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H&R Block 10-Q 2008
e10vq
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
     
(Mark One)    
[X]
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended January 31, 2008
OR
[  ]
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
 
Commission file number 1-6089
 
(H and R BLOCK LOGO)
 
H&R Block, Inc.
 
     
MISSOURI   44-0607856
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
One H&R Block Way
Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
 
(816) 854-3000
 
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   Ö    No        
 
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):
 
             
Large accelerated filer Ö 
  Accelerated filer        Non-accelerated filer         Smaller Reporting company     
    (Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes           No   Ö  
 
The number of shares outstanding of the registrant’s Common Stock, without par value, at the close of business on February 29, 2008 was 325,369,713 shares.


 

 
(H and R BLOCK LOGO)
 
Form 10-Q for the Period Ended January 31, 2008
 
 
 
             
        Page
 
           
PART I
 
Financial Information
       
           
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      50  
           
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      54  
           
      57  
           
      57  
           
      57  
       
    59  
 
 Amendment to the Note Purchase Agreement
 Amendment to the Indenture
 Amendment to the Five-Year Credit and Guarantee Agreement
 Amendment to the Amended and Restated Five-Year Credit and Guarantee Agreement
 Employment Agreement
 Amended and Restated Bridge Credit and Guarantee Agreement
 Amended and Restated Bridge Credit and Guarantee Ageement
 Amended and Restated Note Purchase Agreement
 Amendment to the Receivables Purchase Agreement
 Amendment to the Indenture
 Separation and Release Agreement
 Separation and Release Agreement
 Credit and Guarantee Agreement
 Amendmended and Restated Note Purchase Agreement
 Amended and Restated Receivables Purchase Agreement
 Amended and Restated Indenture
 Separation and Release Agreement
 Certification
 Certification
 Certification
 Certification


Table of Contents

 
(H and R BLOCK LOGO)
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS (amounts in 000s, except share and per share amounts)
 
                 
    January 31, 2008     April 30, 2007  
 
    (Unaudited)        
 
ASSETS
               
Cash and cash equivalents
  $ 1,410,009     $ 921,838  
Cash and cash equivalents – restricted
    326,289       332,646  
Receivables from customers, brokers, dealers and clearing organizations, less allowance for doubtful accounts of $2,362 and $2,292
    414,089       410,522  
Receivables, less allowance for doubtful accounts of
$82,465 and $99,259
    2,711,295       556,255  
Prepaid expenses and other current assets
    258,666       208,564  
Assets of discontinued operations, held for sale
    3,010,999       1,746,959  
                 
Total current assets
    8,131,347       4,176,784  
                 
Mortgage loans held for investment, less allowance for
loan losses of $15,860 and $3,448
    1,040,854       1,358,222  
Property and equipment, at cost less accumulated depreciation and amortization of $651,576 and $647,151
    391,265       379,066  
Intangible assets, net
    154,163       181,413  
Goodwill
    1,010,721       993,919  
Other assets
    846,861       454,646  
                 
Total assets
  $ 11,575,211     $ 7,544,050  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Liabilities:
               
Short-term borrowings
  $ 1,711,485     $ 1,567,082  
Customer banking deposits
    1,958,490       1,129,263  
Accounts payable to customers, brokers and dealers
    593,732       633,189  
Accounts payable, accrued expenses and other current liabilities
    525,882       519,372  
Accrued salaries, wages and payroll taxes
    280,824       307,854  
Accrued income taxes
    78,547       439,472  
Current portion of long-term debt
    8,332       9,304  
Liabilities of discontinued operations, held for sale
    2,513,311       615,373  
                 
Total current liabilities
    7,670,603       5,220,909  
                 
Long-term debt
    2,917,411       519,807  
Other noncurrent liabilities
    523,265       388,835  
                 
Total liabilities
    11,111,279       6,129,551  
                 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, no par, stated value $.01 per share,
800,000,000 shares authorized, 435,890,796 shares issued at
January 31, 2008 and April 30, 2007
    4,359       4,359  
Additional paid-in capital
    685,013       676,766  
Accumulated other comprehensive income (loss)
    (348 )     (1,320 )
Retained earnings
    1,887,466       2,886,440  
Less cost of 110,566,917 and 112,671,610 shares of
common stock in treasury
    (2,112,558 )     (2,151,746 )
                 
Total stockholders’ equity
    463,932       1,414,499  
                 
Total liabilities and stockholders’ equity
  $ 11,575,211     $ 7,544,050  
                 
 
See Notes to Condensed Consolidated Financial Statements


1


Table of Contents

 
(H and R BLOCK LOGO)
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF
INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(unaudited, amounts in 000s,
except per share amounts)
 
                                 
    Three Months Ended January 31,     Nine Months Ended January 31,  
    2008     2007     2008     2007  
 
 
Revenues:
                               
Service revenues
  $ 776,411     $ 749,000     $ 1,471,891     $ 1,399,738  
Other revenues:
                               
Interest income
    58,655       35,961       140,092       91,646  
Product and other revenues
    137,545       146,218       176,661       178,648  
                                 
      972,611       931,179       1,788,644       1,670,032  
                                 
Operating expenses:
                               
Cost of services
    604,153       576,935       1,416,286       1,339,714  
Cost of other revenues
    97,293       69,324       199,628       113,104  
Selling, general and administrative
    269,019       253,968       595,719       566,011  
                                 
      970,465       900,227       2,211,633       2,018,829  
                                 
Operating income (loss)
    2,146       30,952       (422,989 )     (348,797 )
Interest expense
    (624 )     (12,066 )     (1,871 )     (36,292 )
Other income, net
    2,597       3,239       21,663       14,621  
                                 
Income (loss) from continuing operations before taxes (benefit)
    4,119       22,125       (403,197 )     (370,468 )
Income taxes (benefit)
    (5,165 )     181       (166,553 )     (153,576 )
                                 
Net income (loss) from continuing operations
    9,284       21,944       (236,644 )     (216,892 )
Net loss from discontinued operations
    (56,642 )     (82,196 )     (615,565 )     (131,197 )
                                 
Net loss
  $ (47,358 )   $ (60,252 )   $ (852,209 )   $ (348,089 )
                                 
Basic earnings (loss) per share:
                               
Net income (loss) from continuing operations
  $ 0.03     $ 0.07     $ (0.73 )   $ (0.67 )
Net loss from discontinued operations
    (0.18 )     (0.26 )     (1.90 )     (0.41 )
                                 
Net loss
  $ (0.15 )   $ (0.19 )   $ (2.63 )   $ (1.08 )
                                 
Basic shares
    325,074       322,350       324,544       322,588  
                                 
Diluted earnings (loss) per share:
                               
Net income (loss) from continuing operations
  $ 0.03     $ 0.07     $ (0.73 )   $ (0.67 )
Net loss from discontinued operations
    (0.17 )     (0.25 )     (1.90 )     (0.41 )
                                 
Net loss
  $ (0.14 )   $ (0.18 )   $ (2.63 )   $ (1.08 )
                                 
Diluted shares
    327,202       326,048       324,544       322,588  
                                 
Dividends per share
  $ 0.143     $ 0.135     $ 0.42     $ 0.40  
                                 
Comprehensive income (loss):
                               
Net loss
  $ (47,358 )   $ (60,252 )   $ (852,209 )   $ (348,089 )
Change in unrealized gain (loss) on available-for-sale securities, net
    381       (14,350 )     1,544       (15,194 )
Change in foreign currency translation adjustments
    (1,860 )     (268 )     (572 )     221  
                                 
Comprehensive loss
  $ (48,837 )   $ (74,870 )   $ (851,237 )   $ (363,062 )
                                 
 
See Notes to Condensed Consolidated Financial Statements


2


Table of Contents

 
(H and R BLOCK LOGO)
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, amounts in 000s)
 
                 
Nine Months Ended January 31,   2008     2007  
 
 
Cash flows from operating activities:
               
Net loss
  $ (852,209 )   $ (348,089 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    107,989       110,822  
Stock-based compensation expense
    32,988       28,826  
Change in participation in tax client loans receivable
    (1,693,506 )     (1,691,351 )
Changes in assets and liabilities of discontinued operations
    (100,727 )     593,989  
Other, net of business acquisitions
    (862,500 )     (1,433,602 )
                 
Net cash used in operating activities
    (3,367,965 )     (2,739,405 )
                 
Cash flows from investing activities:
               
Mortgage loans originated or purchased for investment, net
    106,721       (1,073,012 )
Purchases of property and equipment, net
    (80,712 )     (127,325 )
Payments made for business acquisitions, net of cash acquired
    (23,835 )     (21,679 )
Net cash provided by investing activities of discontinued operations
    913       12,751  
Other, net
    8,280       (9,422 )
                 
Net cash provided by (used in) investing activities
    11,367       (1,218,687 )
                 
Cash flows from financing activities:
               
Repayments of commercial paper
    (5,125,279 )     (4,901,618 )
Proceeds from issuance of commercial paper
    4,133,197       6,397,656  
Repayments of line of credit borrowings
    (2,161,177 )     (889,722 )
Proceeds from line of credit borrowings
    5,097,662       2,320,105  
Proceeds from issuance of Senior Notes
    599,376       -  
Customer deposits, net
    828,872       1,632,875  
Dividends paid
    (137,049 )     (128,090 )
Purchase of treasury shares
    -       (180,897 )
Proceeds from exercise of stock options
    14,527       19,183  
Net cash provided by financing activities of discontinued operations
    644,173       172,201  
Other, net
    (49,533 )     (79,244 )
                 
Net cash provided by financing activities
    3,844,769       4,362,449  
                 
Net increase in cash and cash equivalents
    488,171       404,357  
Cash and cash equivalents at beginning of the period
    921,838       673,827  
                 
Cash and cash equivalents at end of the period
  $ 1,410,009     $ 1,078,184  
                 
Supplementary cash flow data:
               
Income taxes paid, net of refunds received of $89,865 and $3,154
  $ (55,975 )   $ 378,377  
Interest paid on borrowings
    129,694       84,164  
Interest paid on deposits
    39,498       19,088  
 
See Notes to Condensed Consolidated Financial Statements


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Table of Contents

 
(H and R BLOCK LOGO)
 
 
 
CONDENSED CONSOLIDATED STATEMENT OF
STOCKHOLDERS’ EQUITY
(unaudited, amounts in 000s,
except per share amounts)
 
                                                                                 
                                  Accumulated
                         
                Convertible
    Additional
    Other
                         
    Common Stock     Preferred Stock     Paid-in
    Comprehensive
    Retained
    Treasury Stock     Total
 
    Shares     Amount     Shares     Amount     Capital     Income (Loss)     Earnings     Shares     Amount     Equity  
 
 
Balances at April 30, 2006
    435,891     $ 4,359       -     $ -     $ 653,053     $ 21,948     $ 3,492,059       (107,378 )   $ (2,023,620 )   $ 2,147,799  
Net loss
    -       -       -       -       -       -       (348,089 )     -       -       (348,089 )
Unrealized translation gain (loss)
    -       -       -       -       -       221       -       -       -       221  
Change in net unrealized gain (loss) on available-for-sale securities
    -       -       -       -       -       (15,194 )     -       -       -       (15,194 )
Stock-based compensation
    -       -       -       -       35,669       -       -       -       -       35,669  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (7,010 )     -       -       1,246       23,763       16,753  
Nonvested shares
    -       -       -       -       (20,332 )     -       -       1,041       19,826       (506 )
ESPP
    -       -       -       -       863       -       -       465       8,860       9,723  
Acquisitions
    -       -       -       -       54       -       -       21       396       450  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (8,466 )     (188,562 )     (188,562 )
Cash dividends paid – $0.40 per share
    -       -       -       -       -       -       (128,090 )     -       -       (128,090 )
                                                                                 
Balances at January 31, 2007
    435,891     $ 4,359                -     $           -     $   662,297     $     6,975     $  3,015,880        (113,071 )   $ (2,159,337 )   $  1,530,174  
                                                                                 
                                                                                 
Balances at April 30, 2007
    435,891     $ 4,359       -     $ -     $ 676,766     $ (1,320 )   $ 2,886,440       (112,672 )   $ (2,151,746 )   $ 1,414,499  
Remeasurement of uncertain tax positions upon adoption of FIN 48
    -       -       -       -       -       -       (9,716 )     -       -       (9,716 )
Net loss
    -       -       -       -       -       -       (852,209 )     -       -       (852,209 )
Unrealized translation gain (loss)
    -       -       -       -       -       (572 )     -       -       -       (572 )
Change in net unrealized gain (loss) on available-for-sale securities
    -       -       -       -       -       1,544       -       -       -       1,544  
Stock-based compensation-
    -       -       -       -       37,150       -       -       -       -       37,150  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (8,815 )     -       -       1,072       20,478       11,663  
Nonvested shares
    -       -       -       -       (20,058 )     -       -       938       17,917       (2,141 )
ESPP
    -       -       -       -       (65 )     -       -       412       7,872       7,807  
Acquisitions
    -       -       -       -       35       -       -       8       158       193  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (325 )     (7,237 )     (7,237 )
Cash dividends paid – $0.42 per share
    -       -       -       -       -       -       (137,049 )     -       -       (137,049 )
                                                                                 
Balances at January 31, 2008
    435,891     $ 4,359       -     $ -     $ 685,013     $ (348 )   $ 1,887,466       (110,567 )   $ (2,112,558 )   $ 463,932  
                                                                                 
 
See Notes to Condensed Consolidated Financial Statements


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Table of Contents

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
1.  Basis of Presentation
The condensed consolidated balance sheet as of January 31, 2008, the condensed consolidated statements of income and comprehensive income for the three and nine months ended January 31, 2008 and 2007, the condensed consolidated statements of cash flows for the nine months ended January 31, 2008 and 2007, and the condensed consolidated statement of stockholders’ equity for the nine months ended January 31, 2008 and 2007 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations, cash flows and changes in stockholders’ equity at January 31, 2008 and for all periods presented have been made. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
“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.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2007 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of April 30, 2007 or for the year then ended, are derived from our April 30, 2007 Annual Report to Shareholders on Form 10-K.
Operating revenues of the Tax Services and Business Services segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
 
Discontinued Operations – Recent Developments
On April 19, 2007, we entered into an agreement to sell Option One Mortgage Corporation (OOMC) to Cerberus Capital Management (Cerberus). In conjunction with this plan, we also announced we would terminate the operations of H&R Block Mortgage Corporation (HRBMC), a wholly-owned subsidiary of OOMC.
On December 4, 2007, we agreed to terminate the agreement with Cerberus. We also announced that we would immediately terminate all remaining origination activities and pursue the sale of OOMC’s loan servicing activities. During January 2008, OOMC funded the last loan in its pipeline.
We have estimated the fair values of our servicing and other assets held for sale, and have recorded a valuation allowance of $304.9 million at January 31, 2008, which resulted in impairments of $116.3 million for the nine months ended January 31, 2008.
During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the nine months ended January 31, 2008. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services.
As of January 31, 2008, these businesses are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. See additional information in note 12.


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Table of Contents

2.  Earnings (Loss) Per Share
Basic and diluted earnings (loss) per share is computed using the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share except in those periods with a loss from continuing operations. The computations of basic and diluted earnings (loss) per share from continuing operations are as follows:
 
(in 000s, except per share amounts)
                             
   
    Three Months Ended January 31,   Nine Months Ended January 31,  
    2008   2007   2008     2007  
   
 
Net income (loss) from continuing operations
  $ 9,284   $ 21,944   $ (236,644 )   $ (216,892 )
                             
Basic weighted average common shares
    325,074     322,350     324,544       322,588  
Potential dilutive shares from stock options and restricted stock
    2,126     3,696     -       -  
Convertible preferred stock
    2     2     -       -  
                             
Dilutive weighted average common shares
    327,202     326,048     324,544       322,588  
                             
Earnings (loss) per share from continuing operations:
                           
Basic
  $ 0.03   $ 0.07   $ (0.73 )   $ (0.67 )
Diluted
    0.03     0.07     (0.73 )     (0.67 )
 
 
Diluted earnings per share excludes the impact of nonvested common shares or the exercise of options to purchase 18.0 million shares and 14.4 million shares for the three months ended January 31, 2008 and 2007, respectively, as the effect would be antidilutive. Diluted earnings per share excludes the impact of nonvested common shares or the exercise of options to purchase 24.8 million shares and 28.0 million shares for the nine months ended January 31, 2008 and 2007, respectively, as the effect would be antidilutive due to the net loss from continuing operations during each period.
The weighted average shares outstanding for the nine months ended January 31, 2008 increased to 324.5 million from 322.6 million for the nine months ended January 31, 2007, primarily due the issuance of treasury shares related to our stock-based compensation plans.
During the nine months ended January 31, 2008 and 2007, we issued 2.4 million and 2.8 million shares of common stock, respectively, pursuant to the exercise of stock options, employee stock purchases and awards of nonvested shares, in accordance with our stock-based compensation plans.
During the nine months ended January 31, 2008, we acquired 0.3 million shares of our common stock, which represent shares swapped or surrendered to us in connection with the vesting of nonvested shares and the exercise of stock options, at an aggregate cost of $7.2 million. During the nine months ended January 31, 2007, we acquired 8.5 million shares of our common stock, of which 8.1 million shares were purchased from third parties with the remaining shares swapped or surrendered to us, at an aggregate cost of $188.6 million.
During the nine months ended January 31, 2008, we granted 5.1 million stock options and 1.0 million nonvested shares and units in accordance with our stock-based compensation plans. The weighted average fair value of options granted was $4.48 for manager and director options and $3.07 for options granted to our seasonal associates. At January 31, 2008, the total unrecognized compensation cost for options and nonvested shares and units was $19.1 million and $45.1 million, respectively.


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3.  Receivables
Receivables of continuing operations consist of the following:
 
                         
(in 000s)  
   
    January 31, 2008     January 31, 2007     April 30, 2007  
   
 
Participation in tax client loans
  $ 1,763,030     $ 1,733,155     $ 69,524  
Emerald Advance lines of credit
    361,263       -       -  
Business Services accounts receivable
    257,010       324,399       342,387  
Receivables for tax-related fees
    117,328       135,467       40,164  
Loans to franchisees
    71,349       62,962       48,530  
Royalties from franchisees
    68,573       68,153       2,890  
Other
    155,207       118,223       152,019  
                         
      2,793,760       2,442,359       655,514  
Allowance for doubtful accounts
    (82,465 )     (70,621 )     (99,259 )
                         
    $ 2,711,295     $ 2,371,738     $ 556,255  
                         
 
 
 
4.  Goodwill and Intangible Assets
Changes in the carrying amount of goodwill of continuing operations for the nine months ended January 31, 2008 consist of the following:
(in 000s)
                           
 
    April 30, 2007   Additions   Other     January 31, 2008
 
 
Tax Services
  $ 415,077   $ 14,515   $ 6,529     $ 436,121
Business Services
    404,888     1,497     (5,739 )     400,646
Consumer Financial Services
    173,954     -     -       173,954
                           
Total
  $ 993,919   $ 16,012   $ 790     $ 1,010,721
                           
 
 
We test goodwill for impairment annually at the beginning of our fourth quarter, or more frequently if events occur indicating it is more likely than not the fair value of a reporting unit’s net assets has been reduced below its carrying value. No impairments of goodwill were identified within any of our operating segments during the nine months ended January 31, 2008.
Intangible assets of continuing operations consist of the following:
                                         
(in 000s)
 
    January 31, 2008   April 30, 2007
 
    Gross
            Gross
         
    Carrying
  Accumulated
        Carrying
  Accumulated
     
    Amount   Amortization     Net   Amount   Amortization     Net
 
 
Tax Services:
                                       
Customer relationships
  $ 46,654   $ (20,756 )   $ 25,898   $ 39,347   $ (14,654 )   $ 24,693
Noncompete agreements
    23,027     (19,691 )     3,336     21,237     (18,279 )     2,958
Purchased technology
    12,500     (1,794 )     10,706     12,500     -       12,500
Trade name
    1,025     (92 )     933     1,025     -       1,025
Business Services:
                                       
Customer relationships
    144,107     (97,215 )     46,892     142,315     (90,900 )     51,415
Noncompete agreements
    32,253     (16,891 )     15,362     31,352     (15,524 )     15,828
Trade name – amortizing
    3,290     (3,023 )     267     3,290     (2,430 )     860
Trade name – non-amortizing
    55,637     (4,868 )     50,769     55,637     (4,868 )     50,769
Consumer Financial Services:
                                       
Customer relationships
    293,000     (293,000 )     -     293,000     (271,635 )     21,365
                                         
Total intangible assets
  $ 611,493   $ (457,330 )   $ 154,163   $ 599,703   $ (418,290 )   $ 181,413
                                         
 
 
Amortization of intangible assets of continuing operations for the three and nine months ended January 31, 2008 was $8.6 million and $39.1 million, respectively. Amortization of intangible assets of continuing operations for the three and nine months ended January 31, 2007 was $14.0 million and $42.6 million, respectively. Estimated amortization of intangible assets for fiscal years 2008 through 2012 is $48.4 million, $21.9 million, $19.3 million, $17.5 million and $14.8 million, respectively.


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5.  Borrowings
Borrowings of continuing operations consist of the following:
(in 000s)
                   
 
    January 31, 2008   January 31, 2007   April 30, 2007
 
 
Short-term borrowings:
                 
HSBC credit facility
  $ 1,683,317   $ 1,430,383   $ -
Other credit facilities
    28,168     -     500,000
Commercial paper
    -     1,496,038     992,082
FHLB advances
    -     -     75,000
                   
    $ 1,711,485   $ 2,926,421   $ 1,567,082
                   
Long-term debt:
                 
CLOC borrowings, due August 2010
  $ 1,800,000   $ -   $ -
Senior Notes, 7.875%, due January 2013
    599,383     -     -
Senior Notes, 5.125%, due October 2014
    398,412     398,177     398,236
FHLB borrowings, due April 2009
    104,000     -     104,000
Senior Notes, 81/2%, due April 2007
    -     499,875     -
Other
    23,948     27,861     26,875
                   
      2,925,743     925,913     529,111
Less: Current portion
    8,332     509,730     9,304
                   
    $ 2,917,411   $ 416,183   $ 519,807
                   
 
 
At January 31, 2008, we maintained $2.0 billion in revolving credit facilities to support commercial paper issuance and for general corporate purposes. These unsecured committed lines of credit (CLOCs), and outstanding borrowings thereunder, have a maturity date of August 2010 and an annual facility fee in a range of six to fifteen basis points per annum, based on our credit ratings. We had a combined $1.8 billion outstanding as of January 31, 2008. These borrowings are included in long-term debt on our condensed consolidated balance sheet due to their contractual maturity date. The CLOCs, among other things, require we maintain at least $650.0 million of adjusted net worth, as defined in the agreement, on the last day of any fiscal quarter. On November 19, 2007, the CLOCs were amended to, among other things, require $450.0 million of adjusted net worth, for the fiscal quarters ending October 31, 2007 and January 31, 2008. We had adjusted net worth of $463.9 million at January 31, 2008.
In April 2007, we obtained a $500.0 million credit facility to provide funding for $500.0 million of 81/2% Senior Notes which were due April 16, 2007. This facility matured on December 20, 2007, but was amended to extend the term of the facility. Under the amended facility, $250.0 million will mature on February 29, 2008 and $250.0 million will mature on April 30, 2008. The facility is subject to various covenants that are similar to our primary CLOCs. At January 31, 2008, the balance under this facility was $28.2 million, having been substantially repaid with the proceeds of our Senior Notes as discussed below. This facility was completely repaid as of February 15, 2008.
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 $471.8 million of the $500.0 million facility discussed above, with the remaining proceeds used for working capital and general corporate purposes. As of January 31, 2008, 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 10, 2008 for use as a funding source for the purchase of refund anticipation loan (RAL) participations. This line will make available funding totaling $3.0 billion through March 30, 2008 and $120.0 million thereafter through June 30, 2008. This line is subject to various covenants that are similar to our amended CLOCs, and is secured by our RAL participations. At January 31, 2008, there was $1.7 billion outstanding on this facility.
H&R Block Bank (HRB Bank) is a member of the Federal Home Loan Bank (FHLB) of Des Moines, which extends credit to member banks based on eligible collateral. At January 31, 2008, HRB Bank had FHLB advance capacity of $523.6 million, and there was $104.0 million outstanding on this facility. Mortgage loans held for investment of $940.0 million were pledged as collateral on these advances.


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6.  Income Taxes
In June 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) was issued. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
We adopted the provisions of FIN 48 on May 1, 2007 and, as a result, recognized a $9.7 million decrease to retained earnings as of May 1, 2007. Total unrecognized tax benefits as of May 1, 2007 were $133.3 million, of which $89.0 million, on a gross basis, were tax positions that, if recognized, would impact the effective tax rate. Net unrecognized tax benefits that would impact the effective tax rate totaled $50.0 million as of May 1, 2007.
We recognize interest and, if applicable, penalties related to unrecognized tax benefits as a component of income tax expense. As of May 1, 2007 we accrued $36.6 million for the potential payment of interest and penalties. Interest was estimated by applying the applicable statutory rate of interest of each of the jurisdictions identified on uncertain tax positions.
During the nine months ended January 31, 2008, we accrued an additional $2.1 million of interest & penalties related to our uncertain tax positions. As of January 31, 2008 we had unrecognized tax benefits of $135.5 million. The primary change during the quarter was related to the expiration of statutes of limitations for various jurisdictions during the quarter. We have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at January 31, 2008, which is included in other noncurrent liabilities on the condensed consolidated balance sheet. Amounts that we expect to pay within the next twelve months have been included in accounts payable, accrued expenses and other current liabilities on the condensed consolidated balance sheet.
Based upon the expiration of statutes of limitations, payments of tax and other factors in several jurisdictions, we believe it is reasonably possible that the total amount of previously unrecognized tax benefits may decrease by approximately $15 million to $16 million within twelve months of January 31, 2008.
We file a consolidated federal tax return in the United States and income tax returns in various state and foreign jurisdictions. We are no longer subject to U.S. federal income tax audits for years before 1999. The U.S. federal audit for years 1999 through 2003 is in its final stages. The Internal Revenue Service (IRS) has commenced an audit for the years 2004 and 2005. With respect to our Canadian operations, audits for tax years 1996 through 2001 have been completed and are in the final stages, and tax years 2002 and 2003 are currently under audit. With respect to state and local jurisdictions, with limited exceptions, H&R Block, Inc. and its subsidiaries are no longer subject to income tax audits for years before 1999.
 
7.  Regulatory Requirements
 
Registered Broker-Dealer
H&R Block Financial Advisors, Inc. (HRBFA) is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. At January 31, 2008, HRBFA’s net capital of $80.1 million, which was 18.2% of aggregate debit items, exceeded its minimum required net capital of $8.8 million by $71.3 million. During the nine months ended January 31, 2008, HRBFA paid dividends of $44.5 million to Block Financial LLC (BFC), its direct corporate parent.
HRBFA had pledged customer-owned securities with a fair value of $47.1 million at January 31, 2008 with a clearing organization to satisfy margin deposit requirements of $38.5 million.


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Banking
HRB Bank and the Company are subject to various regulatory capital guidelines and requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HRB Bank and the consolidated financial statements. 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 that involve quantitative measures of HRB Bank’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. HRB Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. HRB Bank files its regulatory Thrift Financial Report (TFR) on a calendar quarter basis.
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, as set forth in the table below. In addition to these minimum ratio requirements, HRB Bank is required to continually maintain a 12.0% minimum leverage ratio as a condition of its charter-approval order through fiscal year 2009. This condition was extended through fiscal year 2012 as a result of a Supervisory Directive issued on May 29, 2007. See further discussion of the Supervisory Directive below. As of January 31, 2008, HRB Bank’s leverage ratio was 12.0%.
As of December 31, 2007, our most recent TFR filing with the Office of Thrift Supervision (OTS), HRB Bank was a “well capitalized” institution under the prompt corrective action provisions of the Federal Deposit Insurance Corporation (FDIC). The five capital categories are: (1) “well capitalized” (total risk-based capital ratio of 10%, Tier 1 Risk-based capital ratio of 6% and leverage ratio of 5%); (2) “adequately capitalized”; (3) “undercapitalized”; (4) “significantly undercapitalized”; and (5) “critically undercapitalized.” There are no conditions or events since December 31, 2007 that management believes have changed HRB Bank’s category.
The following table sets forth HRB Bank’s regulatory capital requirements at December 31, 2007, as calculated in the most recently filed TFR:
(dollars in 000s)
                                     
 
            To Be Well
            Capitalized
            Under Prompt
        For Capital Adequacy
  Corrective Action
    Actual   Purposes   Provisions
    Amount   Ratio   Amount   Ratio   Amount   Ratio
 
 
Total risk-based capital ratio(1)
  $ 194,188     21.6%   $ 71,881     8.0%   $ 89,851     10.0%
Tier 1 risk-based capital ratio(2)
  $ 182,943     20.4%     n/a     n/a   $ 53,910     6.0%
Tier 1 capital ratio (leverage)(3)
  $ 182,943     12.2%   $ 179,555     12.0%   $ 74,814     5.0%
Tangible equity ratio(4)
  $ 182,943     12.2%   $ 22,444     1.5%     n/a     n/a
 
 
  (1)  Total risk-based capital divided by risk-weighted assets.
  (2)  Tier 1 (core) capital less deduction for low-level recourse and residual interest divided by risk-weighted assets.
  (3)  Tier 1 (core) capital divided by adjusted total assets.
  (4)  Tangible capital divided by tangible assets.
BFC made an additional capital contribution to HRB Bank of $107.1 million during the three months ended January 31, 2008. This contribution was necessary for HRB Bank to meet its capital requirements due to seasonal fluctuations in its balance sheet. Also during the three months ended January 31, 2008, we submitted an application to the OTS requesting that HRB Bank be allowed to pay dividends to BFC in an amount that will not exceed the capital necessary to continuously maintain HRB Bank’s required 12.0% leverage ratio. The OTS approved our application on February 29, 2008.
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


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intercompany transactions and approvals. H&R Block, Inc. fell below the three percent minimum ratio at April 30, 2007 and the OTS issued a Supervisory Directive.
The Supervisory Directive included additional conditions that we will be required to meet in addition to the Master Commitment. The significant additional conditions included in the Supervisory Directive are as follows: (1) requires HRB Bank to extend its compliance with a minimum 12.0% leverage ratio through fiscal year 2012; (2) requires H&R Block, Inc. to comply with the Master Commitment at all times, except for the projected capital levels and compliance with the three percent minimum ratio, as provided in the fiscal year 2008 and 2009 capital adequacy projections presented to the OTS on July 19, 2007; (3) institutes reporting requirements to the OTS quarterly and monthly by the Board of Directors and management, respectively; and (4) requires HRB Bank’s Board of Directors to have an independent chairperson and at least the same number of outside directors as inside directors.
H&R Block, Inc. continued to be below the three percent minimum ratio during our third quarter, and had adjusted tangible capital of negative $713.9 million, and a requirement of $311.9 million to be in compliance at January 31, 2008. We are currently seeking the elimination or modification of the three percent minimum capital requirement as a result of cessation of our mortgage business. At this time, we do not expect to be in compliance with the three percent minimum ratio at April 30, 2008. We currently believe that upon disposition of our mortgage business the OTS will reconsider the three percent minimum capital requirement, although there is no assurance that an elimination or modification will occur.
Failure to meet the conditions under the Master Commitment and the Supervisory Directive, including capital levels of H&R Block, Inc., could result in the OTS taking further regulatory actions, such as a supervisory agreement, cease-and-desist orders and civil monetary penalties. The OTS could also require us to sell assets, which could negatively impact our financial results. At this time, the financial impact, if any, of additional regulatory actions cannot be determined.
 
8.   Commitments and Contingencies
Changes in the deferred revenue liability related to our Peace of Mind (POM) program, the current portion of which is included in accounts payable, accrued expenses and other current liabilities and the long-term portion of which is included in other noncurrent liabilities in the condensed consolidated balance sheets, are as follows:
                     
(in 000s)
 
Nine Months Ended January 31,   2008     2007      
 
Balance, beginning of period
  $ 142,173     $ 141,684      
Amounts deferred for new guarantees issued
    19,672       20,971      
Revenue recognized on previous deferrals
    (56,881 )     (59,085 )    
                     
Balance, end of period
  $ 104,964     $ 103,570      
                     
 
 
The following table summarizes certain of our other contractual obligations and commitments:
                 
(in 000s)
 
As of   January 31, 2008   April 30, 2007    
 
 
Commitment to fund Franchise Equity
Lines of Credit
  $ 80,471   $ 79,628    
Media advertising purchase obligation
    28,353     37,749    
Contingent business acquisition obligations
    31,415     19,891    
 
 
On November 1, 2006 we entered into an agreement to purchase $57.2 million in media advertising between November 1, 2006 and June 30, 2009. We expect to make payments totaling $20.6 million and $17.2 million during fiscal years 2008 and 2009, respectively.
Commitments exist to loan McGladrey & Pullen, LLP (M&P) the lower of the value of their accounts receivable, work-in-process and fixed assets or $125.0 million, on a revolving basis through January 31, 2011, subject to certain termination clauses. This revolving facility bears interest at prime rate plus two percent on the outstanding amount. The loan is fully secured by the accounts receivable, work-in-process and fixed assets of M&P. At January 31, 2008, we had a receivable from M&P totaling $95.1 million, $80.0 million of which was assigned to the trust that administers our deferred compensation plans, as allowed by the underlying trust arrangement, to fund the estimated liability.


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We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees, including obligations to protect counterparties from losses arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) litigation involving our directors and officers; and (d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance that such claims will not be successfully asserted, we believe the fair value of these guarantees and indemnifications is not material as of January 31, 2008.
 
9.  Litigation and Related Contingencies
 
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 believe we have meritorious defenses to the remaining RAL Cases and we intend to defend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Likewise, there can be no assurances regarding the impact of the RAL Cases on our financial statements. There were no significant developments regarding the RAL Cases during the fiscal quarter ended January 31, 2008.
 
Peace of Mind Litigation
We are defendants in lawsuits regarding our Peace of Mind program (the “POM Cases”). The POM Cases are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Civil Action 2003L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2002, that was granted class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POM program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (i) statutory fraud by selling insurance without a license, (ii) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (iii) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (i) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (ii) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (iii) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama are excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated or associated with H&R Block Tax Services, Inc., and that sold or sells the POM


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product. The trial court subsequently denied the defendants’ motion to certify class certification issues for interlocutory appeal. Discovery is proceeding. No trial date has been set.
There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is being tried 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 similar allegations. No class has been certified in this case.
We believe the claims in the POM actions are without merit, and we intend to defend them vigorously. The amounts claimed in the POM actions are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate.
 
Electronic Filing Litigation
We are a defendant to a class action filed on August 30, 2002 and entitled Erin M. McNulty and Brian J. Erzar v. H&R Block, Inc., et al., Case No. 02-CIV-4654 in the Court of Common Pleas of Lackawanna County, Pennsylvania, in which the plaintiffs allege that the defendants deceptively portray electronic filing fees as a necessary and required component of standard tax preparation services and do not inform tax preparation clients that they may (i) file tax returns free of charge by mailing the returns, (ii) electronically file tax returns from personal computers either free of charge or at significantly lower fees and (iii) be eligible to electronically file tax returns free of charge via telephone. The plaintiffs seek unspecified damages and disgorgement of all electronic filing, tax preparation and related fees collected during the applicable class period. Class certification was granted in this case on September 5, 2007. We believe the claims in this case are without merit, and we intend to defend them vigorously, but there can be no assurances as to its outcome.
 
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. 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. On July 12, 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than H&R Block Financial Advisors, Inc. and the claims of common law fraud. 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.
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. 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.
In addition to the New York and Mississippi Attorney General actions, a number of civil actions were filed against us concerning the Express IRA matter, the first of which was filed on March 17, 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 in the United States District Court for the Western District of Missouri. We believe the claims in this case are without merit, and we intend to defend these cases vigorously, but there are no assurances as to their outcome.
 
Securities Litigation
On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation 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, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of


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the Company’s operations. The complaint sought unspecified damages and equitable relief. On October 5, 2007, the court dismissed the complaint and granted the plaintiffs leave to re-file the portion of the complaint pertaining to the Company’s financial statements. On November 19, 2007, the plaintiffs re-filed the complaint, alleging, among other things, deceptive, material and misleading financial statements and failure to prepare financial statements in accordance with generally accepted accounting principles. The court dismissed the re-filed complaint on February 19, 2008. We believe the claims in this case are without merit. If the dismissal is appealed, we intend to defend this litigation vigorously.
 
HRBFA Litigation
The NASD brought charges against HRBFA regarding the sale by HRBFA of Enron debentures in 2001. The hearing for this matter was concluded in August 2007, and post-hearing briefs were submitted in October 2007. We intend to defend the NASD charges vigorously, although there can be no assurances regarding the outcome and resolution of the matter.
 
RSM McGladrey Litigation
As part of an industry-wide review, the IRS is investigating tax-planning strategies that certain RSM McGladrey, Inc. (RSM) clients utilized during fiscal years 2000 through 2003. Specifically, the IRS is examining these strategies to determine whether RSM complied with tax shelter reporting and listing regulations and whether such strategies were abusive as defined by the IRS. The IRS has indicated that it will assess a fine against RSM for RSM’s alleged failure to comply with the tax shelter reporting and listing regulations. RSM is in discussions with the IRS regarding this penalty. In addition, some clients that utilized the strategies are seeking recovery from RSM for penalties and interest for underpayment of taxes. We believe that the resolution of this matter will not have a material adverse effect on RSM’s operations or on our consolidated financial statements.
RSM EquiCo, Inc., a subsidiary of RSM, is a party to a putative class action filed on July 11, 2006 and entitled Do Right’s Plant Growers v. RSM EquiCo, Inc., RSM McGladrey, Inc., H&R Block, Inc. and Does 1-100, inclusive, 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. We are in the early stages of discovery in this case and intend to defend this case vigorously, although there can be no assurance regarding the outcome and resolution of this matter.
 
Other Litigation
We have from time to time been 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. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. Some of these investigations, claims and lawsuits pertain to RALs, the origination and servicing of mortgage loans, the electronic filing of customers’ income tax returns, the POM guarantee program, and our Express IRA program and other investment products and RSM EquiCo, Inc. business valuation services. In addition, it is possible that the number of these claims with respect to the origination or servicing of mortgage loans may increase in light of the current non-prime mortgage environment. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously, although there is no assurance as to their outcome. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could have a material adverse effect on our consolidated financial statements.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (Other Claims) concerning investment products, the preparation of customers’ income tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage


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foreclosures, other aspects of the mortgage business, intellectual property disputes, employment matters and contract disputes. We believe we have meritorious defenses to each of the Other Claims, and we are defending them vigorously. 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 financial statements.
 
10.  Segment Information
Information concerning our operations by reportable operating segment is as follows:
 
                                 
(in 000s)  
   
    Three Months Ended January 31,     Nine Months Ended January 31,  
    2008     2007     2008     2007  
   
 
Revenues:
                               
Tax Services
  $ 661,787     $ 627,846     $ 822,454     $ 775,488  
Business Services
    191,884       192,163       623,755       616,334  
Consumer Financial Services
    117,112       107,511       332,738       267,888  
Corporate
    1,828       3,659       9,697       10,322  
                                 
    $ 972,611     $ 931,179     $ 1,788,644     $ 1,670,032  
                                 
Pretax income (loss):
                               
Tax Services
  $ 45,879     $ 59,973     $ (325,559)     $ (259,974)  
Business Services
    6,614       1,207       16,489       (4,736)  
Consumer Financial Services
    12,988       10,959       10,113       5,572  
Corporate
    (61,362)       (50,014)       (104,240)       (111,330)  
                                 
Income (loss) of continuing operations before taxes (benefit)
  $ 4,119     $ 22,125     $ (403,197)     $ (370,468)  
                                 
 
 
As of January 31, 2008, the related financial results of OOMC, HRBMC and other smaller lines of business are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. See note 12 for additional information.
 
11.  Accounting Pronouncements
In December 2007, Statement of Financial Accounting Standards No. 141(R), “Business Combinations,” (SFAS 141R), and Statement of Financial Accounting Standards No. 160, “Non-Controlling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51” (SFAS 160) were issued. These standards will require an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction, including non-controlling interests, at the acquisition-date fair value with limited exceptions. The provisions of these standards are effective as of the beginning of our fiscal year 2010. We are currently evaluating what effect the adoption of SFAS 141R and SFAS 160 will have on our consolidated financial statements.
In March 2006, Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140,” (SFAS 156), was issued. The provisions of this standard require mortgage servicing rights to be initially valued at fair value. SFAS 156 allows servicers to choose to subsequently measure their servicing rights at fair value or to continue using the “amortization method” under SFAS 140. We adopted SFAS 156 on May 1, 2007. Upon adoption we identified mortgage servicing rights (MSRs) relating to all existing residential mortgage loans as a class of servicing rights and elected to continue to use the “amortization method” for these MSRs. Presently, this class represents all of our MSRs. See note 12 for additional information on our MSRs. The adoption of SFAS 156 did not have a material impact on our condensed consolidated financial statements.
In February 2006, Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments – An Amendment of FASB Statements No. 133 and 140” (SFAS 155), was issued. The provisions of this standard establish a requirement to evaluate all newly acquired interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an


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embedded derivative requiring bifurcation. The standard permits a hybrid financial instrument required to be bifurcated to be accounted for in its entirety if the holder irrevocably elects to measure the hybrid financial instrument at fair value, with changes in fair value recognized currently in earnings. We adopted SFAS 155 on May 1, 2007. Our residual interests typically have interests in derivative instruments embedded within the securitization trusts, which were previously excluded from evaluation. Concurrent with the adoption of SFAS 155, we elected to account for all newly-acquired residual interests on a fair value basis as trading securities, with changes in fair value recorded in earnings in the period in which the change occurs. Prior to adoption, we accounted for our residual interests as available-for-sale (AFS) securities with unrealized gains recorded in other comprehensive income. For residual interests recorded prior to the adoption of SFAS 155, we continue to record unrealized gains as a component of other comprehensive income. The adoption of SFAS 155 did not have a material impact on our condensed consolidated financial statements.
As discussed in note 6, we adopted the provisions of FIN 48 effective May 1, 2007.
 
12.  Discontinued Operations
On April 19, 2007, we entered into an agreement to sell OOMC to Cerberus. In conjunction with this plan, we also announced we would terminate the operations of HRBMC, a wholly-owned subsidiary of OOMC. On December 4, 2007, we agreed to terminate the agreement. We also announced that we would immediately terminate all remaining origination activities and pursue the sale of OOMC’s loan servicing activities. During January 2008, OOMC funded the last loan in its pipeline. See additional discussion of recent developments in note 1.
During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the nine months ended January 31, 2008. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services.
As of January 31, 2008, these businesses are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.
 
Financial Statement Presentation
At January 31, 2008, we had fully impaired the carrying value of goodwill and long-lived assets of our mortgage businesses. Cumulative impairments in excess of amounts related to the write-off of goodwill and other long-lived assets totaled $304.9 million at January 31, 2008 and are reflected as a valuation allowance relating to remaining assets held-for-sale. At April 30, 2007, this amount totaled $193.4 million, and was reflected as a liability under the April 2007 agreement with Cerberus. We recorded impairments of $116.3 million during the nine months ended January 31, 2008 and $345.8 million in fiscal year 2007 relating to the disposition of our mortgage businesses.
Overhead costs which would have previously been allocated to discontinued businesses totaled $1.1 million and $3.6 million for the three and nine months ended January 31, 2008, respectively, and $3.1 million and $9.4 million for the three and nine months ended January 31, 2007, respectively. These amounts are included in continuing operations.
As provided by in EITF No. 87-24, “Allocation of Interest to Discontinued Operations,” our losses from discontinued operations include interest on debt that will be repaid as a result of the disposal transaction and the allocation of other consolidated interest. Interest to be repaid as a result of the disposal transaction primarily relates to interest on our Servicing Advance Facility. The allocation of other consolidated interest is based on borrowings specifically attributable to these operations at a rate of LIBOR plus 250 basis points. Losses of our discontinued operations include interest expense of $36.9 million and $83.0 million for the three and nine months ended January 31, 2008, respectively, including other consolidated interest expense of $23.1 million and $65.9 million that was allocated to discontinued operations, respectively. Interest expense of $12.0 million and $20.7 million was allocated to discontinued operations for the three and nine months ended January 31, 2007, respectively. The increase in allocated interest expense over the prior year is due to the significant operating losses and other working capital needs of our mortgage operations during the last nine months. Concurrent with the completion of the sale of our loan servicing activities, we will cease allocating other consolidated interest expense to mortgage


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operations. Remaining interest costs associated with debt that is not repaid as a result of the sale will be reported in continuing operations.
The major classes of assets and liabilities reported as held-for-sale are as follows:
 
                   
(in 000s)
 
    January 31, 2008     April 30,2007    
 
 
Cash and cash equivalents
  $ 30,641     $ 65,019    
Cash and cash equivalents – restricted
    277       43,754    
Residual interests in securitizations – trading
    558       72,691    
Mortgage loans:
                 
Held for sale, net
    21,870       101,567    
Repurchase option
    1,630,664       121,243    
Servicing and related assets
    1,157,016       445,354    
Beneficial interest in Trusts
    -       41,057    
Residual interests in securitizations – AFS
    25,371       90,283    
Mortgage servicing rights
    165,490       253,067    
Deferred tax assets, net
    200,142       299,559    
Prepaid expenses and other assets
    83,837       213,365    
Valuation allowance
    (304,867 )     -    
                   
Assets held for sale
  $ 3,010,999     $ 1,746,959    
                   
Accounts payable, accrued expenses and deposits
  $ 155,407     $ 248,983    
Servicing advance facility, net(1)
    696,871       -    
Mortgage loan repurchase liability
    1,630,664       121,243    
Other liabilities
    30,369       245,147    
                   
Liabilities directly associated with assets held for sale
  $ 2,513,311     $ 615,373    
                   
 
 
 
(1) Includes outstanding borrowings of $857.1 million, net of collections and reserves of $160.2 million.
 
The financial results of discontinued operations are as follows:
 
                                 
(in 000s)  
   
    Three Months Ended January 31,     Nine Months Ended January 31,  
    2008     2007     2008     2007  
   
 
Revenue:
                               
Gains (losses) on sales of mortgage assets, net
  $ (67,061 )   $ (65,671 )   $ (623,082 )   $ 36,843  
Interest income
    8,015       12,184       34,642       42,108  
Loan servicing revenue
    85,677       109,833       276,092       332,336  
Other
    4,925       23,737       16,441       33,963  
                                 
    $ 31,556     $ 80,083     $ (295,907 )   $ 445,250  
                                 
Loss from operations before impairment and income tax benefit
  $ (127,069 )   $ (165,254 )   $ (867,406 )   $ (254,112 )
Change in valuation allowance
    29,926       -       (116,303 )     -  
                                 
Pretax loss
    (97,143 )     (165,254 )     (983,709 )     (254,112 )
Income tax benefit
    (40,501 )     (83,058 )     (368,144 )     (122,915 )
                                 
Net loss from discontinued operations
  $ (56,642 )   $ (82,196 )   $ (615,565 )   $ (131,197 )
                                 
 
 


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Mortgage Loans
We have entered into servicing agreements for loans we have securitized which include a “removal of accounts provision” that gives us the right, but not the obligation, to repurchase mortgage loans from the securitization trust. Rights under this provision can generally be exercised for loans that are 90 to 119 days delinquent. At the time this right becomes exercisable by us, Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (SFAS 140) requires that we record both the mortgage loans on our balance sheet and an offsetting mortgage loan repurchase liability. Mortgage loans, and the corresponding liability, recorded pursuant to this accounting requirement totaled $1.6 billion at January 31, 2008 and $121.2 million at April 30, 2007. We do not intend to exercise our right under these provisions and, therefore, these do not represent mortgage loans that we are required to sell or repurchase obligations we are required to fulfill.
The gross principal amount of mortgage loans we are holding for sale at January 31, 2008, totaled $57.7 million. We have recorded valuation adjustments relating to these loans totaling $35.8 million, resulting in net loans held for sale of $21.9 million.
 
Mortgage Banking Activities
We ceased origination activities during the three months ended January 31, 2008. Historically, we originated mortgage loans and sold most non-prime loans the same day the loans were funded to qualifying special purpose entities (QSPEs or Trusts). The Trusts are not consolidated. The sale was recorded in accordance with SFAS 140. The Trusts purchased the loans from us using warehouse facilities. As origination activities had ceased, the off-balance sheet Trusts held no loans as of January 31, 2008, compared to $1.5 billion at April 30, 2007. The beneficial interest in Trusts was written down to zero at January 31, 2008 compared to a balance of $41.1 million at April 30, 2007.
Trading residual interests totaled $0.6 million at January 31, 2008. During the nine months ended January 31, 2008, we recorded impairments of $45.9 million, while no such impairments were recorded during the nine months ended January 31, 2007.
We adopted SFAS 155 on May 1, 2007 and concurrently elected to account for all newly-acquired residual interests on a fair value basis, with changes in fair value recorded in earnings in the period in which the change occurs. Residual interests existing prior to the adoption of SFAS 155 will continue to be accounted for with unrealized gains recorded in other comprehensive income.
AFS residual interests in securitizations totaled $25.4 million and $90.3 million at January 31, 2008 and April 30, 2007, respectively. We recorded impairments of fair value of $80.0 million and $73.1 million during the nine months ended January 31, 2008 and 2007, respectively.
We did not securitize any mortgage loans during the third quarter of fiscal year 2008. Cash flows from AFS residual interests of $1.6 million and $13.1 million were received from the securitization trusts for the nine months ended January 31, 2008 and 2007, respectively, and are included in investing activities of discontinued operations in the condensed consolidated statements of cash flows.
The following transactions were treated as non-cash investing activities in the condensed consolidated statement of cash flows:
 
                 
(in 000s)
 
Nine Months Ended January 31,   2008   2007    
 
 
Residual interest mark-to-market
  $ 3,446   $ 2,861    
Additions to residual interests
    -     39,379    
Transfer of loans from held for investment to held for sale
    193,648     -    
 
 


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Activity related to MSRs, which are initially measured at fair value and subsequently amortized and assessed for impairment, consists of the following:
 
                     
(in 000s)
 
Nine Months Ended January 31,   2008     2007      
 
 
Balance, beginning of period
  $ 253,067     $ 272,472      
Additions
    29,082       134,216      
Amortization
    (115,203 )     (143,548 )    
Impairment of fair value
    (1,456 )     -      
                     
Balance, end of period
  $ 165,490     $ 263,140      
                     
 
 
 
Estimated amortization of MSRs for fiscal years 2008 through 2012 is $27.9 million, $74.4 million, $34.7 million, $14.1 million and $5.8 million, respectively.
In conjunction with our adoption of SFAS 156, we identified all of our residential mortgage loans as a class of servicing rights and elected to continue the amortization method. See additional discussion of our adoption of SFAS 156 in note 11. Servicing fees earned during the nine months ended January 31, 2008 and 2007 totaled $279.8 million and $317.4 million, respectively, and are included in discontinued operations on our condensed consolidated income statements.
As part of our loan servicing responsibilities, we are required to advance funds to cover delinquent scheduled principal and interest payments to security holders, as well as to cover delinquent tax and insurance payments and other costs required to protect the investors’ interest in the collateral securing the loans. Generally, servicing advances are recoverable from either the mortgagor, the insurer of the loan or the investor through the non-recourse provision of the loan servicing contract. During the nine months ended January 31, 2008 we entered into a facility to fund servicing advances. See additional discussion under “Financing.”
The key weighted average assumptions we used to estimate the cash flows and values of the residual interests initially recorded during the nine months ended January 31, 2008 and 2007 are as follows:
 
                 
 
Nine months ended January 31,   2008   2007    
 
Estimated credit losses
    6.36%     3.24%    
Discount rate
    28.00%     21.91%    
Variable returns to third-party beneficial interest holders
  LIBOR forward curve at closing date
 
 
The key weighted average assumptions we used to estimate the cash flows and values of residual interests and MSRs at January 31, 2008 and April 30, 2007 are as follows:
 
                 
 
    January 31, 2008   April 30, 2007    
 
 
Estimated credit losses – residual interests
    17.24%     5.04%    
Discount rate – residual interests
    30.00%     24.82%    
Discount rate – MSRs
    20.00%     20.00%    
Variable returns to third-party beneficial interest holders
  LIBOR forward curve at valuation date
 
 
Estimated credit losses in the table above includes residual interests from all fiscal years with outstanding underlying loan balances using unpaid principal balances as part of the weighted average calculation. See credit losses table below for detailed information by fiscal year.


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A key assumption used to estimate the cash flows and values of residual interests and MSRs is average annualized prepayment speeds. Prepayment speeds include voluntary prepayments, involuntary prepayments and scheduled principal payments. Prepayment rate assumptions used during the current fiscal quarter are as follows:
 
                   
 
        Months Outstanding After
    Prior to Initial
  Initial Rate Reset Date
    Rate Reset Date   Zero - 3   Remaining Life
 
 
Adjustable-rate mortgage loans:
                 
With prepayment penalties
    11%     24%     15%
Without prepayment penalties
    11%     24%     15%
Fixed-rate mortgage loans:
                 
With prepayment penalties
    9%     11%     11%
 
 
 
For fixed-rate mortgages without prepayment penalties, we use an average prepayment rate of 22% over the life of the loans. Prepayment rate is projected based on actual paydown including voluntary, involuntary and scheduled principal payments.
Expected static pool credit losses are as follows:
 
                                           
 
    Mortgage Loans Securitized in Fiscal Year
 
    Prior to 2002   2003   2004   2005   2006   2007   2008
 
 
As of:
                                         
January 31, 2008
    -%     -%     -%     -%     -%     17.15%     17.49%
April 30, 2007
    5.11%     2.57%     3.45%     5.48%     6.79%     6.41%     -
April 30, 2006
    4.22%     2.13%     2.18%     2.48%     3.05%     -     -
April 30, 2005
    4.01%     2.08%     2.30%     2.83%     -     -     -
 
 
Static pool credit losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets.
At January 31, 2008, the sensitivities of the current fair value of residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are as presented in the following table. These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
 
                     
(dollars in 000s)
 
    Residual Interests
           
    Securitizations     MSRs      
 
 
Carrying amount/fair value
  $ 25,929     $ 165,490      
Weighted average remaining life (in years)
    14.5       1.5      
Dollar impact on fair value:
                   
Prepayments (including defaults):
                   
Adverse 10%
  $ (3,797 )   $ (8,873 )    
Adverse 20%
    (5,546 )     (17,201 )    
Credit losses:
                   
Adverse 10%
  $ (8,036 )     Not applicable      
Adverse 20%
    (11,112 )     Not applicable      
Discount rate:
                   
Adverse 10%
  $ (4,116 )   $ (8,159 )    
Adverse 20%
    (7,142 )     (15,644 )    
Variable interest rates:
                   
Adverse 10%
  $ (1,170 )     Not applicable      
Adverse 20%
    (1,164 )     Not applicable      
 
 


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Mortgage loans that have been securitized and mortgage loans held for sale at January 31, 2008 and April 30, 2007, past due sixty days or more and the related credit losses incurred are presented below:
 
                                     
(in 000s)
 
    Total Principal
  Principal Amount of
  Credit Losses
    Amount of Loans
  Loans 60 Days or
  (net of recoveries)
    Outstanding   More Past Due   Three Months Ended
 
    January 31,
  April 30,
  January 31,
  April 30,
  January 31,
  April 30,
    2008   2007   2008   2007   2008   2007
 
 
Securitized mortgage loans
  $ 18,730,052   $ 18,434,940   $ 3,929,653   $ 1,383,832   $ 90,491   $ 41,235
Mortgage loans in warehouse Trusts
    -     1,456,078     -     -     -     -
Mortgage loans held for sale(1)
    57,698     295,208     30,985     202,941     77,697     104,972
                                     
Total loans
  $ 18,787,750   $ 20,186,226   $ 3,960,638   $ 1,586,773   $ 168,188   $ 146,207
                                     
 
 
 
(1) Does not include loans recorded pursuant to “removal of accounts provisions” as we do not intend to exercise our right under these provisions and, therefore, we are not subject to market risk with respect to these loans.
 
Derivative Instruments
A summary of our derivative instruments as of January 31, 2008 and April 30, 2007, and gains or losses incurred during the three and nine months ended January 31, 2008 and 2007 is as follows:
 
                                               
(in 000s)  
   
          Gain (Loss) For
    Gain (Loss) For
 
          the Three
    the Nine
 
    Asset (Liability) Balance at     Months Ended     Months Ended  
   
    January 31,
  April 30,
    January 31,     January 31,  
    2008   2007     2008     2007     2008     2007  
   
 
Rate-lock equivalents
  $        -   $ (987 )   $ 516     $ (9,237 )   $ 987     $ (5,207 )
Interest rate swaps
    -     10,774       (59 )     46,640       (738 )     26,372  
Put options on Eurodollar futures
    -     1,212       -       400       942       (1,657 )
Prime short sales
    -     75       (162 )     (131 )     49       864  
Forward loan sale commitments
    -     -       -       (2,493 )     -       -  
                                               
    $ -   $ 11,074     $    295     $ 35,179     $  1,240     $ 20,372  
                                               
 
 
We discontinued our hedging activities during our second quarter of fiscal year 2008, and therefore had no derivative instruments to which we were a party at January 31, 2008.
 
Commitments and Contingencies
As of December 4, 2007, OOMC and HRBMC stopped accepting mortgage loan applications, and in January 2008, OOMC funded its last loan. As a result, we have no commitments to fund mortgage loans at January 31, 2008, compared to commitments of $2.4 billion at April 30, 2007.


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In the normal course of business, we maintain recourse with standard representations and warranties. Violations of these representations and warranties or early payment defaults by borrowers may require us to repurchase loans previously sold. Repurchased loans are normally sold in subsequent sale transactions. The following table summarizes our loan repurchase activity:
 
                               
(dollars in 000s)
 
    Three Months Ended
  Nine Months Ended
  Fiscal Year Ended
    January 31,   January 31,   April 30,
    2008   2007   2008   2007   2007
 
 
Loans repurchased from third parties
  $ 99,501   $ 403,502   $ 480,943   $ 812,293   $ 978,756
Repurchase reserves added
during the period
  $ 49,474   $ 111,122   $ 379,440   $ 251,083   $ 388,733
Repurchase reserves added
as a percent of originations
    115.07%     1.77%     9.37%     1.18%     1.44%
 
 
A liability has been established related to the potential loss on repurchase of loans previously sold of $69.0 million and $38.4 million at January 31, 2008 and April 30, 2007, respectively. This reserve relates to potential losses that could be incurred as a result of loan repurchases arising from either early payment defaults or breaches of representations and warranties customary to the mortgage banking industry. On an ongoing basis, we monitor the adequacy of our repurchase liability, which is included in liabilities held-for-sale in the condensed consolidated balance sheets. During the nine months ended January 31, 2008, we increased our reserve for losses on loan repurchases primarily due to expected repurchases under representation and warranty provisions. The portion of our reserve balance related to losses on representation and warranty repurchases totaled $66.8 million and $5.6 million at January 31, 2008 and April 30, 2007, respectively. Expected repurchases arising from early payment defaults has declined significantly, as our contractual obligation to repurchase loans relating to delinquency has lapsed on many of our previous loan sales. In establishing our reserve for early payment defaults, we’ve assumed all loans that are currently delinquent and subject to contractual repurchase terms will be repurchased. Based on historical experience, we assumed an average 50% loss severity at January 31, 2008, compared to 42% at October 31, 2007 and 26% at April 30, 2007, on all loans repurchased and expected to be repurchased. At January 31, 2008, our repurchase reserve of $69.0 million covered estimated future losses on the repurchase of loans with an outstanding principal balance of $137.8 million.
 
Financing
In connection with our decision to cease all loan origination activities, we terminated all remaining on- and off-balance sheet warehouse facilities during the three months ended January 31, 2008. OOMC held $57.7 million in gross principle of mortgage loans for sale as of January 31, 2008.
On October 1, 2007, OOMC entered into a facility to fund servicing advances (the “Servicing Advance Facility”), in which the servicing advances are collateral for the facility. The Servicing Advance Facility originally provided funding of up to $400.0 million to fund servicing advances through October 1, 2008. During the three months ended January 31, 2008, the facility was amended, increasing the available funding to $1.2 billion. This facility is subject to various triggers, events or occurrences that could result in earlier termination, and bears interest at one-month LIBOR plus an additional margin rate. The Servicing Advance Facility terminates upon a “change in control” of OOMC, in which (i) a party or parties acting in concert acquire a 20% or more equity interest in OOMC or (ii) the Company does not own more than a 50% equity interest in OOMC. This on-balance sheet facility had a balance of $857.1 million at January 31, 2008, which is reported in liabilities held-for-sale. If and when our loan servicing activities are sold, this facility will be paid off with the proceeds from that sale.
 
Restructuring Charge
During fiscal year 2007, we initiated a restructuring plan to reduce costs within our mortgage operations. Restructuring activities continued through fiscal year 2008, including our previously announced closure of all mortgage origination activities. Charges incurred during the nine months ended January 31, 2008 totaled $105.0 million, which included $33.9 million in fixed asset write-offs, with the remainder included in “other adjustments” in the table below. These charges are included in the net loss from discontinued


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operations on our condensed consolidated income statements. Changes in our restructuring charge liability during the nine months ended January 31, 2008 are as follows:
 
                           
(in 000s)
 
    Accrual Balance as of
  Cash
    Other
  Accrual Balance as of
    April 30, 2007   Payments     Adjustments   January 31, 2008
 
 
Employee severance costs
  $ 3,688   $ (37,462 )   $ 50,232   $ 16,458
Contract termination costs
    10,919     (7,298 )     17,023     20,644
                           
    $ 14,607   $ (44,760 )   $ 67,255   $ 37,102
                           
 
 
The remaining liability related to this restructuring charge is included in liabilities held-for-sale on our condensed consolidated balance sheet and relates to lease obligations for vacant space resulting from branch office closings and employee severance costs.
 
13.  Condensed Consolidating Financial Statements
BFC, formerly Block Financial Corporation, is an indirect, wholly owned consolidated subsidiary of the Company. BFC was converted to a Delaware limited liability company effective January 1, 2008. BFC is the Issuer and the Company is the Guarantor of the $500.0 million credit facility entered into in April 2007, the Senior Notes issued on January 11, 2008 and October 26, 2004, the CLOCs and other indebtedness issued from time to time. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions.
 
                                         
   
Condensed Consolidating Income Statements     (in 000s)  
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
January 31, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 211,150     $ 774,765     $ (13,304 )   $ 972,611  
                                         
Cost of services
    -       70,088       534,018       47       604,153  
Cost of other revenues
    -       78,126       19,167       -       97,293  
Selling, general and administrative
    -       137,674       144,566       (13,221 )     269,019  
                                         
Total expenses
    -       285,888       697,751       (13,174 )     970,465  
                                         
Operating income (loss)
    -       (74,738 )     77,014       (130 )     2,146  
Interest expense
    -       -       (624 )     -       (624 )
Other income, net
    4,119       9       2,588       (4,119 )     2,597  
                                         
Income (loss) from continuing operations before taxes (benefit)
    4,119       (74,729 )     78,978       (4,249 )     4,119  
Income taxes (benefit)
    (5,165 )     (32,407 )     27,299       5,108       (5,165 )
                                         
Net income (loss) from continuing operations
    9,284       (42,322 )     51,679       (9,357 )     9,284  
Net loss from discontinued operations
    (56,642 )     (55,707 )     (2,622 )     58,329       (56,642 )
                                         
Net income (loss)
  $ (47,358 )   $ (98,029 )   $ 49,057     $ 48,972     $ (47,358 )
                                         
 
 
 


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Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
January 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 255,407     $ 679,261     $ (3,489 )   $ 931,179  
                                         
Cost of services
    -       54,818       522,149       (32 )     576,935  
Cost of other revenues
    -       60,453       8,871       -       69,324  
Selling, general and administrative
    -       86,017       169,829       (1,878 )     253,968  
                                         
Total expenses
    -       201,288       700,849       (1,910 )     900,227  
                                         
Operating income (loss)
    -       54,119       (21,588 )     (1,579 )     30,952  
Interest expense
    -       (11,811 )     (255 )     -       (12,066 )
Other income, net
    22,125       (3,958 )     7,197       (22,125 )     3,239  
                                         
Income (loss) from continuing operations before tax (benefit)
    22,125       38,350       (14,646 )     (23,704 )     22,125  
Income taxes (benefit)
    181       28,043       (27,849 )     (194 )     181  
                                         
Net income from continuing operations
    21,944       10,307       13,203       (23,510 )     21,944  
Net income (loss) from discontinued operations
    (82,196 )     (87,293 )     2,257       85,036       (82,196 )
                                         
Net income (loss)
  $ (60,252 )   $ (76,986 )   $ 15,460     $ 61,526     $ (60,252 )
                                         
 
 
 
                                         
   
Nine Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
January 31, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 504,001     $ 1,301,716     $ (17,073 )   $ 1,788,644  
                                         
Cost of services
    -       185,058       1,231,236       (8 )     1,416,286  
Cost of other revenues
    -       165,402       34,226       -       199,628  
Selling, general and administrative
    -       234,503       377,934       (16,718 )     595,719  
                                         
Total expenses
    -       584,963       1,643,396       (16,726 )     2,211,633  
                                         
Operating loss
    -       (80,962 )     (341,680 )     (347 )     (422,989 )
Interest expense
    -       -       (1,871 )     -       (1,871 )
Other income, net
    (403,197 )     (12 )     21,675       403,197       21,663  
                                         
Loss from continuing operations before tax benefit
    (403,197 )     (80,974 )     (321,876 )     402,850       (403,197 )
Income tax benefit
    (166,553 )     (36,012 )     (130,398 )     166,410       (166,553 )
                                         
Net loss from continuing operations
    (236,644 )     (44,962 )     (191,478 )     236,440       (236,644 )
Net loss from discontinued operations
    (615,565 )     (609,717 )     (6,212 )     615,929       (615,565 )
                                         
Net loss
  $ (852,209 )   $ (654,679 )   $ (197,690 )   $ 852,369     $ (852,209 )
                                         
 
 
 

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Nine Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
January 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 540,530     $ 1,138,702     $ (9,200 )   $ 1,670,032  
                                         
Cost of services
    -       147,698       1,192,015       1       1,339,714  
Cost of other revenues
    -       99,040       14,064       -       113,104  
Selling, general and administrative
    -       184,345       386,363       (4,697 )     566,011  
                                         
Total expenses
    -       431,083       1,592,442       (4,696 )     2,018,829  
                                         
Operating income (loss)
    -       109,447       (453,740 )     (4,504 )     (348,797 )
Interest expense
    -       (35,429 )     (863 )     -       (36,292 )
Other income, net
    (370,468 )     5       14,616       370,468       14,621  
                                         
Income (loss) from continuing operations before tax (benefit)
    (370,468 )     74,023       (439,987 )     365,964       (370,468 )
Income tax (benefit)
    (153,576 )     45,114       (196,823 )     151,709       (153,576 )
                                         
Net income (loss) from continuing operations
    (216,892 )     28,909       (243,164 )     214,255       (216,892 )
Net loss from discontinued operations
    (131,197 )     (124,067 )     (12,200 )     136,267       (131,197 )
                                         
Net loss
  $ (348,089 )   $ (95,158 )   $ (255,364 )   $ 350,522     $ (348,089 )
                                         
 
 
 
                                     
 
Condensed Consolidating Balance Sheets     (in 000s)
 
    H&R Block, Inc.
  BFC
    Other
          Consolidated
January 31, 2008   (Guarantor)   (Issuer)     Subsidiaries     Elims     H&R Block
 
 
Cash & cash equivalents
  $ -   $ 994,400     $ 415,609     $ -     $ 1,410,009
Cash & cash equivalents – restricted
    -     324,934       1,355       -       326,289
Receivables from customers, brokers and dealers, net
    -     414,089       -       -       414,089
Receivables, net
    348     2,241,112       469,835       -       2,711,295
Mortgage loans held for investment
    -     1,040,854       -       -       1,040,854
Intangible assets and goodwill, net
    -     176,409       988,475       -       1,164,884
Investments in subsidiaries
    3,572,710     -       493       (3,572,710 )     493
Assets held for sale
    -     2,996,798       14,201       -       3,010,999
Other assets
    -     264,171       1,232,125       3       1,496,299
                                     
Total assets
  $ 3,573,058   $ 8,452,767     $ 3,122,093     $ (3,572,707 )   $ 11,575,211
                                     
Short-term borrowings
  $ -   $ 1,711,485     $ -     $ -     $ 1,711,485
Customer deposits
    -     1,958,490       -       -