statements for additional information.
We have also initiated a program to optimize our retail tax office network, including the mix of franchised and company-owned offices. During fiscal year 2009 we sold certain offices to existing franchisees for sales proceeds totaling $16.9 million. The net gain on these transactions totaled $14.9 million. We expect to continue this program in the coming years. The extent to which we refranchise offices will depend upon ongoing analysis regarding the optimal mix of offices for our network, including geographic location, as well as our ability to identify qualified franchisees.
OFFICES A summary of our company-owned and franchise offices is as follows:
The acquisition of our last major independent franchise operator included a network of over 600 tax offices, nearly two-thirds of which converted to company-owned offices upon the closing of the transaction, as reflected in the table above.
Offices in shared locations at April 30, 2009, include 722 offices in Sears stores operated as H&R Block at Sears and 1,030 offices operated in Wal-Mart stores. The Sears license agreement expires in July 2010. The Wal-Mart agreement expired in May 2009, and the related offices have been closed.
During fiscal year 2007, we acquired ExpressTax, a national franchisor of tax preparation businesses, for an aggregate cash purchase price of $5.7 million. This acquisition added 249 offices to our network, which continue to operate under the ExpressTax brand. There are currently 368 offices operating under the ExpressTax brand.
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SERVICE AND PRODUCT OFFERINGS We offer a number of digital tax preparation alternatives. TaxCut® from H&R Block enables do-it-yourself users to prepare their federal and state tax returns easily and accurately. Our software products may be purchased through third-party retail stores, direct mail or online.
We also offer our clients many online options: multiple versions of do-it-yourself tax preparation; professional tax review; tax advice; and tax preparation through a tax professional, whereby the client completes a tax organizer and sends it to a tax professional for preparation and/or signature.
By offering professional and do-it-yourself tax preparation options through multiple channels, we seek to serve our clients in the manner they choose to be served.
We also offer clients a number of options for receiving their income tax refund, including a check directly from the IRS, an electronic deposit directly to their bank account, a prepaid debit card, a refund anticipation check (RAC) or a RAL.
The following are some of the services and products we offer in addition to our tax preparation service:
RALs. RALs are offered to our U.S. clients by a designated bank primarily through a contractual relationship with HSBC Holdings plc (HSBC). An eligible, electronic filing client may apply for a RAL at one of our offices. After meeting certain eligibility criteria, clients are offered the opportunity to apply for a loan from HSBC in amounts up to $9,999 based on their anticipated federal income tax refund. We simultaneously transmit the income tax return information to the IRS and the lending bank. Within a few days after the filing date, the client receives a check, direct deposit or prepaid debit card in the amount of the loan, less the banks transaction fee, our tax return preparation fee and other fees for client-selected services. Additionally, qualifying electronic filing clients are eligible to receive their RAL proceeds, less applicable fees, in approximately one hour after electronic filing using the Instant Money service. A RAL is repaid when the IRS directly deposits the participating clients federal income tax refund into a designated account at the lending bank. See related discussion in Loan Participations below.
RACs. Refund Anticipation Checks are offered to U.S. clients who would like to either: (1) receive their refund faster and do not have a bank account for the IRS to direct deposit their refund; (2) have their tax preparation fees paid directly out of their refund; or (3) receive their refund faster but do not qualify for a RAL under the existing credit criteria. A RAC is not a loan and is provided through a contractual relationship with HSBC.
Peace of Mind (POM) Guarantee. The POM guarantee is offered to U.S. clients, in addition to our standard guarantee, whereby we (1) represent our clients if audited by the IRS, and (2) assume the cost, subject to certain limits, of additional taxes owed by a client resulting from errors attributable to one of our tax professionals work. The POM program has a per client cumulative limit of $5,000 in additional taxes assessed with respect to the federal, state and local tax returns we prepared for the taxable year covered by the program.
Emerald Advance Lines of Credit. Emerald Advance lines of credit are offered to clients in tax offices from mid-November through early January, currently in an amount not to exceed $1,000 (previously $500). If the borrower meets certain criteria as agreed in the loan terms, the line of credit can be increased and utilized year-round. These lines of credit are offered by HRB Bank.
H&R Block Prepaid Emerald Mastercard®. The H&R Block Prepaid Emerald MasterCard® allows a client to receive a tax refund from the IRS directly on a prepaid debit card, or to direct RAL or RAC proceeds to the card to avoid high-cost check-cashing fees. The card can be used for everyday purchases, bill payments and ATM withdrawals anywhere MasterCard® is accepted. Additional funds can be added to the card account year-round through direct deposit or at participating retail locations. The H&R Block Prepaid Emerald MasterCard® is issued by HRB Bank.
Tax Return Preparation Courses. We offer income tax return preparation courses to the public, which teach students how to prepare income tax returns and provide us with a source of trained tax professionals.
Software Products. We develop and market TaxCut® income tax preparation software. TaxCut® offers a simple step-by-step tax preparation interview, data imports from money management software and tax preparation software, calculations, completion of the appropriate tax forms, checking for errors and electronic filing.
During fiscal year 2007, we acquired TaxWorks LLC and its affiliated entities, a provider of commercial tax preparation software targeting the independent tax preparer market. The primary software product, TaxWorks®, is designed for small to mid-sized CPA firms who file tax returns for individuals and businesses. See Item 8, note 2 to our consolidated financial statements.
Online Tax Preparation. We offer a comprehensive range of online tax services, from tax advice to complete professional and do-it-yourself tax return preparation and electronic filing, through our websites at www.hrblock.com and www.taxcut.com. These websites allow clients to prepare their federal and state income tax returns using the TaxCut® Online Tax Program, access tax tips, advice and tax-related news and use calculators for tax planning.
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We participate in the Free File Alliance (FFA). This alliance was created by the tax return preparation industry and the IRS, and allows qualified filers with adjusted gross incomes less than $56,000 to prepare and file their federal return online at no charge. We feel this program provides a valuable public service and increases our visibility with new clients, while also providing an opportunity to offer our state return preparation and other services to these clients.
CashBack Program. We offer a refund discount (CashBack) program to our customers in Canada. In accordance with current Canadian regulations, if a customers tax return indicates the customer is entitled to a tax refund, we issue a check to the client in the amount of the refund, less a discount. The client assigns to us the full amount of the tax refund to be issued by the Canada Revenue Agency (CRA) and the refund check is then sent by the CRA directly to us. In accordance with the law, the discount is deemed to include both the tax return preparation fee and the fee for tax refund discounting. This program is financed by short-term borrowings. The number of returns discounted under the CashBack program in fiscal year 2009 was approximately 782,000, compared to 749,000 in 2008 and 670,000 in 2007.
LOAN PARTICIPATIONS Since July 1996, we have been a party to agreements with HSBC and its predecessors to participate in RALs provided by a lending bank to H&R Block tax clients. During fiscal year 2006, we signed a new agreement with HSBC in which we obtained the right to purchase a 49.9% participation interest in all RALs obtained through our retail offices. We received a signing bonus from HSBC during fiscal year 2006 in connection with this agreement, which was recorded as deferred revenue and is earned over the contract term. The agreement is effective through June 2011 and we have extensions through 2013. Our purchases of the participation interests are financed through short-term borrowings and we bear all of the credit risk associated with our participation interests. Revenue from our participation is calculated as the rate of participation multiplied by the fee paid by the borrower to the lending bank. Our RAL participation revenue was $142.7 million, $190.2 million and $192.4 million in fiscal years 2009, 2008 and 2007, respectively.
SEASONALITY OF BUSINESS Because most of our clients file their tax returns during the period from January through April of each year, substantially all of our revenues from income tax return preparation and related services and products are received during this period. As a result, our tax segment generally operates at a loss through the first eight months of the fiscal year. Peak revenues occur during the applicable tax season, as follows:
COMPETITIVE CONDITIONS The retail tax services business is highly competitive. There are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services. Many tax return preparation firms and many firms not otherwise in the tax return preparation business are involved in providing electronic filing and RAL services to the public. Commercial tax return preparers and electronic filers are highly competitive with regard to price and service. In terms of the number of offices and personal tax returns prepared and electronically filed in offices, online and via our software, we believe we are the largest company providing direct tax return preparation and electronic filing services in the U.S. We also believe we operate the largest tax return preparation businesses in Canada and Australia.
Our digital tax solutions businesses compete with a number of companies. Intuit, Inc. is the largest supplier of tax preparation software and online tax preparation services. There are many smaller competitors in the online market, as well as free state-sponsored online filing programs. Price and marketing competition for digital tax preparation services is increasing, including offers of free tax preparation services.
GOVERNMENT REGULATION Federal legislation requires income tax return preparers to, among other things, set forth their signatures and identification numbers on all tax returns prepared by them and retain all tax returns prepared by them for three years. Federal laws also subject income tax return preparers to accuracy-related penalties in connection with the preparation of income tax returns. Preparers may be prohibited from further acting as income tax return preparers if they continuously and repeatedly engage in specified misconduct.
The federal government regulates the electronic filing of income tax returns in part by requiring electronic filers to comply with all publications and notices of the IRS applicable to electronic filing. We are required to provide certain electronic filing information to the taxpayer and comply with advertising standards for electronic filers. We are also subject to possible monitoring by the IRS, penalties for improper disclosure or use of income tax return preparation, other preparer penalties and suspension from the electronic filing program.
The Gramm-Leach-Bliley Act and related Federal Trade Commission (FTC) regulations require income tax preparers to adopt and disclose consumer privacy policies, and provide consumers a reasonable opportunity to opt-out of having personal information disclosed to unaffiliated third-parties for marketing purposes. Some states have adopted or proposed strict opt-in requirements in connection with use or disclosure of consumer
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information. In addition, the IRS generally prohibits the use or disclosure by tax return preparers of taxpayer information without the prior written consent of the taxpayer.
Federal statutes and regulations also regulate an electronic filers involvement in RALs. Electronic filers must clearly explain the RAL is a loan and not a substitute for or a quicker way of receiving an income tax refund. Federal laws place restrictions on the fees an electronic filer may charge in connection with RALs. In addition, some states and localities have enacted laws and adopted regulations for RAL facilitators and/or the advertising of RALs.
Certain states have regulations and requirements relating to offering income tax courses. These requirements include licensing, bonding and certain restrictions on advertising.
As noted above under Offices, many of the income tax return preparation offices operating in the U.S. under the name H&R Block are operated by franchisees. Our franchising activities are subject to the rules and regulations of the FTC and various state laws regulating the offer and sale of franchises. The FTC and various state laws require us to furnish to prospective franchisees a franchise offering circular containing prescribed information. A number of states in which we are currently franchising regulate the sale of franchises and require registration of the franchise offering circular with state authorities and the delivery of a franchise offering circular to prospective franchisees. We are currently operating under exemptions from registration in several of these states based on our net worth and experience. Substantive state laws regulating the franchisor/franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time that would provide for federal regulation of the franchisor/franchisee relationship in certain respects. The state laws often limit, among other things, the duration and scope of non-competition provisions, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply. From time to time, we may make appropriate amendments to our franchise offering circular to comply with our disclosure obligations under federal and state law.
We also seek to determine the applicability of all government and self-regulatory organization statutes, ordinances, rules and regulations in the other countries in which we operate (collectively, Foreign Laws) and to comply with these Foreign Laws. In addition, the Canadian government regulates the refund-discounting program in Canada. These laws have not materially affected our international operations.
See discussion in Item 1A, Risk Factors for additional information.
GENERAL Our Business Services segment offers accounting, tax and business consulting services, wealth management and capital markets services to middle-market companies. Segment revenues constituted
22.0% of our consolidated revenues from continuing operations for fiscal year 2009, 23.0% for fiscal year 2008 and 25.1% for fiscal year 2007.
This segment consists primarily of RSM, which provides accounting, tax and business consulting services in 93 cities and 25 states and offers services in 21 of the 25 top U.S. markets.
From time to time, we have acquired related businesses and may continue to do so if future conditions warrant and satisfactory terms can be negotiated.
RELATIONSHIP WITH ATTEST FIRMS By regulation, we cannot provide financial statement attest services. McGladrey & Pullen LLP (M&P) and other public accounting firms (collectively, the Attest Firms) operate in an alternative practice structure with RSM, and provide attest and other services related to client financial statements. Through a number of agreements with these Attest Firms, we provide accounting, payroll, human resources, marketing and other administrative services to the Attest Firms. We receive a management fee for these services. We also have a cost-sharing arrangement with the Attest Firms, whereby they reimburse us for certain costs, mainly for the use of RSM-owned or leased real estate, property and equipment. The Attest Firms generally may terminate these arrangements upon 210 days notice. Following such a termination, the Attest Firms generally are prohibited for a period of three years from engaging in businesses in which RSM engages or soliciting RSM clients. In addition, we provide working capital to M&P through a revolving credit facility in an amount equal to the lower of the value of their accounts receivable, work-in-process and fixed assets or $125.0 million. This credit facility is secured by M&Ps accounts receivable, work-in-process and fixed assets. The Attest Firms are limited liability partnerships with their own independent management, legal and business advisors, professional liability insurance, quality assurance and risk management policies. Accordingly, the Attest Firms are separate legal entities and not affiliates. Some partners and employees of the Attest Firms are also employees of RSM. The terms of the RSM/Attest Firms arrangements are based on the mutual agreement of the parties. As a result, from time to time, the parties assess various aspects of the relationship, such as the extent and cost of the RSM services, mutually supportive marketing initiatives, acquisition strategies and financing, and, when mutually agreed, have
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implemented appropriate changes in the relationship. Such a discussion is currently underway, which could lead to additional changes in the relationship.
SEASONALITY OF BUSINESS Revenues for this segment are largely seasonal in nature, with peak revenues occurring during January through April.
COMPETITIVE CONDITIONS The accounting, tax and consulting business is highly competitive. The principal methods of competition are price, service and reputation for quality. There are a substantial number of accounting firms offering similar services at the international, national, regional and local levels. As our focus is on middle-market businesses, our principal competition is with national and regional accounting firms.
GOVERNMENT REGULATION Many of the same federal and state regulations relating to tax preparers and the information concerning tax reform discussed previously in Tax Services apply to the Business Services segment as well. RSM is not, and is not eligible to be, a licensed public accounting firm and takes measures to ensure that it does not provide services prohibited by regulation, such as attest services. RSM, through its subsidiaries, provides capital markets and wealth management services and is subject to state and federal regulations governing investment advisors and securities brokers and dealers.
Auditor independence rules of the SEC, the Public Company Accounting Oversight Board (PCAOB) and various states apply to the Attest Firms as public accounting firms. In applying its auditor independence rules, the SEC views us and the Attest Firms as a single entity and requires that the SEC independence rules for the Attest Firms apply to us and requires us to be independent of any SEC audit client of the Attest Firms. The SEC regards any financial interest or prohibited business relationship we have with a client of the Attest Firms as a financial interest or prohibited business relationship between the Attest Firms and the client for purposes of applying its auditor independence rules.
We and the Attest Firms have jointly developed and implemented policies, procedures and controls designed to ensure the Attest Firms independence as audit firms complying with applicable SEC regulations and professional responsibilities. These policies, procedures and controls are designed to monitor and prevent violations of applicable independence rules and include, among other things: (1) informing our officers, directors and other members of senior management concerning auditor independence matters; (2) procedures for monitoring securities ownership; (3) communicating with SEC audit clients regarding the SECs interpretation and application of relevant independence rules and guidelines; and (4) requiring RSM employees to comply with the Attest Firms independence and relationship policies (including the Attest Firms independence compliance questionnaire procedures).
See discussion in Item 1A, Risk Factors for additional information.
CONSUMER FINANCIAL SERVICES
GENERAL Our Consumer Financial Services segment is engaged in providing retail banking offerings through HRB Bank, primarily to Tax Services clients in the U.S. HRB Bank offers the H&R Block Prepaid Emerald MasterCard® and Emerald Advance lines of credit through our Tax Services segment. HRB Bank also offers traditional banking services including prepaid debit card accounts, checking and savings accounts, individual retirement accounts and certificates of deposit. Segment revenues constituted 3.5% of our consolidated revenues from continuing operations for fiscal year 2009, 3.5% for 2008 and 2.1% for 2007. This segment previously included HRBFA, which was sold to Ameriprise during fiscal year 2009 and has been presented as a discontinued operation in the accompanying consolidated financial statements.
The operations of HRB Bank are primarily focused on providing limited retail banking services to tax clients of H&R Block. In fiscal years 2008 and 2007, HRB Bank purchased mortgage loans, primarily from former affiliates. Although HRB Bank no longer intends to purchase mortgage loans, it continues to hold mortgage loans for investment purposes. HRB Bank had mortgage loans held for investment of $744.9 million and $966.3 million at April 30, 2009 and 2008, respectively.
HRB Bank earns interest income on mortgage loans held for investment and other investments, bank card transaction fees on the use of debit cards, fees from the use of ATM networks and interest and fees related to Emerald Advance lines of credit. H&R Block and its affiliates provide certain administrative services to HRB Bank. A significant portion of HRB Banks deposit base includes deposits relating to the business of affiliates.
The information required by the SECs Industry Guide 3, Statistical Disclosure by Bank Holding Companies, is included in Item 7.
SEASONALITY OF BUSINESS HRB Banks operating results are subject to seasonal fluctuations primarily related to the offering of the H&R Block Prepaid Emerald MasterCard® and Emerald Advance lines of credit. These services are primarily offered to Tax Services clients, and therefore peak in January and February and taper off through the remainder of the tax season.
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COMPETITIVE CONDITIONS HRB Bank is highly integrated with our Tax Services segment and its customer base of tax preparation clients. For many of these clients, HRB Bank is their only access to banking services. HRB Bank does not seek to compete broadly with regional or national retail banks.
GOVERNMENT REGULATION HRB Bank is subject to regulation, supervision and examination by the Office of Thrift Supervision (OTS), the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). All savings associations are subject to the capital adequacy guidelines and the regulatory framework for prompt corrective action. HRB Bank must meet specific capital guidelines involving quantitative measures of HRB Banks assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. HRB Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. As a savings and loan holding company, H&R Block, Inc. is also subject to regulation by the OTS.
See Item 7, Regulatory Environment and Item 8, note 16 to the consolidated financial statements for additional discussion of regulatory requirements.
Also see discussion in 1A, Risk Factors for additional information.
We have made a practice of selling our services and products under service marks and trademarks and of obtaining protection for these by all available means. Our service marks and trademarks are protected by registration in the U.S. and other countries where our services and products are marketed. We consider these service marks and trademarks, in the aggregate, to be of material importance to our business, particularly our business segments providing services and products under the H&R Block brand.
We have no registered patents material to our business.
We have approximately 8,300 regular full-time employees as of April 30, 2009. The highest number of persons we employed during the fiscal year ended April 30, 2009, including seasonal employees, was approximately 133,700.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website at www.hrblock.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at www.sec.gov containing reports, proxy and information statements and other information regarding issuers who file electronically with the SEC.
Copies of the following corporate governance documents are posted on our website:
If you would like a printed copy of any of these corporate governance documents, please send your request to the Office of the Secretary, H&R Block, Inc., One H&R Block Way, Kansas City, Missouri 64105.
Information contained on our website does not constitute any part of this report.
An investment in our common stock involves risk, including the risk that the value of an investment may decline or that returns on that investment may fall below expectations. There are a number of significant factors which could cause actual conditions, events or results to differ materially from those described in forward-looking statements, many of which are beyond managements control or its ability to accurately forecast or predict, or could adversely affect our operating results and the value of any investment in our stock. Other factors besides those listed below or discussed in reports filed with the SEC could adversely affect our results.
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Our businesses may be adversely affected by economic conditions generally, including the current economic recession.
An economic recession, as we are currently experiencing, is frequently characterized by rising unemployment and declining consumer and business spending. Poor economic conditions may negatively affect demand and pricing for our services. In addition, the recent downturn in the residential housing market and increase in mortgage defaults has negatively impacted our operating results and may continue to do so. An economic recession will likely reduce the ability of our borrowers to repay mortgage loans, and declining home values could increase the severity of loss we may incur in the event of default. In addition to mortgage loans, we also extend secured and unsecured credit to other customers, including RALs and Emerald Advance lines of credit to our tax preparation customers. We may incur significant losses on credit we extend, which in turn could reduce our profitability.
Our access to liquidity may be negatively impacted if disruptions in credit markets occur, if credit rating downgrades occur or if we fail to meet certain covenants. Funding costs may increase, leading to reduced earnings.
We need liquidity to meet our off-season working capital requirements, to service debt obligations including refinancing of maturing obligations, to purchase RAL participations and for other related activities. Although we believe we have sufficient liquidity to meet our current needs, our access to and the cost of liquidity could be negatively impacted in the event of credit-rating downgrades or if we fail to meet existing debt covenants. In addition, events could occur which could increase our need for liquidity above current levels.
If rating agencies downgrade our credit rating, the cost of debt would likely increase and capital market availability could decrease or become unavailable. Our unsecured committed lines of credit (CLOCs) are subject to various covenants, including a covenant requiring that we maintain minimum net worth equal to $650.0 million and a requirement that we reduce the aggregate outstanding principal amount of short-term debt (as defined) to $200.0 million or less for a minimum period of thirty consecutive days during the period from March 1 to June 30 of each year. Violation of a covenant could impair our access to liquidity currently available through the CLOCs. If current sources of liquidity were to become unavailable, we would need to obtain additional sources of funding, which may not be possible or may be available under less favorable terms.
The industries in which we operate face substantial litigation, and such litigation may damage our reputation or result in material liabilities and losses.
We have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation arising in connection with our various business activities. Adverse outcomes related to litigation could result in substantial damages and could cause our earnings to decline. Negative public opinion can also result from our actual or alleged conduct in such claims, possibly damaging our reputation and could cause the market price of our stock to decline. See Item 3, Legal Proceedings for additional information.
Failure to comply with laws and regulations that protect our customers personal and financial information could result in significant fines, penalties and damages and could harm our brand and reputation.
Privacy concerns relating to the disclosure of consumer financial information have drawn increased attention from federal and state governments. The IRS generally prohibits the use or disclosure by tax return preparers of taxpayers information without the prior written consent of the taxpayer. In addition, other regulations require financial service providers to adopt and disclose consumer privacy policies and provide consumers with a reasonable opportunity to opt-out of having personal information disclosed to unaffiliated third-parties for marketing purposes. Although we have established security procedures to protect against identity theft, breaches of our clients privacy may occur. To the extent the measures we have taken prove to be insufficient or inadequate, we may become subject to litigation or administrative sanctions, which could result in significant fines, penalties or damages and harm to our brand and reputation.
In addition, changes in these federal and state regulatory requirements could result in more stringent requirements and could result in a need to change business practices, including how information is disclosed. Establishing systems and processes to achieve compliance with these new requirements may increase costs and/or limit our ability to pursue certain business opportunities.
We are subject to operational risk and risks associated with our controls and procedures, which may result in incurring financial and reputational losses.
There is a risk of loss resulting from inadequate or failed processes or systems, theft or fraud. These can occur in many forms including, among others, errors, business interruptions arising from natural disasters or other events, inadequate design and development of products and services, inappropriate behavior of or misconduct by our employees or those contracted to perform services for us, and vendors that do not perform in accordance with
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their contractual agreements. These events could potentially result in financial losses or other damages. We utilize internally developed processes, internal and external information and technological systems to manage our operations. We are exposed to risk of loss resulting from breaches in the security or other failures of these processes and systems. Our ability to recover or replace our major operational systems and processes could have a significant impact on our core business operations and increase our risk of loss due to disruptions of normal operating processes and procedures that may occur while re-establishing or implementing information and transaction systems and processes. As our businesses are seasonal, our systems must be capable of processing high volumes during peak season. Therefore, service interruptions resulting from system failures could negatively impact our ability to serve our customers, which in turn could damage our brand and reputation, or adversely impact our profitability.
We also face the risk that the design of our controls and procedures may prove to be inadequate or that our controls and procedures may be circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. It is possible that any lapses in the effective operations of controls and procedures could materially affect earnings or harm our reputation. Lapses or deficiencies in internal control over financial reporting could also be material to us.
Government initiatives that simplify tax return preparation could reduce the need for our services as a third-party tax return preparer. In addition, changes in government regulations or processes regarding the preparation and filing of tax returns may increase our operating costs or reduce our revenues.
Many taxpayers seek assistance from paid tax return preparers such as us because of the level of complexity involved in the tax return preparation and filing process. From time to time, government officials propose measures seeking to simplify the preparation and filing of tax returns or to provide additional assistance with respect to preparing and filing such tax returns. The passage of any measures that significantly simplify tax return preparation or otherwise reduce the need for a third-party tax return preparer could reduce demand for our services, causing our revenues or results of operations to decline.
Governmental regulations and processes affect how we provide services to our clients. Changes in these regulations and processes may require us to make corresponding changes to our client service systems and procedures. The degree and timing of changes in governmental regulations and processes may impair our ability to serve our clients in an effective and cost-efficient manner or reduce demand for our services, causing our revenues or results of operations to decline.
Federal and state legislators and regulators have increasingly taken an active role in regulating financial products such as RALs. In addition, we are dependent on third-party financial institutions to provide certain of these financial products to our clients and these institutions could cease or significantly reduce the offering of such products. These trends or potential developments could impede our ability to facilitate these financial products, reduce demand for our services and harm our business.
Changes in government regulation related to RALs could limit the offering of RALs to our clients or our ability to purchase participation interests. In addition, third-party financial institutions currently originating RALs and similar products could decide to cease or significantly limit such offerings and related collection practices. Changes in IRS practices could impair our ability to limit our bad debt exposure. Changes in any of these, as well as possible litigation related to financial products offered through our distribution channels, may cause our revenues or profitability to decline. See discussion of RAL litigation in Item 3, Legal Proceedings. In addition to the loss of revenues and income directly attributable to the RAL program, the inability to offer RALs could indirectly result in the loss of retail tax clients and associated tax preparation revenues, unless we were able to take mitigating actions.
Total revenues related directly to the RAL program (including revenues from participation interests) were $141.0 million for the year ended April 30, 2009, representing 3.5% of consolidated revenues and contributed $56.8 million to the Tax Services segments pretax results. Revenues related directly to the RAL program totaled $189.8 million for the year ended April 30, 2008, representing 4.6% of consolidated revenues and contributed $87.0 million to pretax results.
Increased competition for tax preparation clients in our retail offices and our online and software channels could adversely affect our current market share and profitability, and could limit our ability to grow our client base. Offers of free tax preparation services could adversely affect our revenues and profitability.
The retail tax services business is highly competitive. There are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services. Many tax return preparation firms and many firms not otherwise in the tax return preparation business are involved in providing electronic filing, RALs and
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other related services to the public. Commercial tax return preparers and electronic filers are highly competitive with regard to price and service. Our digital tax solutions businesses also compete with in-office tax preparation services and a number of online and software companies, primarily on the basis of price and functionality.
Federal and certain state taxing authorities currently offer, or facilitate the offer of, tax return preparation and electronic filing options to taxpayers at no charge. In addition, many of our direct competitors offer certain free online tax preparation and electronic filing options. We have free offerings as well and prepared 788,000 federal income tax returns in fiscal year 2009 at no charge as part of the FFA. Government tax authorities and direct competitors may elect to expand free offerings in the future. Intense price competition, including offers of free service, could result in a loss of market share, lower revenues or lower margins.
See tax returns prepared statistics included in Item 7, under Tax Services.
The RSM alternative practice structure involves relationships with Attest Firms that are subject to regulatory restrictions and other constraints. Failure to comply with these restrictions, or operational difficulties involving the Attest Firms, could damage our brand reputation, lead to reduced earnings and impair our investment in RSM.
RSMs relationship with the Attest Firms requires compliance with applicable regulations regarding the practice of public accounting and auditor independence rules and requirements. Many of RSMs clients are also clients of the Attest Firms. In addition, the relationship with the Attest Firms closely links our RSM McGladrey brand with the Attest Firms. If the Attest Firms were to encounter regulatory or independence issues pertaining to the alternative practice structure or if significant litigation arose involving the Attest Firms or their services, such developments could have an adverse effect on our brand reputation and our ability to realize the mutual benefits of our relationship. In addition, a significant judgment or settlement of a claim against the Attest Firms could (1) impair M&Ps ability to meet its payment obligations under various service arrangements with RSM and to repay amounts borrowed under the revolving credit facility it maintains with us, (2) impact RSMs ability to attract and retain clients and quality professionals, (3) have a significant indirect adverse effect on RSM, as the Attest Firm partners are also RSM employees and (4) result in significant management distraction. This in turn could result in reduced revenue and earnings and, if sufficiently significant, impairment of our investment in RSM.
RSM receives a significant portion of its revenues from clients that are also clients of the Attest Firms. A termination of the alternative practice structure between RSM and the Attest Firms could result in a material loss of revenue to RSM and an impairment of our investment in RSM.
Under the alternative practice structure, RSM and the Attest Firms market their services jointly and provide services to a significant number of common clients. RSM also provides operational and administrative support services to the Attest Firms, including accounting, payroll, human resources, marketing, administrative services and personnel, and office space and equipment. In return for these services, RSM receives a management fee and reimbursement of certain costs, mainly for the use of RSM-owned or leased real estate, property and equipment. If the RSM/Attest Firms relationship under the alternative practice structure were to be terminated, RSM could lose key employees and clients. In addition, RSM may not be able to recoup its costs associated with the infrastructure used to provide the operational and administrative support services to the Attest Firms. This in turn could result in reduced revenue, increased costs and reduced earnings and, if sufficiently significant, impairment of our investment in RSM.
CONSUMER FINANCIAL SERVICES
We are subject to extensive government regulation, including banking rules and regulations. If we fail to comply with applicable banking laws, rules and regulations, we could be subject to disciplinary actions, damages, penalties or restrictions that could significantly harm our business.
The OTS can, among other things, censure, fine, issue cease-and-desist orders or suspend or expel a bank or any of its officers or employees with respect to banking activities. Similarly, the attorneys general of each state could bring legal action on behalf of the citizens of the various states to ensure compliance with local laws.
HRB Bank is subject to various regulatory capital requirements administered by the OTS. Failure to meet minimum capital requirements may trigger actions by regulators that, if undertaken, could have a direct material effect on HRB Bank. HRB Bank must meet specific capital guidelines involving quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. A banks capital amounts and classification are also subject to qualitative judgments by the regulators about the strength of components of its capital, risk-weightings of assets, off-balance sheet transactions and other factors. Quantitative measures established by regulation to ensure capital adequacy require HRB Bank to maintain minimum amounts and ratios of tangible equity, total risk-based capital and Tier 1 capital. In addition to these minimum ratio requirements, HRB Bank is required to continually maintain a 12.0% minimum leverage ratio through fiscal year 2012.
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See Item 8, note 16 to the consolidated financial statements for the calculation of required ratios.
Economic conditions that negatively affect housing prices and the job market may result in deterioration in credit quality of our loan portfolio, and such deterioration could have a negative impact on our business and profitability.
The overall credit quality of mortgage loans held for investment is impacted by the strength of the U.S. economy and local economic conditions, including residential housing prices. Economic trends that negatively affect housing prices and the job market could result in deterioration in credit quality of our mortgage loan portfolio and a decline in the value of associated collateral. Future interest rate resets could also lead to increased delinquencies in our mortgage loans held for investment. Recent trends in the residential mortgage loan market reflect an increase in loan delinquencies and declining collateral values. As a result of similar trends in our loan portfolio, we recorded significant loan loss provisions totaling $63.9 million during fiscal year 2009.
Our loan portfolio is concentrated in the states of Florida, California, New York and Wisconsin, which represented 19.4%, 17.0%, 13.7% and 8.3%, respectively, of our total mortgage loans held for investment at April 30, 2009. No other state held more than 5% of our loan balances. If adverse trends in the residential mortgage loan market continue, particularly in geographic areas in which we own a greater concentration of mortgage loans, we could incur additional significant loan loss provisions.
Mortgage loans purchased from Sand Canyon Corporation (SCC), formerly Option One Mortgage Corporation, represented approximately 65% of total loans held for investment at April 30, 2009. These loans have been subject to higher delinquency rates than other loans in our portfolio, and may expose us to greater risk of credit loss.
Significant changes have been proposed relating to the regulation of financial institutions. Although the ultimate impact of pending proposals is uncertain at this time, increased regulation could impact operating activities of our bank.
Various legislative proposals have been made regarding changes in the regulation of financial institutions, including the recently released Financial Regulatory Reform Plan. Prior proposals included legislation which would have empowered courts to modify the terms of mortgage loans including a reduction in the principal amount to reflect lower underlying property values.
Future changes in regulation could increase compliance requirements and operating costs of HRB Bank, and could potentially limit operating activities of the bank. Should proposals be enacted into law allowing government modification of mortgage loans, we could report losses on mortgage loans in excess of current levels. The availability of principal reductions or other mortgage loan modifications could make bankruptcy a more attractive option for troubled borrowers, leading to increased bankruptcy filings and accelerated defaults.
SCC is subject to potential litigation stemming from discontinued mortgage operations, which may result in significant financial losses.
Although SCC terminated its mortgage loan origination activities and sold its loan servicing business during fiscal year 2008, it remains subject to investigations, claims and lawsuits pertaining to its loan origination and servicing activities prior to such termination and sale. The costs involved in defending against and/or resolving these investigations, claims and lawsuits may be substantial in some instances and the ultimate resulting liability is difficult to predict. In the current non-prime mortgage environment, the number and frequency of investigations, claims and lawsuits has increased over historical experience and is likely to continue at increased levels. In the event of unfavorable outcomes, the amount SCC may be required to pay in the discharge of liabilities or settlements could be substantial and, because SCCs operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
We are subject to potential contingent liabilities related to loan repurchase obligations, which may result in significant financial losses.
SCC remains exposed to losses relating to mortgage loans it previously originated. Non-prime mortgage loans originated by SCC were sold either as whole-loan sales to single third-party buyers or in the form of a securitization.
SCC entered into indemnification agreements with third-parties relating to the mortgage loans transferred through such whole-loan sales or securitizations. In some instances, H&R Block, Inc. was required to guarantee SCCs obligations. Obligations to repurchase loans or indemnify a third-party up to an agreed upon amount may arise from breaches of various representations and warranties SCC made under such indemnification agreements. These representations and warranties vary based on the nature of the transaction and the buyers requirements but generally pertain to the ownership of the loan, the property securing the loan and compliance with applicable laws
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and SCC underwriting guidelines. These representations and warranties and corresponding repurchase obligations generally are not subject to stated limits or a stated term.
SCC records a liability for contingent losses relating to representation and warranty claims by estimating loan repurchase volumes and indemnification obligations for both known claims and projections of expected future claims. To the extent that future valid claim volumes exceed current estimates, or the value of mortgage loans and residential home prices decline, future losses may be greater than these estimates and those differences may be significant.
Most of our tax offices, except those in shared locations, are operated under leases throughout the U.S. Our Canadian executive offices are located in a leased office in Calgary, Alberta. Our Canadian tax offices are operated under leases throughout Canada.
RSMs executive offices are located in leased offices in Bloomington, Minnesota. Its administrative offices are located in leased offices in Davenport, Iowa. RSM also leases office space throughout the U.S.
HRB Bank is headquartered and its single branch location is located in our corporate headquarters.
We own our corporate headquarters, which is located in Kansas City, Missouri. All current leased and owned facilities are in good repair and adequate to meet our needs.
The information below should be read in conjunction with the information included in Item 8, note 18 to our consolidated financial statements.
RAL LITIGATION We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, RAL Cases). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things: disclosures in the RAL applications were inadequate, misleading and untimely; the RAL interest rates were usurious and unconscionable; we did not disclose that we would receive part of the finance charges paid by the customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act and unfair competition regarding debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial in some instances, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the Texas RAL Settlement) and other settlements resulting in a combined pretax expense in fiscal year 2006 of $70.2 million.
We have settled all but one of the RAL Cases. The sole remaining RAL Case is a putative class action entitled Sandra J. Basile, et al. v. H&R Block, Inc., et al., April Term 1992 Civil Action No. 3246 in the Court of Common Pleas, First Judicial District Court of Pennsylvania, Philadelphia County, instituted on April 23, 1993. In Basile, the court decertified the class in December 2003, and the Pennsylvania appellate court subsequently reversed the trial courts decertification decision. In September 2006, the Pennsylvania Supreme Court reversed the appellate courts reversal of the trial courts decertification decision. In June 2007, the appellate court affirmed its earlier decision to reverse the trial courts decertification decision. The Pennsylvania Supreme Court has granted our request to review the appellate court ruling. We believe we have meritorious defenses to this case and we intend to defend it vigorously. There can be no assurances, however, as to the outcome of this case or its impact on our financial statements.
PEACE OF MIND LITIGATION We are defendants in lawsuits regarding our Peace of Mind program (collectively, the POM Cases), under which our applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The POM Cases are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Case No. 08-CV-591 in the U.S. District Court for the Southern District of Illinois, is a class action case originally filed in the Circuit Court of Madison County, Illinois on January 18, 2002, in which class certification was granted in August 2003. The plaintiffs allege that the sale of POM guarantees constitutes (1) statutory fraud by selling insurance without a license, (2) an unfair trade practice, by omission and by cramming (i.e., charging customers for the guarantee even though they did not request it or
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want it), and (3) a breach of fiduciary duty. The court has certified plaintiff classes consisting of all persons residing in 13 states who from January 1, 1997 to final judgment (1) were charged a separate fee for POM by H&R Block; (2) were charged a separate fee for POM by an H&R Block entity not licensed to sell insurance; or (3) had an unsolicited charge for POM posted to their bills by H&R Block. Persons who received the POM guarantee through an H&R Block Premium office were excluded from the plaintiff class. In August 2008, we removed the case from state court in Madison County, Illinois to the U.S. District Court for the Southern District of Illinois. In December 2008, the U.S. District Court remanded the case back to state court. On April 3, 2009, the United States Court of Appeals for the Seventh Circuit reversed the decision to remand the case back to state court, ruling that the case had been properly removed to federal court. The plaintiffs have filed a petition for rehearing of this decision with the Seventh Circuit.
There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is pending before the same judge that presided over the Texas RAL Settlement, involves the same plaintiffs attorneys that are involved in the Marshall litigation in Illinois, and contains allegations similar to those in the Marshall case. No class has been certified in this case.
We believe we have meritorious defenses to the claims in the POM Cases, and we intend to defend them vigorously. The amounts claimed in the POM Cases are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate.
EXPRESS IRA LITIGATION On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York (Index No. 06/401110) entitled The People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc. et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. In July 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than HRBFA and the claims of common law fraud. The intermediate appellate court reversed this ruling in January 2009. We believe we have meritorious defenses to the claims in this case and intend to defend this case vigorously, but there are no assurances as to its outcome.
On January 2, 2008, the Mississippi Attorney General filed a lawsuit in the Chancery Court of Hinds County, Mississippi First Judicial District (Case No. G 2008 6 S 2) entitled Jim Hood, Attorney for the State of Mississippi v. H&R Block, Inc., et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. The defendants have filed a motion to dismiss. We believe we have meritorious defenses to the claims in this case, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
In addition to the New York and Mississippi Attorney General actions, a number of civil actions were filed against HRBFA and us concerning the Express IRA product, the first of which was filed on March 15, 2006. Except for two cases pending in state court, all of the civil actions have been consolidated by the panel for Multi-District Litigation into a single action styled In re H&R Block, Inc. Express IRA Marketing Litigation (Case No. 06-1786-MD-RED) in the United States District Court for the Western District of Missouri. The amounts claimed in these cases are substantial. We believe we have meritorious defenses to the claims in these cases and intend to defend these cases vigorously, but there are no assurances as to their outcome.
Although we sold HRBFA effective November 1, 2008, we remain responsible for the Express IRA litigation through an indemnification agreement with Ameriprise. See additional discussion in Item 8, note 19 to the consolidated financial statements.
SECURITIES LITIGATION On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation (Case No. 06-0236-CV-W-ODS) was filed against the Company and certain of its officers in the United States District Court for the Western District of Missouri. The complaint alleged, among other things, deceptive, material and misleading financial statements and failure to prepare financial statements in accordance with generally accepted accounting principles. The complaint sought unspecified damages and equitable relief. The court dismissed the complaint in February 2008, and the plaintiffs appealed the dismissal in March 2008. In addition, plaintiffs in a shareholder derivative action that was consolidated into the securities litigation filed a separate appeal in March 2008, contending that the derivative action was improperly consolidated. The derivative action is Iron Workers Local 16 Pension Fund v. H&R Block, et al., in the United States District Court for the Western District of Missouri, Case No. 06-cv-00466-ODS (instituted on June 8, 2006) and was brought against certain of our directors and officers purportedly on behalf of the Company. The derivative action alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste, and unjust enrichment pertaining to (1) our restatement of financial results in fiscal year 2006 due to errors in determining our state effective income tax rate and (2) certain of our products and business activities. We believe we have meritorious defenses to the claims in these cases and intend to defend
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this litigation vigorously. We currently do not believe that we will incur a material loss with respect to this litigation.
RSM MCGLADREY LITIGATION RSM McGladrey Business Services, Inc. and certain of its subsidiaries are parties to a class action filed on July 11, 2006 and entitled Do Rights Plant Growers, et al. v. RSM EquiCo, Inc., et al. Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations regarding business valuation services provided by RSM EquiCo, Inc., including fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition and seeks unspecified damages, restitution and equitable relief. On March 17, 2009, the court granted plaintiffs motion for class certification on all claims. The class consists of all RSM EquiCo U.S. clients who signed platform agreements and for whom RSM EquiCo did not ultimately market their business for sale. RSM EquiCo has filed an appeal of this certification ruling and intends to defend this case vigorously. The amount claimed in this action is substantial and could have a material adverse impact on our consolidated results of operations. There can be no assurance regarding the outcome of this matter.
RSM has a relationship with the Attest Firms pursuant to which (1) some RSM employees are also partners or employees of the Attest Firms, (2) many clients of the Attest Firms are also RSM clients, and (3) our RSM McGladrey brand is closely linked to the Attest Firms. The Attest Firms are parties to claims and lawsuits (collectively, Attest Firm Claims) arising in the normal course of business. Judgments or settlements arising from Attest Firm Claims exceeding the Attest Firms insurance coverage could have a direct adverse effect on Attest Firm operations and could impair RSMs ability to attract and retain clients and quality professionals. For example, accounting and auditing firms (including one of the Attest Firms) have become subject to claims based on losses their clients suffered from investments in investment funds managed by third-parties. Although RSM may not have a direct liability for significant Attest Firm Claims, such Attest Firm Claims could have a material adverse effect on RSMs operations and impair the value of our investment in RSM. There is no assurance regarding the outcome of the Attest Firm Claims.
LITIGATION AND CLAIMS PERTAINING TO DISCONTINUED MORTGAGE OPERATIONS Although mortgage loan origination activities were terminated and the loan servicing business was sold during fiscal year 2008, SCC remains subject to investigations, claims and lawsuits pertaining to its loan origination and servicing activities that occurred prior to such termination and sale. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, municipalities, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others alleged to be similarly situated. Among other things, these investigations, claims and lawsuits allege discriminatory or unfair and deceptive loan origination and servicing practices, public nuisance, fraud, and violations of the Truth in Lending Act, Equal Credit Opportunity Act and the Fair Housing Act. In the current non-prime mortgage environment, the number of these investigations, claims and lawsuits has increased over historical experience and is likely to continue at increased levels. The amounts claimed in these investigations, claims and lawsuits are substantial in some instances, and the ultimate resulting liability is difficult to predict. In the event of unfavorable outcomes, the amounts SCC may be required to pay in the discharge of liabilities or settlements could be substantial and, because SCCs operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a lawsuit in the Superior Court of Suffolk County, Massachusetts (Case No. 08-2474-BLS) entitled Commonwealth of Massachusetts v. H&R Block, Inc., et al., alleging unfair, deceptive and discriminatory origination and servicing of mortgage loans and seeking equitable relief, disgorgement of profits, restitution and statutory penalties. In November 2008, the court granted a preliminary injunction limiting the ability of the owner of SCCs former loan servicing business to initiate or advance foreclosure actions against certain loans originated by SCC or its subsidiaries without (1) advance notice to the Massachusetts Attorney General and (2) if the Attorney General objects to foreclosure, approval by the court. The preliminary injunction generally applies to loans meeting all of the following four characteristics: (1) adjustable rate mortgages with an introductory period of three years or less; (2) the borrower has a debt-to-income ratio generally exceeding 50 percent; (3) an introductory interest rate at least 2 percent lower than the fully indexed rate (unless the debt-to-income ratio is 55% or greater); and (4) loan-to-value ratio of 97 percent or certain prepayment penalties. We have appealed this preliminary injunction. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
SCC also remains subject to potential claims for indemnification and loan repurchases pertaining to loans previously sold. In the current non-prime mortgage environment, it is likely that the frequency of repurchase and indemnification claims may increase over historical experience and give rise to additional litigation. In some instances, H&R Block, Inc. was required to guarantee SCCs obligations. The amounts involved in these potential claims may be substantial, and the ultimate resulting liability is difficult to predict. Because SCCs operating
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results are included in our consolidated financial statements, the amounts SCC may be required to pay in the discharge or settlement of these claims in the event of unfavorable outcomes could have a material adverse impact on our consolidated results of operations.
OTHER CLAIMS AND LITIGATION We are from time to time party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others similarly situated. Some of these investigations, claims and lawsuits pertain to RALs, the electronic filing of customers income tax returns, the POM guarantee program, wage and hour claims and investment products. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously. The amounts claimed in these claims and lawsuits are substantial in some instances, however the ultimate liability with respect to such litigation and claims is difficult to predict. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are party to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (collectively, Other Claims) concerning the preparation of customers income tax returns, the fees charged customers for various products and services, relationships with franchisees, intellectual property disputes, employment matters and contract disputes. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material adverse effect on our consolidated operating results, financial position or cash flows.
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2009.
H&R Blocks common stock is traded on the New York Stock Exchange (NYSE) under the symbol HRB. On May 31, 2009, there were 24,835 shareholders of record and the closing stock price on the NYSE was $14.60 per share.
In October 2008, we sold 8.3 million shares of our common stock in a registered direct offering through subscription agreements with selected institutional investors. See additional information in Item 8, note 11 to the consolidated financial statements.
During the fiscal year ended April 30, 2009, we issued approximately 8,500 shares of our common stock as purchase price consideration for acquisitions. These issuances were private offerings exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.
On March 4, 2009, we also issued a total of 8,604 shares of our common stock to former members of our Board of Directors (4,302 shares each to Roger W. Hale and Henry F. Frigon) as compensation pursuant to the 2008 Deferred Stock Unit Plan for Outside Directors, in reliance upon the administrative position set forth in SEC Release No. 33-6188 (February 1, 1980) 17 C.F.R. 231.6188 (1989) and SEC Release No. 33-6281 (January 15, 1981) 17 C.F.R. 231.6281 (1989).
The information regarding H&R Blocks common stock regarding quarterly sales prices and dividends declared appears in Item 8, note 21 to our consolidated financial statements.
A summary of our securities authorized for issuance under equity compensation plans as of April 30, 2009 is as follows:
The remaining information called for by this item relating to Securities Authorized for Issuance under Equity Compensation Plans is reported in Item 8, note 12 to our consolidated financial statements.
H&R BLOCK 2009 Form 10K 15
A summary of our purchases of H&R Block common stock during the fourth quarter of fiscal year 2009 is as follows:
PERFORMANCE GRAPH The following graph compares the cumulative five-year total return provided shareholders on H&R Block, Inc.s common stock relative to the cumulative total returns of the S&P 500 index and the S&P Diversified Commercial & Professional Services index. An investment of $100, with reinvestment of all dividends, is assumed to have been made in our common stock and in each of the indexes on April 30, 2004, and its relative performance is tracked through April 30, 2009.
We derived the selected consolidated financial data presented below as of and for each of the five years in the period ended April 30, 2009, from our audited consolidated financial statements. At April 30, 2009, HRBFA and its direct corporate parent are presented as discontinued operations in the consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. The data set forth below should be read in conjunction with Item 7 and our consolidated financial statements in Item 8.
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Our subsidiaries provide tax preparation, retail banking and various business advisory and consulting services. We are the only major company offering a full range of software, online and in-office tax preparation solutions to individual tax clients.
A summary of our fiscal year 2009 results is as follows:
H&R BLOCK 2009 Form 10K 17
RESULTS OF OPERATIONS
This segment primarily consists of our income tax preparation businesses retail, online and software. This segment includes our tax operations in the U.S., Canada and Australia. The following discussion excludes the results of our former tax business in the United Kingdom, which is reported in discontinued operations for fiscal year 2007.
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FISCAL 2009 COMPARED TO FISCAL 2008 Tax Services revenues increased $44.5 million, or 1.5%, compared to the prior year.
Tax preparation fees from our retail offices increased $59.0 million, or 2.8%, for fiscal year 2009. This increase is primarily due to an increase of 6.8% in the net average fee per U.S. tax return prepared in company-owned offices, offset by a 2.8% decrease in the number of U.S. tax returns prepared in those offices. Tax return volume was positively affected by the November 2008 acquisition of our last major independent franchise operator, which resulted in an increase of 470,000 tax returns prepared in company-owned offices. See Item 8, note 2 to the consolidated financial statements for additional information on this acquisition. Excluding operating results attributable to the acquired franchise operator, tax returns prepared in company-owned offices decreased 7.3% from the prior year and tax preparation fees decreased $32.9 million.
Increases in our net average fee are due primarily to increased tax return complexity. In addition, planned pricing increases of approximately 1% and lower discounts contributed to an increase in net average fee. We believe that declines during the year in tax return volume were attributable to a decline of approximately 6% in IRS tax filings overall, and difficult economic conditions which resulted in clients seeking lower-cost tax preparation alternatives.
Tax returns prepared in our international operations grew 5.1%, and the related tax preparation revenues increased 8.9% in local currencies. However, unfavorable exchange rates caused these revenues in U.S. dollars to decline $9.5 million, or 5.6%, from the prior year.
Other service revenue increased $3.6 million, or 1.0%, primarily due to $10.7 million in additional license fees earned from bank products, mainly RACs, coupled with additional revenues from online tax preparation. We also earned an incremental $6.6 million in connection with an agreement with HRB Bank for the H&R Block Emerald Prepaid MasterCard® program, under which, this segment shares in the revenues and expenses associated with the program. These increases were partially offset by a $10.6 million decline in e-filing revenues, as a result of the elimination of separate e-filing fees related to our TaxCut® software product.
Royalty revenue increased $17.6 million, or 7.4%, primarily due to a 7.2% increase in the net average fee and an increase in royalty rates at sub-franchises of the acquired franchise operator.
Loan participation fees and related revenues decreased $47.5 million, or 25.0%, from the prior year. This decrease is primarily due to a 24.6% decline in RAL volume, mainly as a result of many clients choosing lower cost alternatives such as RACs rather than a loan. In addition, stricter credit criteria were required by our third-party loan originator.
Other revenues increased $11.9 million, or 11.8%, primarily due to $22.7 million in incremental fees earned in connection with the Emerald Advance loan program, also under a revenue and expense sharing agreement with HRB Bank. This increase was partially offset by a decline in software revenues.
Total expenses decreased $63.5 million, or 2.9%, compared with the prior year, due primarily to lower tax return volumes, lower bad debt on loan products and planned cost reduction initiatives. Cost of services decreased $19.3 million, or 1.2%, from the prior year almost exclusively as a result of a decrease in commission-based wages resulting from a corresponding decrease in tax returns prepared.
Cost of other revenues, selling, general and administrative expenses decreased $44.2 million, or 7.4%. This decrease was due, in part, to a $17.1 million decline in bad debt expense due to lower RAL volumes and the impact of loss provisions in the prior year which did not repeat in fiscal year 2009, partially offset by an increase in Emerald Advance loan volumes. We also saw a decline of $32.4 million in allocated corporate and support department costs due to cost reduction efforts, offset by a planned increase of $43.0 million in marketing costs. During fiscal year 2009 we sold certain company-owned offices to franchisees, recognizing a net gain of $14.9 million, which is included above as a reduction to cost of other revenues, selling, general and administrative expenses.
Pretax income for fiscal year 2009 increased $108.0 million, or 13.7%, from 2008. As a result of cost reduction initiatives and the acquisition of our last major franchise operator, pretax margin for the segment increased from 26.3% in fiscal year 2008, to 29.5% in fiscal year 2009, in excess of our stated minimum goal to achieve a 200 basis point margin improvement.
FISCAL 2008 COMPARED TO FISCAL 2007 Tax Services revenues increased $302.8 million, or 11.3%, compared to fiscal year 2007.
Tax preparation fees from our retail offices increased $200.0 million, or 10.5%, for fiscal year 2008. This increase was primarily due to an increase of 6.5% in the net average fee per U.S. tax return prepared in company-owned offices, and a 1.9% increase in the number of U.S. tax returns prepared in those offices. Our international operations contributed $33.2 million to the increase, resulting from a 6.1% increase in tax returns prepared.
Other service revenue increased $62.2 million, or 20.6%, primarily due to $23.9 million in additional license fees earned from bank products and $16.2 million in additional revenues from our online tax preparation and e-filing
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services. This segment also earned $15.1 million in additional customer fees based on an agreement with HRB Bank for the H&R Block Emerald Prepaid MasterCard® program.
Royalty revenue increased $17.9 million, or 8.1%, due to a 2.1% increase in tax returns prepared in franchise offices and a 4.4% increase in the net average fee.
Loan participation fees and related revenues decreased $19.8 million, or 9.4%, from fiscal year 2007. This decrease was primarily due to participation fees earned on Instant Money Advance Loans (IMALs) in fiscal year 2007. IMALs were not offered during fiscal year 2008. This decrease was offset by an increase in other revenues related to Emerald Advance lines of credit.
Other revenues increased $42.6 million, or 73.5%, primarily due to $24.1 million in fees earned in connection with the Emerald Advance loan program, also under a revenue and expense sharing agreement with HRB Bank. Additionally, $16.2 million of the increase was due to sales of commercial tax preparation software, TaxWorks®, which was acquired in February 2007.
Total expenses increased $222.1 million, or 11.2%, compared to fiscal year 2007. Cost of services increased $117.4 million, or 7.9%, from fiscal year 2007. Compensation and benefits increased $63.9 million, or 7.7%, primarily as a result of a 6.5% increase in commission-based wages resulting from a corresponding increase in tax returns prepared and net average charge. Occupancy expenses increased $29.4 million, or 8.5%, primarily as a result of higher rent expenses, due to a 2.8% increase in company-owned offices under lease and a 3.4% increase in the average rent. Bad debt expense increased $17.0 million due to increased settlement product withholdings and increased delinquency rates. Other cost of services increased $14.1 million, or 7.4%, primarily due to additional support department costs for information technology and other projects and costs associated with the H&R Block Emerald Prepaid MasterCard® program, which this segment shares with HRB Bank.
Cost of other revenues, selling, general and administrative expenses increased $104.6 million, or 21.2%. This increase was primarily due to $58.1 million of incremental bad debt expense related to RALs and our new Emerald Advance program. Approximately $14.2 million of the increase in bad debt expense was due to the elimination of third-party cross-collect practices, whereby banks no longer collect amounts due from clients on our behalf, and an additional $12.0 million resulted from changes in IRS taxpayer fraud detection practices. The remaining increase was primarily due to an incremental $31.5 million in bad debt expense related to the Emerald Advance loan program, which replaced the IMAL. This increase was primarily due to the participation rate on IMALs, which was 26%, while Emerald Advances are funded by HRB Bank with nearly 100% participation by this segment in loans outstanding at April 30, 2008. We also saw increases of $23.3 million, $10.6 million and $9.8 million in corporate wages, amortization of intangibles and legal expenses, respectively.
Pretax income for fiscal year 2008 increased $80.7 million, or 11.4%, from 2007.
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This segment offers accounting, tax and business consulting services, wealth management and capital market services to middle-market companies. The following discussion excludes the results of three businesses reported in discontinued operations in fiscal years 2008 and 2007.
FISCAL 2009 COMPARED TO FISCAL 2008 Business Services revenues for fiscal year 2009 decreased $43.9 million, or 4.7%, from the prior year, primarily due to declines in capital markets, leased employee revenues and outside contractor services.
Revenues from core tax, consulting and accounting services increased $25.0 million, or 3.4%, over the prior year. Tax services revenues increased $15.9 million, or 3.6%, over the prior year due to increases in net billed rate per hour. Business consulting revenues increased $12.2 million, or 5.2%, over the prior year primarily due to a large one-time financial institutions engagement.
Weak economic conditions in the current year severely reduced investment and transaction activity. As a result, capital markets revenues decreased $32.9 million, or 64.4%, from the prior year primarily due to a 57.4% decline in the number of transactions closed.
Leased employee revenue decreased due to a change in organizational structure between the businesses we acquired from American Express Tax and Business Services, Inc. (AmexTBS) and the Attest Firms that, while not affiliates of our company, also serve our clients. Employees we previously leased to the Attest Firms were transferred to the separate attest practices over the last two fiscal years. As a result, we no longer record the revenues and expenses associated with leasing these employees, which resulted in a reduction of $25.0 million to current year revenues, and a similar reduction in compensation and benefits.
Other revenue declined $12.1 million, or 11.0%, primarily due to a decrease in outside contractor services provided to our clients.
Total expenses decreased $51.2 million, or 6.0%, compared to the prior year. Compensation and benefits decreased $14.4 million, primarily due to the change in organizational structure with AmexTBS and fewer capital markets commissions resulting from the decline in transactions, as discussed above. These decreases were partially offset by severance costs incurred in the current year.
Selling, general and administrative expenses decreased $36.7 million, or 22.6%, primarily due to declines in external consulting fees, allocated corporate and support department costs and travel and entertainment expenses.
Pretax income for the year ended April 30, 2009 of $96.1 million compares to $88.8 million in the prior year. Pretax margin for the segment increased from 9.4% in fiscal year 2008, to 10.7% in fiscal year 2009, below our stated
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goal to achieve a 12.0% pretax margin primarily due to poor results in our capital markets business and lower than expected revenue growth in our core businesses.
FISCAL 2008 COMPARED TO FISCAL 2007 Business Services revenues for fiscal year 2008 increased $9.3 million, or 1.0%, over fiscal year 2007.
Tax services revenues increased $33.7 million, or 8.2% and business consulting revenues increased $31.6 million, or 15.4%, over fiscal year 2007. These increases resulted primarily from both an increase in the number of client service professionals as well as an improvement in productivity per professional.
Capital markets revenues increased $2.3 million, primarily due to a $12.6 million increase in underwriting revenues due to a 37.4% increase in revenue per transaction. Valuation and seminar revenues declined $10.4 million due to a 70.3% decline in the number of business valuation projects as a result of the wind-down of this service line.
Leased employee revenue decreased due to the change in organizational structure with AmexTBS as discussed above, which resulted in a reduction of $58.1 million to fiscal year 2008 revenues, and a similar reduction in compensation and benefits.
Total expenses decreased $21.8 million, or 2.5%, for fiscal year 2008 compared to 2007. Compensation and benefits decreased due to the change in organizational structure with AmexTBS as discussed above, which was almost entirely offset by additional compensation resulting from increases in the number of personnel and the average wage per employee.
Selling, general and administrative expenses decreased $20.4 million, or 11.2%, primarily due to decreases in external consulting and legal fees. During fiscal year 2007, additional consulting fees were incurred related to our marketing initiatives, and additional legal expenses were incurred related to international acquisitions that were ultimately not completed.
Pretax income for the year ended April 30, 2008 of $88.8 million compares to $57.7 million in fiscal year 2007.
This segment is engaged in providing retail banking offerings primarily to Tax Services clients through HRB Bank. HRB Bank offers traditional banking services including prepaid debit card accounts, Emerald Advance lines of credit, checking and savings accounts, individual retirement accounts and certificates of deposit. This segment previously included HRBFA, which has been presented as a discontinued operation in the accompanying consolidated financial statements.
22 H&R BLOCK 2009 Form 10K
FISCAL 2009 COMPARED TO FISCAL 2008 Consumer Financial Services revenues, net of interest expense and provision for loan losses, for fiscal year 2009 increased $6.9 million, or 13.3% over the prior year.
Net interest income increased $18.8 million, or 34.7%, over the prior year. Interest income earned from our Emerald Advance loan program increased $22.9 million as a result of higher volumes. Interest expense on deposits declined $28.8 million due to lower interest rates and lower average balances. Interest income on mortgage loans held for investment declined $28.5 million due to lower balances and an increase in non-accrual loans from $110.8 million at April 30, 2008 to $222.4 million at April 30, 2009. The following table summarizes the key drivers of net interest income:
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Our non-performing assets consist of the following:
Details of our mortgage loans held for investment and the related allowance at April 30, 2009 and 2008 are as follows:
Mortgage loans held for investment include loans originated by our affiliate, SCC, and purchased by HRB Bank totaling $531.2 million, or approximately 65% of the total loan portfolio at April 30, 2009. Loans originated by and purchased from SCC have characteristics which are representative of Alt-A loans loans to customers who have credit ratings above sub-prime, but may not conform to government-sponsored standards. As such, we have experienced higher rates of delinquency and have greater exposure to loss with respect to this segment of our loan portfolio. Cumulative losses on our original loan portfolio purchased from SCC and retained for investment, including losses on loans now classified as other real estate, totaled approximately 14% at April 30, 2009. Our remaining loan portfolio totaled $290.6 million and is characteristic of a prime loan portfolio, and we believe subject to a lower loss exposure.
We recorded a provision for loan losses on our mortgage loans held for investment of $63.9 million during the current year, compared to $42.0 million in the prior year. Our loan loss provision increased primarily as a result of continued declines in residential home prices, particularly in certain states where we have a higher concentration of loans. In addition, loan loss reserves increased due to higher projected delinquencies and higher reserves on modified loans. Our allowance for loan losses as a percent of mortgage loans was 10.23%, or $84.1 million, at April 30, 2009, compared to 4.49%, or $45.4 million, at April 30, 2008. This allowance represents our best estimate of losses inherent in the loan portfolio as of the balance sheet dates.
Residential real estate markets are experiencing significant declines in property values and mortgage default rates are increasing. If adverse market trends continue, including trends within our portfolio specifically, we may be required to record additional loan loss provisions, and those losses may be significant.
Other revenue increased $10.0 million, or 25.2%, primarily due to incremental fees earned related to our H&R Block Prepaid Emerald MasterCard® program.
Non-interest expenses increased $32.9 million, or 81.6%, from the prior year, primarily related higher expenses from the H&R Block Prepaid Emerald MasterCard® and Emerald Advance line of credit programs, reflecting higher volumes. The revenues and expenses from these programs are shared with the Tax Services segment.
The pretax loss for fiscal year 2009 was $14.5 million compared to prior year income of $11.5 million, primarily due to a $21.9 million increase in provision for loan losses.
FISCAL 2008 COMPARED TO FISCAL 2007 Consumer Financial Services revenues, net of interest expense and provision for loan loss reserves, for fiscal year 2008 increased $11.2 million, or 27.7%, over fiscal year 2007.
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Net interest income increased $30.4 million due to interest income received on our Emerald Advance loan products and an increase in average mortgage loans held for investment, partially offset by an increase in average deposits. The following table summarizes the key drivers of net interest income:
Detail of our mortgage loans held for investment and the related allowance at April 30, 2008 and 2007 is as follows:
We recorded a provision for loan losses on our mortgage loans held for investment of $42.0 million during fiscal year 2008, compared to $3.6 million in 2007. Our loan loss provision increased significantly during 2008 as a result of declining collateral values due to declining residential home prices and increasing delinquencies occurring in our portfolio. Our loan loss reserve as a percent of mortgage loans was 4.49%, or $45.4 million, at April 30, 2008, compared to 0.25%, or $3.4 million, at April 30, 2007.
Other revenues increased $19.2 million, primarily due to increases in fees received in connection with the H&R Block Prepaid Emerald MasterCard® program.
Non-interest expenses increased $22.8 million from the prior year, primarily due to additional expenses associated with the H&R Block Prepaid Emerald MasterCard® program and the Emerald Advance lines of credit.
Pretax income for fiscal year 2008 was $11.5 million compared to prior year income of $23.1 million.
CORPORATE, ELIMINATIONS AND INCOME TAXES ON CONTINUING OPERATIONS
FISCAL 2009 COMPARED TO FISCAL 2008 The pretax loss recorded in our corporate operations for fiscal year 2009 was $136.0 million compared to $151.0 million in the prior year. The decreased loss was primarily due to severance-related costs of $11.3 million recorded in the prior year, coupled with benefits in the current year resulting from the cost reduction program implemented in fiscal year 2008.
Our effective tax rate for continuing operations was 38.9% for fiscal year 2009 compared to 39.3% in the prior year.
FISCAL 2008 COMPARED TO FISCAL 2007 The pretax loss recorded in our corporate operations for fiscal year 2008 was $151.0 million compared to $158.7 million in 2007. The decreased loss was primarily due to a decline in interest expense, which resulted from increased allocation of interest expense to our discontinued mortgage operations.
Our effective tax rate for continuing operations was 39.3% for fiscal year 2008 compared to 41.1% in 2007. The decrease was primarily due to decreases in our state effective rates and releases of valuation allowances.
Effective November 1, 2008, we sold HRBFA to Ameriprise. HRBFA and its direct corporate parent are presented as discontinued operations in the consolidated financial statements for all periods presented.
Our discontinued operations also include our former mortgage loan origination and servicing business, as well as three smaller lines of business previously reported in our Business Services segment.
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FISCAL 2009 COMPARED TO FISCAL 2008 The pretax loss of our discontinued operations for fiscal year 2009 was $47.6 million compared to a loss of $1.2 billion in the prior year. The loss from discontinued operations for the prior year period included significant losses from our former mortgage loan businesses, including losses relating to loan repurchase obligations of $582.4 million and impairments of residual interests of $137.8 million. Net of applicable tax benefits, the loss from discontinued operations for fiscal year 2009 was $27.4 million compared to a loss of $754.6 million in the prior year.
Our effective tax rate for discontinued operations was 42.5% and 35.3% for the fiscal years 2009 and 2008, respectively. Our effective tax rate increased primarily due to a tax benefit recorded in conjunction with the sale of HRBFA.
FISCAL 2008 COMPARED TO FISCAL 2007 The pretax loss of our discontinued operations for fiscal year 2008 was $1.2 billion, which was essentially flat compared to fiscal year 2007. The loss from discontinued operations for both periods included significant losses from our former mortgage loans businesses.
Our effective tax rate for discontinued operations was 35.3% and 34.4% for the fiscal years 2008 and 2007, respectively.
We consider the policies discussed below to be critical to understanding our financial statements, as they require the use of significant judgment and estimation in order to measure, at a specific point in time, matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. We have reviewed and discussed each of these policies with the Audit Committee of our Board of Directors. For all of these policies, we caution that future events rarely develop precisely as forecasted and estimates routinely require adjustment and may require material adjustment.
ALLOWANCE FOR LOAN LOSSES The principal amount of mortgage loans held for investment totaled $821.8 million at April 30, 2009. We are exposed to the risk that borrowers may not repay amounts owed to us when they become contractually due. We record an allowance representing our estimate of credit losses inherent in the portfolio of loans held for investment at the balance sheet date. Determination of our allowance for loan losses is considered a critical accounting policy because loss provisions can be material to our operating results, projections of loan delinquencies and related matters are inherently subjective, and actual losses are impacted by factors outside of our control including economic conditions, unemployment rates and residential home prices.
We record a loan loss allowance for loans less than 60 days past due on a pooled basis. The aggregate principal balance of these loans totaled $518.0 million at April 30, 2009, and the portion of our allowance for loan losses allocated to these loans totaled $18.8 million. In estimating our loan loss allowance for these loans, we stratify the loan portfolio based on our view of risk associated with various elements of the pool and assign estimated loss rates based on those risks. Loss rates are based primarily on historical experience and our assessment of economic and market conditions. Loss rates consider both the rate at which loans will become delinquent (frequency) and the amount of loss that will ultimately be realized upon occurrence of a liquidation of collateral (severity). Frequency rates are based primarily on historical migration analysis of loans to delinquent status. Severity rates are based primarily on recent broker quotes or appraisals of collateral. Because of imprecision and uncertainty inherent in developing estimates of future credit losses, in particular during periods of rapidly declining collateral values or increasing delinquency rates, our estimation process during fiscal year 2009 included development of ranges of possible outcomes. Ranges were developed by stressing initial estimates of both frequency and severity rates. Stressing of frequency and severity assumptions is intended to model deterioration in credit quality that is difficult to predict during declining economic conditions. Future deterioration in credit quality may exceed our modeled assumptions.
Mortgage loans held for investment include loans originated by our affiliate, SCC, and purchased by HRB Bank. We have greater exposure to loss with respect to this segment of our loan portfolio as a result of historically higher delinquency rates. Therefore, we assign higher frequency rate assumptions to SCC-originated loans compared with loans originated by other third-party banks as we consider estimates of future losses. At April 30, 2009 our weighted-average frequency assumption was 10.6% for SCC-originated loans compared to 1.3% for remaining loans in the portfolio.
Loans 60 days past due are considered impaired and are reviewed individually. We record loss estimates typically based on the value of the underlying collateral. Our specific loan loss allowance for these impaired loans reflected an average loss severity of approximately 38.5% at April 30, 2009. The aggregate principal balance of loans 60 days past due or more totaled $143.1 million at April 30, 2009, and the portion of our allowance for loan losses allocated to these loans totaled $55.2 million.
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Modified loans that meet the definition of a troubled debt restructuring (TDR) are also considered impaired and are reviewed individually. We record impairment equal to the difference between the principal balance of the loan and the present value of expected future cash flows discounted at the loans effective interest rate. However, if we assess that foreclosure of a modified loan is probable, we record impairment based on the estimated fair value of the underlying collateral. The aggregate principal balance of TDR loans totaled $160.7 million at April 30, 2009, and the portion of our allowance for loan losses allocated to these loans totaled $10.1 million.
The loan loss allowance as a percent of mortgage loans held for investment was 10.23% at April 30, 2009, compared to 4.49% at April 30, 2008. The loan loss provision increased significantly during the current year primarily as a result of declining collateral values due to lower residential home prices and modeled expectations for future loan delinquencies in the portfolio. The residential mortgage industry has experienced significant adverse trends for an extended period. If adverse trends continue for a sustained period or at rates worse than modeled by us, we may be required to record additional loan loss provisions, and those losses may be significant.
Determining the allowance for credit losses for loans held for investment requires us to make estimates of losses that are highly uncertain and requires a high degree of judgment. If our underlying assumptions prove to be inaccurate, the allowance for loan losses could be insufficient to cover actual losses. Our mortgage loan portfolio is a static pool, as we are no longer originating or purchasing new mortgage loans, and we believe that factor over time will limit variability in our loss estimates. Our allowance at April 30, 2009 currently assumes that loans in the principal amount of approximately $280 million will become delinquent and that we will incur losses on delinquent loans at an approximate loss severity of 40%. We have estimated that future delinquencies where a loss is probable as of April 30, 2009, may be as high as $315 million and that loss-severity rates may be subject to variability up to 200 basis points. We have estimated the high end of a range of possible outcomes to be approximately $20 million greater than presently recorded.
MORTGAGE LOAN REPURCHASE OBLIGATION SCC is obligated to repurchase loans sold or securitized in the event of a breach of representations and warranties it made to purchasers or insurers of such loans, or otherwise indemnify certain third-parties for losses incurred by them. SCC records a liability for contingent losses relating to representation and warranty claims by estimating loan repurchase volumes and indemnification obligations for both known claims and projections of expected future claims. Projections of future claims are based on an analysis that includes a combination of reviewing historical repurchase trends, developing loss expectations on loans sold or securitized, and predicting the level at which previously originated loans may be subject to valid claims regarding representation and warranty breaches.
Based on an analysis as of April 30, 2009, SCC estimated its liability for loan repurchase and indemnification obligations pertaining to claims of breach of representation and warranties to be $206.6 million. Actual losses charged against this reserve during fiscal year 2009 totaled $44.2 million. To the extent that valid claim volumes in the future exceed current estimates, or the value of mortgage loans and residential home prices decline, future losses may be greater than our current estimates and those differences may be significant. See Item 8, note 17 to our consolidated financial statements.
LITIGATION It is our policy to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue and an analysis of historical experience in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies, and related pronouncements. Therefore, we have recorded reserves related to certain legal matters for which we believe it is probable that a loss will be incurred and the range of such loss can be estimated. With respect to other matters, we have concluded that a loss is only reasonably possible or remote, or is not estimable and, therefore, no liability is recorded.
Assessing the likely outcome of pending litigation, including the amount of potential loss, if any, is highly subjective. Our judgments regarding likelihood of loss and our estimates of probable loss amounts may differ from actual results due to difficulties in predicting the outcome of jury trials, arbitration hearings, settlement discussions and related activity, predicting the outcome of class certification actions and various other uncertainties. Due to the number of claims which are periodically asserted against us, and the magnitude of damages sought in those claims, actual losses in the future may significantly exceed our current estimates.
VALUATION OF GOODWILL The evaluation of goodwill for impairment is a critical accounting estimate due both to the magnitude of our goodwill balances, and the judgment involved in determining the fair value of our reporting units. Goodwill balances in our continuing operations totaled $850.2 million as of April 30, 2009 and $831.3 million as of April 30, 2008.
We test goodwill and other indefinite-life intangible assets for impairment annually or more frequently if events occur or circumstances change which would, more likely than not, reduce the fair value of a reporting unit below its carrying value. Our goodwill impairment analysis is based on a discounted cash flow approach and market
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comparables. This analysis, at the reporting unit level, requires significant management judgment with respect to revenue and expense forecasts, anticipated changes in working capital and the selection and application of an appropriate discount rate. Changes in projections or assumptions could materially affect our estimate of reporting unit fair values. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could affect our conclusions regarding the existence or amount of potential impairment. Finally, strategic changes in our outlook regarding reporting units or intangible assets may alter our valuation approach and could result in changes to our conclusions regarding impairment.
Estimates of fair value for certain of our reporting units exceed the corresponding carrying value by a significant margin. In certain instances, however, the excess of estimated fair value over carrying value is not significant. Future estimates of fair value may be adversely impacted by declining economic conditions. In addition, if future operating results of our reporting units are below our current modeled expectations, fair value estimates may decline. Any of these factors could result in future impairments, and those impairments could be significant.
In assessing potential goodwill impairment of our RSM reporting unit, we estimate fair value based on an assumption that the collaboration between RSM and M&P under their alternative practice structure arrangement will continue. Were M&P to exit the alternative practice structure, or the collaboration between these two businesses otherwise cease, we believe our fair value estimates could be lower than presently assumed. In addition, adverse business results for M&P could also negatively impact our fair value estimates for RSM. Goodwill balances for RSM totaled $402.6 million at April 30, 2009. Changes in our future assessment of fair value for this reporting unit could result in an impairment of goodwill and such impairment could be significant.
We recorded goodwill impairments within our Tax Services segment of $2.2 million and $5.7 million during fiscal years 2009 and 2008, respectively. There was no goodwill impairment in our continuing operations during fiscal year 2007, however, we recorded $154.9 million in goodwill impairments in discontinued operations related to the sale and wind-down of our mortgage operations.
INCOME TAXES We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), as further interpreted by FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).
We calculate our current and deferred tax provision for the fiscal year based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the applicable calendar year. Adjustments based on filed returns are recorded in the appropriate periods when identified. We file a consolidated federal tax return on a calendar year basis, generally in the second fiscal quarter of the subsequent year.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered taxable income in carry-back periods, historical and forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, and tax planning strategies in determining the need for a valuation allowance against our deferred tax assets. Determination of a valuation allowance for deferred tax assets requires that we make judgments about future matters that are not certain, including projections of future taxable income and evaluating potential tax-planning strategies. To the extent that actual results differ from our current assumptions, the valuation allowance will increase or decrease. In the event we were to determine we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination. Likewise, if we later determine it is more likely than not that the deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.
The income tax laws of jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and applicable government taxing authorities. Income tax returns filed by us are based on our interpretation of these rules. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which may result in proposed assessments, including assessments of interest and/or penalties. Our estimate for the potential outcome for any uncertain tax issue is highly subjective and based on our best judgments. Actual results may differ from our current judgments due to a variety of factors, including changes in law, interpretations of law by taxing authorities that differ from our assessments, changes in the jurisdictions in which we operate and results of routine tax examinations. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate on a quarterly basis.
REVENUE RECOGNITION We have many different revenue sources, each governed by specific revenue recognition policies. Our revenue recognition policies can be found in Item 8, note 1 to our consolidated financial statements.
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OTHER SIGNIFICANT ACCOUNTING POLICIES Other significant accounting policies, not involving the same level of judgment or uncertainty as those discussed above are nevertheless important to an understanding of the financial statements. These policies may require judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standard setters and regulators. Although specific conclusions reached by these standard setters may cause a material change in our accounting policies, outcomes cannot be predicted with confidence. See Item 8, note 1 to our consolidated financial statements, which discusses accounting policies we have selected when there are acceptable alternatives and new or proposed accounting standards that may affect our financial reporting in the future.
CAPITAL RESOURCES AND LIQUIDITY Our sources of capital include cash from operations, issuances of common stock and debt. We use capital primarily to fund working capital, pay dividends, repurchase treasury shares and acquire businesses. Our operations are highly seasonal and therefore generally require the use of cash to fund operating losses during the period May through mid-January.
Given the likely availability of a number of liquidity options discussed herein, including borrowing capacity under our CLOCs, we believe, that in the absence of any unexpected developments, our existing sources of capital at April 30, 2009 are sufficient to meet our operating needs.
CASH FROM OPERATING ACTIVITIES Cash provided by operations totaled $1.0 billion for fiscal year 2009, compared to cash provided by operations of $258.8 million in 2008 and cash used in operations of $557.0 million in 2007. Operating cash flows in fiscal year 2009 increased from fiscal year 2008 primarily due to net income of $485.7 million in the current year compared to a net loss of $308.6 million in the prior year.
Restricted Cash. We hold certain cash balances that are restricted as to use. Cash and cash equivalents restricted totaled $51.7 million at April 30, 2009, and primarily consisted of cash held by our captive insurance subsidiary that will be used to pay claims.
CASH FROM INVESTING ACTIVITIES Cash provided by investing activities totaled $5.6 million for fiscal year 2009, compared to $1.1 billion in fiscal year 2008 and $1.2 billion used in fiscal year 2007.
Acquisitions and Sales. Total cash paid for acquisitions was $293.8 million, $24.9 million and $57.6 million during fiscal years 2009, 2008 and 2007, respectively. On November 3, 2008, we acquired the assets and franchise rights of our last major independent franchise operator for an aggregate purchase price of $279.2 million. See Item 8, note 2 to our consolidated financial statements.
Total cash received from sales of discontinued operations totaled $304.0 million and $1.1 billion during fiscal years 2009 and 2008, respectively.
Mortgage Loans Held for Investment. We received net proceeds of $91.3 million and $207.6 million on our mortgage loans held for investment in fiscal years 2009 and 2008, respectively. We used $954.3 million for originating and purchasing mortgage loans held for investment in fiscal year 2007.
CASH FROM FINANCING ACTIVITIES Cash used in financing activities totaled $40.2 million for fiscal year 2009, compared to $1.6 billion in fiscal year 2008 and cash provided of $2.0 billion in fiscal year 2007. Changes from prior year amounts are primarily the result of significant borrowings in fiscal year 2007, which were then repaid in fiscal year 2008.
Debt. We borrow under our CLOCs to support working capital requirements primarily arising from off-season operating losses in our Tax Services and Business Services segments, pay dividends, repurchase treasury shares and acquire businesses. We had no balance outstanding under our CLOCs at April 30, 2009, 2008 or 2007. See additional discussion below in Borrowings.
We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Issuances of Common Stock. In October 2008, we sold 8.3 million shares of our common stock, without par value, at a price of $17.50 per share in a registered direct offering through subscription agreements with selected institutional investors. We received net proceeds of $141.4 million, after deducting placement agent fees and other offering expenses. The purpose of the equity offering was to ensure we maintained adequate equity levels, as a condition of our CLOCs, during our off-season. Proceeds were used for general corporate purposes.
Proceeds from the issuance of common stock in accordance with our stock-based compensation plans totaled $71.6 million, $23.3 million and $25.7 million in fiscal years 2009, 2008 and 2007, respectively.
Dividends. We have consistently paid quarterly dividends. Dividends paid totaled $198.7 million, $183.6 million and $172.0 million in fiscal years 2009, 2008 and 2007, respectively.
H&R BLOCK 2009 Form 10K 29
Share Repurchases. In June 2008, our Board of Directors rescinded the previous authorizations to repurchase shares of our common stock and approved an authorization to purchase up to $2.0 billion of our common stock through June 2012. During the fourth quarter of fiscal year 2009, we repurchased 5.6 million shares pursuant to this authorization at an aggregate price of $98.7 million, or an average price of $17.53 per share. There was $1.9 billion remaining under this authorization at April 30, 2009.
Customer Deposits. Customer deposits provided $64.4 million in the current year compared to $345.4 million used in fiscal year 2008 and $1.1 billion provided in fiscal year 2007. These deposits are held by HRB Bank, which is included in the Consumer Financial Services segment.
SEGMENT CASH FLOWS A condensed consolidating statement of cash flows by segment for the fiscal year ended April 30, 2009, follows. Generally, interest is not charged on intercompany activities between segments. Our consolidated statements of cash flows are located in Item 8.
Tax Services. Tax Services has historically been our largest provider of annual operating cash flows. The seasonal nature of Tax Services generally results in a large positive operating cash flow in the fiscal fourth quarter. Tax Services generated $531.2 million in operating cash flows primarily related to net income, as cash is generally collected from clients at the time services are rendered. Cash used in investing activities of $314.0 million was primarily for business acquisitions and capital expenditures.
Our international operations are generally self-funded. However, H&R Block Canada, Inc. (Block Canada) utilized intercompany borrowings to fund its CashBack program and working capital requirements during the last two fiscal years. Cash balances are held in Canada and Australia independently in local currencies.
Business Services. Business Services funding requirements are largely related to receivables for completed work and work in process and funding relating to acquired businesses. We have provided funding in the normal course of business sufficient to cover these working capital needs. Business Services also has future obligations and commitments, which are summarized in Contractual Obligations and Commercial Commitments.
This segment generated $62.2 million in operating cash flows primarily related to net income. Additionally, Business Services used $24.7 million in investing activities primarily related to capital expenditures.
Consumer Financial Services. In fiscal year 2009, Consumer Financial Services provided $104.8 million in investing activities primarily due to principal payments received on mortgage loans held for investment. Cash provided by financing activities of $41.0 million is primarily due to changes in customer deposits net of payments on Federal Home Loan Bank (FHLB) borrowings.
HRB Banks current liquidity needs are generally met through deposits from banking clients. HRB Bank has access to traditional funding sources such as deposits, federal funds purchased and repurchase agreements. HRB Bank maintains a credit facility with the FHLB. At April 30, 2009, $100.0 million was drawn under this facility.
Block Financial LLC (BFC) made additional capital contributions to HRB Bank of $245.0 million during fiscal year 2009. These contributions were provided for HRB Bank to meet its capital requirements due to seasonal fluctuations in the size of its balance sheet. Also during fiscal year 2009, we submitted an application to the OTS requesting that HRB Bank be allowed to pay dividends to BFC in an amount that would not exceed the capital necessary to continuously maintain HRB Banks required 12.0% leverage ratio. The OTS approved our application on January 12, 2009. HRB Bank paid dividends of $235.0 million to BFC in fiscal year 2009.
See additional discussion of regulatory and capital requirements of HRB Bank in Regulatory Environment.
We believe the funding sources for Consumer Financial Services are stable. Liquidity risk within this segment is primarily limited to maintaining sufficient capital levels at HRB Bank.
Discontinued Operations. Discontinued operations provided $255.1 million in cash from investing activities primarily due to proceeds received from the sale of HRBFA.
30 H&R BLOCK 2009 Form 10K
The following chart provides the debt ratings for BFC:
At April 30, 2009, we maintained $2.0 billion in revolving credit facilities to support commercial paper issuance and for general corporate purposes. These CLOCs, and any outstanding borrowings thereunder, have a maturity date of August 2010, bear interest in a range of LIBOR plus 14 to 45 basis points per annum and an annual facility fee in a range of 6 to 15 basis points per annum, based on our credit ratings. These lines are subject to various affirmative and negative covenants, including (1) a minimum net worth covenant requiring us to maintain at least $650.0 million of net worth on the last day of any fiscal quarter, (2) limits on our indebtedness and (3) a requirement that we reduce the aggregate outstanding principal amount of short-term debt, as defined in the agreement, to $200.0 million or less for a minimum period of thirty consecutive days during the period from March 1 to June 30 of each year (the Clean-down requirement). At April 30, 2009, we were in compliance with these covenants and had net worth of $1.4 billion. There was no balance outstanding on this facility at April 30, 2009.
Lehman Brothers Bank, FSB (Lehman) is a participating lender in our $2.0 billion CLOCs, with a $50.0 million credit commitment. In September 2008, Lehmans parent company declared bankruptcy. Since then, Lehman has not honored any funding requests under these facilities, thereby effectively reducing our available liquidity under our CLOCs to $1.95 billion. We do not expect this change to have a material impact on our liquidity or consolidated financial statements.
On January 11, 2008, we issued $600.0 million of 7.875% Senior Notes under our shelf registration. The Senior Notes are due January 15, 2013 and are not redeemable by the bondholders prior to maturity. The net proceeds of this transaction were used to repay a $500.0 million facility, with the remaining proceeds used for working capital and general corporate purposes. As of April 30, 2009, we had $250.0 million remaining under our shelf registration for additional debt issuances.
We entered into a committed line of credit agreement with HSBC Finance Corporation effective January 14, 2009 for use as a funding source for the purchase of RAL participations. This line provided funding totaling $2.5 billion through March 30, 2009 and $120.0 million thereafter through June 30, 2009. This line is subject to various covenants that are similar to our CLOCs and is secured by our RAL participations. All borrowings on this facility were repaid as of April 30, 2009 and the facility is now closed.
During fiscal year 2009, borrowing needs in our Canadian operations were funded by corporate borrowings in the U.S. To mitigate the foreign currency exchange rate risk, we used foreign exchange forward contracts. We do not enter into forward contracts for speculative purposes. In estimating the fair value of derivative positions, we utilize quoted market prices, if available, or quotes obtained from external sources. There were no forward contracts outstanding as of April 30, 2009.
A summary of our obligations to make future payments as of April 30, 2009, is as follows:
The amount of liabilities recorded in connection with FIN 48 that we expect to pay within twelve months is $15.1 million at April 30, 2009 and is included in accounts payable, accrued expenses and other current liabilities on our consolidated balance sheet. The remaining amount is included in other noncurrent liabilities on our
H&R BLOCK 2009 Form 10K 31
consolidated balance sheet. Because the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty, the estimated FIN 48 liability has been excluded from the table above. See Item 8, note 13 to the consolidated financial statements for additional information.
A summary of our commitments as of April 30, 2009, which may or may not require future payments, are as follows:
See discussion of contractual obligations and commitments in Item 8, within the notes to our consolidated financial statements.
HRB Bank is a federal savings bank and H&R Block, Inc. is a savings and loan holding company. As a result, each is subject to regulation by the OTS. Federal savings banks are subject to extensive regulation and examination by the OTS, their primary federal regulator, as well as the FDIC. In conjunction with H&R Block, Inc.s application with the OTS for HRB Bank, H&R Block, Inc. made commitments as part of our charter approval order (Master Commitment) which included, but were not limited to: (1) H&R Block, Inc. to maintain a three percent minimum ratio of adjusted tangible capital to adjusted total assets, as defined by the OTS; (2) maintain all HRB Bank capital within HRB Bank in accordance with the submitted three-year business plan; and (3) follow federal regulations surrounding intercompany transactions and approvals. Effective April 30, 2008, the three percent minimum ratio of adjusted tangible capital to adjusted total assets requirement was eliminated and a Supervisory Directive relating to prior non-compliance with this requirement was rescinded.
All savings associations are subject to the capital adequacy guidelines and the regulatory framework for prompt corrective action. HRB Bank must meet specific capital guidelines involving quantitative measures of HRB Banks assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. HRB Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. As of March 31, 2009, our most recent Thrift Financial Report (TFR) filing with the OTS, HRB bank was a well capitalized institution under the prompt corrective action provisions of the FDIC. See Item 8, note 16 to the consolidated financial statements for additional discussion of regulatory capital requirements and classifications.
HRB Bank is an indirect wholly-owned subsidiary of H&R Block, Inc. and its customer deposits are insured by the FDIC. If an insured institution fails, claims for administrative expenses of the receiver and for deposits in U.S. branches (including claims of the FDIC as subrogee of the failed institution) have priority over the claims of general unsecured creditors. In addition, the FDIC has authority to require H&R Block, Inc. to reimburse it for losses it incurs in connection with the failure of HRB Bank or with the FDICs provision of assistance to a banking subsidiary that is in danger of failure.
H&R Block, Inc. is a legal entity separate and distinct from its subsidiary, HRB Bank. Various federal and state statutory provisions and regulations limit the amount of dividends HRB Bank may pay without regulatory approval. The OTS has authority to prohibit HRB Bank from engaging in unsafe or unsound practices in conducting their business. The payment of dividends, depending on the financial condition of the bank, could be deemed an unsafe or unsound practice. The ability of HRB Bank to pay dividends in the future is currently, and could be further, influenced by bank regulatory policies and capital guidelines.
The U.S., various state, local, provincial and foreign governments and some self-regulatory organizations have enacted statutes and ordinances, and/or adopted rules and regulations, regulating aspects of our business. These aspects include, but are not limited to, commercial income tax return preparers, income tax courses, the electronic filing of income tax returns, the facilitation of RALs, loan originations and assistance in loan originations, mortgage lending, privacy, consumer protection, franchising, sales methods, banking, accountants and the accounting practice. We seek to determine the applicability of such statutes, ordinances, rules and regulations (collectively, Laws) and comply with those Laws.
From time to time in the ordinary course of business, we receive inquiries from governmental and self-regulatory agencies regarding the applicability of Laws to our services and products. In response to past inquiries, we have agreed to comply with such Laws, convinced the authorities that such Laws were not applicable or that
32 H&R BLOCK 2009 Form 10K
compliance already exists and/or modified our activities in the applicable jurisdiction to avoid the application of all or certain parts of such Laws. We believe the past resolution of such inquiries and our ongoing compliance with Laws has not had a material adverse effect on our consolidated financial statements. We cannot predict what effect future Laws, changes in interpretations of existing Laws or the results of future regulator inquiries with respect to the applicability of Laws may have on our consolidated financial statements. See additional discussion of legal matters in Item 3, Legal Proceedings and Item 8, note 18 to our consolidated financial statements.
FUTURE LEGISLATION In light of current conditions in the U.S. and global financial markets and the U.S. and global economy, regulators have increased their focus on the regulation of the financial services industry. Proposals that could substantially intensify the regulation of the financial services industry are expected to be introduced in the U.S. Congress, in state legislatures and from applicable regulatory authorities. These proposals may change banking statutes and regulation and our operating environment in substantial and unpredictable ways. If enacted, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any of these proposals will be enacted and, if enacted, the effect that it, or any impending regulations, would have on our business, results of operations or financial condition.
This section presents information required by the SECs Industry Guide 3, Statistical Disclosure by Bank Holding Companies. The tables in this section include HRB Bank information only.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL The following table presents average balance data and interest income and expense data for our banking operations, as well as the related interest yields and rates for fiscal years 2009, 2008 and 2007:
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The following table presents the rate/volume variance in interest income and expense for the last two fiscal years:
INVESTMENT PORTFOLIO The following table presents the cost basis and fair value of HRB Banks investment portfolio at April 30, 2009, 2008 and 2007:
The following table shows the cost basis, scheduled maturities and average yields for HRB Banks investment portfolio at April 30, 2009: