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H&R Block 10-Q 2011 Documents found in this filing:Table of Contents
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C.
20549
Commission file
number 1-6089
H&R
Block, Inc.
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 has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
(§ 232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant
was required to submit and post such files).
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):
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 28, 2011 was 305,250,229 shares.
Form 10-Q
for the Period Ended January 31, 2011
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CONDENSED
CONSOLIDATED BALANCE SHEETS
(amounts
in 000s, except share and per share amounts)
See Notes to
Condensed Consolidated Financial Statements
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See Notes to
Condensed Consolidated Financial Statements
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See Notes to
Condensed Consolidated Financial Statements
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Basis of Presentation
The condensed consolidated balance sheet as of January 31,
2011, the condensed consolidated statements of operations and
comprehensive income (loss) for the three and nine months ended
January 31, 2011 and 2010, and the condensed consolidated
statements of cash flows for the nine months ended
January 31, 2011 and 2010 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 and cash flows at January 31, 2011 and for all
periods presented have been made.
A restatement was made to the historical condensed consolidated
statement of cash flows for the nine months ended
January 31, 2010. Loans made to franchisees and cash
receipts from franchise loans of $88.6 million and
$8.5 million, respectively, were previously reported in
cash flows from operating activities and are now reported in
cash flows from investing activities.
“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, 2010
Annual Report to Shareholders on
Form 10-K.
All amounts presented herein as of April 30, 2010 or for
the year then ended, are derived from our April 30, 2010
Annual Report to Shareholders on
Form 10-K.
Management Estimates
The preparation of financial statements in conformity with
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. Significant estimates, assumptions and judgments are
applied in the determination of our allowance for loan losses,
potential losses from loan repurchase and indemnity obligations
associated with our discontinued mortgage business, contingent
losses associated with pending litigation, fair value of
reporting units, reserves for uncertain tax positions, credit
losses on receivable balances and related matters. We revise our
estimates when facts and circumstances dictate. However, future
events and their effects cannot be determined with absolute
certainty. As such, actual results could differ materially from
those estimates.
Seasonality of
Business
Our operating revenues 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.
Concentrations of
Risk
Our mortgage loans held for investment include concentrations of
loans to borrowers in certain states, which may result in
increased exposure to loss as a result of changes in real estate
values and underlying economic or market conditions related to a
particular geographical location. Approximately 51% of our
mortgage loan portfolio consists of loans to borrowers located
in the states of Florida, California and New York.
Financing
Receivables and Related Allowances
Our financing receivables consist primarily of mortgage loans
held for investment, Emerald Advance lines of Credit (EAs), tax
client receivables related to refund anticipation loans (RALs)
and loans made to franchisees. Policies related to our mortgage
loans held for investment and the related allowance are included
in our Annual Report on
Form 10-K.
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The current portion of EAs, tax client receivables and loans
made to franchisees is included in accounts receivable, while
the noncurrent portion is included in other assets in the
condensed consolidated financial statements. These amounts as of
January 31, 2011 are as follows:
Related allowance for doubtful accounts is detailed in
note 4.
Emerald Advance
lines of
credit. Interest
income on EAs is calculated using the average daily balance
method and is recognized based on the principal amount
outstanding until the outstanding balance is paid or becomes
delinquent. Loan commitment fees on EAs, net of related
expenses, are initially deferred and recognized as revenue over
the commitment period, which is typically two months. EAs are
placed on non-accrual status as soon as they become delinquent.
We review the credit quality of these receivables based on the
year the loans were originated, with different bad debt rates
applied to each year. As of January 31, 2011, we had EA
receivables of $648.1 million, $12.3 million and
$14.7 million which were originated in fiscal years 2011,
2010 and 2009 and prior, respectively. We also had receivables
of $12.8 million related to EA receivables of clients who
paid off their original EA and qualified to maintain their loan
year-round. As of January 31, 2011, $33.2 million of
EAs were on non-accrual status. Payments on past due amounts are
recorded as a reduction in the receivable balance.
We determine our allowance for these receivables collectively,
based on a review of receipts taking into consideration
historical experience. These receivables are not specifically
identified and charged-off, but are evaluated on a pooled basis.
Initial bad debt rates also consider whether the loan was made
to a new or repeat client. At the end of each tax season the
outstanding balances on these receivables are evaluated based on
collections received and expected collections over the upcoming
tax season. We adjust our allowance accordingly, with these
adjustments reflected as bad debt expense.
Tax client
receivables related to
RALs. Historically,
RALs were offered in our US retail tax offices through a
contractual relationship with HSBC Holdings plc (HSBC). We
purchased a 49.9% participation interest in all RALs obtained
through our retail offices. In December 2010, HSBC terminated
its contract with us based on restrictions placed on HSBC by its
regulator and RALs are not being offered in our tax offices this
tax season. In connection with the contract termination, we
obtained the remaining rights to collect on the outstanding
balances of RALs originated in years 2006 and later. All tax
client receivables outstanding at January 31, 2011 were
originated prior to fiscal year 2011 and are past due. We do not
accrue interest on these receivables. Payments on past due
amounts are recorded as a reduction in the receivable balance.
We review the credit quality of these receivables based on the
year the loans were originated, with different bad debt rates
applied to each year. As of January 31, 2011, we had tax
client receivables of $1.7 million, $2.7 million and
$6.4 million which were originated by HSBC in fiscal years
2010, 2009 and 2008 and prior, respectively. These receivables
are not specifically identified and charged-off, but are
evaluated on a pooled basis. At the end of each tax season the
outstanding balances on these receivables are evaluated based on
collections received and expected collections over the upcoming
tax season. We adjust our allowance accordingly, with these
adjustments reflected as bad debt expense.
Loans made to
franchisees. Interest
income on loans made to franchisees is calculated using the
average daily balance method and is recognized based on the
principal amount outstanding until the outstanding balance is
paid or becomes delinquent. Loans made to franchisees totaled
$216.6 million at January 31, 2011, and consisted of
$145.4 million in term loans made to finance the purchase
of franchises and $71.2 million in revolving lines of
credit made to existing franchisees primarily for the purpose of
funding their off-season needs. The credit quality of these
receivables is determined on a specific franchisee basis, taking
into account the franchisee’s credit score, their payment
history on existing loans and operational amounts due to us, the
loan-to-value
ratio and
debt-to-income
ratio. Credit scores,
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loan-to-value
ratio and
debt-to-income
ratio are obtained at the time of underwriting. Payment history
is monitored on a regular basis. We believe all loans to
franchisees fall within the same credit quality category. Loans
are evaluated for impairment when they become delinquent.
Amounts deemed to be uncollectible are written off to bad debt
expense and bad debt related to these loans has typically been
insignificant. Additionally, the franchise office serves as
collateral for the loan. In the event the franchisee is unable
to repay the loans, we revoke their franchise rights, write off
the remaining balance of the loans and assume control of the
office. We had no loans to franchisees past due or on
non-accrual status as of January 31, 2011 and we had no
allowance for bad debts recorded related to loans to franchisees
at January 31, 2011.
Effective July 20, 2010, our Business Services segment
acquired certain non-attest assets and liabilities of
Caturano & Company, Inc. (Caturano), a Boston-based
accounting firm, for an aggregate purchase price of
$40.2 million. We expect this acquisition to expand our
presence in the Boston market. We made cash payments of
$32.6 million, including $29.8 million at closing.
Payment of the remaining purchase price is deferred and will be
paid over 14 years. The following table summarizes the fair
value of identifiable assets acquired and liabilities assumed
and the resulting goodwill as of January 31, 2011:
In connection with the acquisition a deferred compensation plan,
an employee retention program and a performance bonus plan were
put in place for eligible employees. Expenses related to these
plans will be treated as compensation and will be expensed as
incurred. We incurred expenses totaling $2.0 million under
these plans during the nine months ended January 31, 2011.
In October 2010, we signed a definitive merger agreement to
acquire all of the outstanding shares of 2SS Holdings, Inc.,
developer of TaxACT digital tax preparation solutions, for
$287.5 million in cash. Completion of the transaction is
subject to the satisfaction of customary closing conditions,
including regulatory approval.
Basic and diluted earnings (loss) per share is computed using
the two-class method. The two-class method is an earnings
allocation formula that determines net income per share for each
class of common stock and participating security according to
dividends declared and participation rights in undistributed
earnings. Per share amounts are computed by dividing net income
from continuing operations attributable to common shareholders
by 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. Diluted earnings per share excludes
the impact of shares of common stock issuable upon the lapse of
certain restrictions or the exercise of options to purchase
9.6 million shares for the three months ended
January 31, 2010, as the effect would be antidilutive.
Diluted earnings per share excludes the impact of shares of
common stock issuable upon the lapse of certain restrictions or
the exercise of options to purchase 12.6 million shares for
the three and nine months ended January 31,
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2011, and 16.8 million shares for the nine months ended
January 31, 2010, as the effect would be antidilutive due
to the net loss from continuing operations during each period.
The computations of basic and diluted earnings (loss) per share
from continuing operations are as follows:
The weighted average shares outstanding for the three and nine
months ended January 31, 2011 decreased to
305.1 million and 310.5 million, respectively, from
333.0 million and 334.3 million for the three and nine
months ended January 31, 2010, respectively. During the
nine months ended January 31, 2011, we purchased and
immediately retired 19.0 million shares of our common stock
at a cost of $279.9 million. We may continue to repurchase
and retire common stock or retire shares held in treasury from
time to time in the future. The cost of shares retired during
the period was allocated to the components of stockholders’
equity as follows:
During the nine months ended January 31, 2011 and 2010, we
issued 1.1 million and 2.2 million shares of common
stock, respectively, due to the exercise of stock options,
employee stock purchases and vesting of nonvested shares.
During the nine months ended January 31, 2011, we acquired
0.2 million shares of our common stock at an aggregate cost
of $3.5 million, and during the nine months ended
January 31, 2010, we acquired 0.2 million shares at an
aggregate cost of $4.2 million. Shares acquired during
these periods represented shares swapped or surrendered to us in
connection with the vesting of nonvested shares and the exercise
of stock options.
During the nine months ended January 31, 2011, we granted
2.1 million stock options and 0.8 nonvested shares and
units in accordance with our stock-based compensation plans. The
weighted average fair value of options granted was $2.25 for
management options. These awards vest over a four year period
with one-fourth vesting each year. Stock-based compensation
expense of our continuing operations totaled $4.4 million
and $10.6 million for the three and nine months ended
January 31, 2011, respectively, and $7.2 million and
$19.3 million for the three and nine months ended
January 31, 2010, respectively. At January 31, 2011,
unrecognized compensation cost for options totaled
$5.4 million, and for nonvested shares and units totaled
$13.8 million.
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Current receivables consist of the following:
The decrease in tax client receivables from January 2010 is due
to the termination of our contract with HSBC to offer RALs
during the current tax season. See additional discussion in
note 1. The decrease in Business Services receivables from
January 2010 is primarily a result of the change in the
administrative services agreement between RSM and
McGladrey & Pullen, LLP (M&P) in February 2010.
Our allowance for doubtful accounts as of January 31, 2011
consists of the following:
There were no changes to our methodology related to the
calculation of our allowance for doubtful accounts during the
quarter.
The composition of our mortgage loan portfolio as of
January 31, 2011 and April 30, 2010 is as follows:
Activity in the allowance for loan losses for the nine months
ended January 31, 2011 and 2010 is as follows:
(in
000s)
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Our loan loss reserve as a percent of mortgage loans was 14.7%
at January 31, 2011 compared to 13.7% at April 30,
2010.
When determining our allowance for loan losses, we evaluate
loans less than 60 days past due on a pooled basis, while
loans we consider impaired (which includes those loans more than
60 days past due or that have been modified) are evaluated
individually. The balance of these loans and the related
allowance is as follows at January 31, 2011:
We review the credit quality of our portfolio based on the
following criteria: (1) originator, (2) the level of
documentation obtained for loan at origination,
(3) occupancy status of property at origination,
(4) geography, and (5) credit score and loan to value
at origination. We specifically evaluate each loan and assign an
internal risk rating of high, medium or low to each loan. The
risk rating is based upon multiple loan characteristics that
correlate to delinquency and loss. These characteristics
include, but are not limited to, the five criteria listed above,
plus loan to value. These loan attributes are tested annually
against a variety of additional characteristics to ensure the
appropriate data is being utilized to determine the level of
risk within the portfolio.
All criteria are obtained at the time of origination and are
only subsequently updated if the loan is refinanced.
Our portfolio includes loans originated by Sand Canyon
Corporation (SCC) and purchased by H&R Block Bank (HRB
Bank) which constitute approximately 63% of the total loan
portfolio at January 31, 2011. We have experienced higher
rates of delinquency and have greater exposure to loss with
respect to this segment of our loan portfolio. Our remaining
loan portfolio totaled $221.9 million and is characteristic
of a prime loan portfolio, and we believe subject to a lower
loss exposure. Detail of our mortgage loans held for investment
and the related allowance at January 31, 2011 is as follows:
Detail of the aging of the mortgage loans in our portfolio that
are past due as of January 31, 2011 is as follows:
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Credit quality indicators at January 31, 2011 include the
following:
In cases where we modify a loan and in so doing grant a
concession to a borrower experiencing financial difficulty, the
modification is considered a troubled debt restructuring (TDR).
TDR loans totaled $112.4 million and $145.0 million at
January 31, 2011 and April 30, 2010, respectively. The
principal balance of non-performing assets as of
January 31, 2011 and April 30, 2010 is as follows:
Activity related to our real estate owned (REO) is as follows:
(in
000s)
We use the following valuation methodologies for assets and
liabilities measured at fair value and the general
classification of these instruments pursuant to the fair value
hierarchy.
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include certain agency and non-agency mortgage-backed
securities, U.S. states and political subdivisions debt
securities and other debt and equity securities.
The following table presents for each hierarchy level the assets
that were remeasured at fair value on both a recurring and
non-recurring basis during the nine months ended
January 31, 2011 and 2010:
There were no changes to the unobservable inputs used in
determining the fair values of our level 2 and level 3
financial assets.
The following methods were used to determine the fair values of
our other financial instruments:
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The carrying amounts and estimated fair values of our financial
instruments at January 31, 2011 are as follows:
(in
000s)
Changes in the carrying amount of goodwill for the nine months
ended January 31, 2011 consist of the following:
We test goodwill for impairment annually at the beginning of our
fourth quarter, or more frequently if events occur which could,
more likely than not, reduce the fair value of a reporting
unit’s net assets below its carrying value.
The RedGear reporting unit within our Tax Services segment
experienced lower than expected settlement product revenues, and
as a result, we evaluated this reporting unit’s goodwill
for impairment at January 31, 2011. The measurement of
impairment of goodwill consists of two steps. In the first step,
we compared the fair value of this reporting unit, determined
using discounted cash flows, to its carrying value. As the
results of the first test indicated that the fair value was less
than its carrying value, we then performed the second step,
which was to determine the implied fair value of its goodwill
and to compare that to its carrying value. The second step
included hypothetically valuing all of the tangible and
intangible assets of this reporting unit. As a result, we
recorded an impairment of the reporting unit’s goodwill of
$22.7 million during the three months ended
January 31, 2011, leaving a remaining goodwill balance of
approximately $14 million. The impairment is included in
selling, general and administrative expenses on the condensed
consolidated statements of operations.
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Intangible assets consist of the following:
Amortization of intangible assets for the three and nine months
ended January 31, 2011 was $7.4 and $21.6 million
respectively, and $7.1 million and $21.4 million for
the three and nine months ended January 31, 2010,
respectively. Estimated amortization of intangible assets for
fiscal years 2011 through 2015 is $30.7 million,
$29.1 million, $24.7 million, $21.1 million and
$15.7 million, respectively.
In connection with the acquisition of Caturano, as discussed in
note 2, we recorded a liability related to unfavorable
operating lease terms in the amount of $5.9 million, which
will be amortized over the remaining contractual life of the
operating lease. The net balance was $5.6 million at
January 31, 2011.
Borrowings consist of the following:
We had commercial paper borrowings of $632.6 million at
January 31, 2011, compared to $792.6 million at the
same time last year. These borrowings were used to fund our
off-season losses and cover our seasonal working capital needs.
We also had other short-term borrowings of $882.5 million
outstanding at January 31, 2010 to fund our participation
interests in RALs.
At January 31, 2011, we maintained a committed line of
credit (CLOC) agreement to support commercial paper issuances,
general corporate purposes or for working capital needs. This
facility provides funding up to $1.7 billion and matures
July 31, 2013. This facility bears interest at an annual
rate of LIBOR plus 1.30% to 2.80% or PRIME plus 0.30% to 1.80%
(depending on the type of borrowing) and includes an annual
facility fee of 0.20% to 0.70% of the committed amounts, based
on our credit ratings. Covenants in this facility include:
(1) maintenance of a minimum net worth of
$650.0 million on the last day of any fiscal
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quarter; and (2) reduction of the aggregate outstanding
principal amount of short-term debt, as defined in the
agreement, to $200.0 million or less for thirty consecutive
days during the period March 1 to June 30 of each year
(“Clean-down requirement”). At January 31, 2011,
we were in compliance with these covenants and had net worth of
$827.7 million. We had no balance outstanding under the
CLOCs at January 31, 2011.
HRB Bank is a member of the FHLB of Des Moines, which extends
credit to member banks based on eligible collateral. At
January 31, 2011, HRB Bank had total FHLB advance capacity
of $226.2 million. There was $75.0 million outstanding
on this facility, leaving remaining availability of
$151.2 million. Mortgage loans held for investment of
$381.5 million serve as eligible collateral and are used to
determine total capacity.
We file a consolidated federal income tax return in the United
States and file tax returns in various state and foreign
jurisdictions. The U.S. Federal consolidated tax returns
for the years 1999 through 2007 are currently under examination
by the Internal Revenue Service, with the
1999-2005 years
currently at the appellate level. Federal returns for tax years
prior to 1999 are closed by statute. Historically, tax returns
in various foreign and state jurisdictions are examined and
settled upon completion of the exam.
During the nine months ended January 31, 2011, we accrued
additional gross interest and penalties of $4.5 million
related to our uncertain tax positions. We had gross
unrecognized tax benefits of $131.5 million and
$129.8 million at January 31, 2011 and April 30,
2010, respectively. The gross unrecognized tax benefits
increased $1.7 million in the current year, due to accruals
of tax and interest on positions related to prior years. Except
as noted below, we have classified the liability for
unrecognized tax benefits, including corresponding accrued
interest, as long-term at January 31, 2011, and included
this amount in other noncurrent 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 gross amount of reserves for
previously unrecognized tax benefits may decrease by
approximately $16.5 million within twelve months of
January 31, 2011. This portion of our liability for
unrecognized tax benefits has been classified as current and is
included in accounts payable, accrued expenses and other current
liabilities on the condensed consolidated balance sheets.
The following table shows the components of interest income and
expense of our continuing operations:
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HRB Bank files its regulatory Thrift Financial Report (TFR) on a
calendar quarter basis with the Office of Thrift Supervision
(OTS). The following table sets forth HRB Bank’s regulatory
capital requirements at December 31, 2010, as calculated in
the most recently filed TFR:
As of January 31, 2011, HRB Bank’s leverage ratio was
20.7%.
In June 2009, the Financial Accounting Standards Board (FASB)
issued revised authoritative guidance associated with the
consolidation of variable interest entities (VIEs). The revised
guidance replaced the previous quantitative-based assessment for
determining whether an enterprise is the primary beneficiary of
a VIE and focuses primarily on a qualitative assessment. This
assessment requires identifying the enterprise that has
(1) the power to direct the activities of the VIE that can
most significantly impact the entity’s performance; and
(2) the obligation to absorb losses and the right to
receive benefits from the VIE that could potentially be
significant to such entity. The revised guidance also requires
that the enterprise continually reassess whether it is the
primary beneficiary of a VIE rather than conducting a
reassessment only upon the occurrence of specific events.
We implemented this guidance on May 1, 2010 and evaluated
our financial interests to determine if we had interests in VIEs
and if we are the primary beneficiary of the VIE.
The following is a description of our financial interests in
VIEs which we consider significant or where we are the sponsor.
For these VIEs we have determined that we are not the primary
beneficiary and, therefore have not consolidated the VIEs. Prior
to implementation of this new guidance we did not consolidate
these entities.
We have concluded that RSM is not the primary beneficiary of
M&P and, therefore, we have not consolidated M&P. RSM
does not have an equity interest in M&P, nor does it have
the power to direct any activities of M&P and does not
receive any of its income. We have no assets or liabilities
included in our condensed consolidated balance sheets related to
our variable interests. We believe RSM’s maximum exposure
to economic loss, resulting from various agreements with
M&P, relates primarily to shared office space from
operating leases under the administrative services agreement
equal to approximately $112.4 million at January 31,
2011, and variability in our operating results due to the
compensation agreements with RSM managing directors. We do not
provide any support that is not contractually required.
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Our identification of the primary beneficiary of the Trusts was
based on a determination that the servicer of the underlying
mortgage loans has the power to direct the most significant
activities of the Trusts because the servicer handles all of the
loss mitigation activities for the mortgage loans.
SCC is not the servicer of the mortgage loans underlying the
REMIC Trusts. Therefore, SCC is not the primary beneficiary of
the REMIC Trusts because it does not have the power to direct
the most significant activities of the REMIC Trusts, which is
the servicing of the underlying mortgage loans.
SCC does have the exclusive right to appoint a servicer when
certain conditions have been met for specific loans related to
two of the NIM Trusts. As of January 31, 2011, those
conditions have been met for a minority portion of the loans
underlying those Trusts. As this right pertains only to a
minority of the loans, we have concluded that SCC does not have
the power to direct the most significant activities of these two
NIM Trusts, as the servicer has the power to direct significant
activities over the majority of the mortgage loans. In the
remaining NIM Trusts, SCC has a shared right to appoint a
servicer under certain conditions. For these NIM Trusts, we have
concluded that SCC is not the primary beneficiary because the
power to direct the most significant activities, which is the
servicing of the underlying mortgage loans, is shared with other
unrelated parties.
At January 31, 2011, we had no significant assets or
liabilities included in our condensed consolidated balance
sheets related to SCC’s variable interests in the Trusts.
We have a liability, as discussed in note 13, and a
deferred tax asset recorded in our condensed consolidated
balance sheets related to obligations for representations and
warranties SCC made in connection with the transfer of mortgage
loans, including mortgage loans held by the securitization
trusts. We have no remaining exposure to economic loss arising
from impairment of SCC’s beneficial interest in the Trusts.
If SCC receives cash flows in the future as a holder of
beneficial interests we would record gains as other income in
our income statement. Neither we nor SCC has liquidity
arrangements, guarantees or other commitments for the Trusts,
nor has any support been provided that was not contractually
required.
Changes in deferred revenue balances 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 addition to amounts accrued for our POM guarantee, we had
accrued $11.9 million and $14.5 million at
January 31, 2011 and April 30, 2010, respectively,
related to our standard guarantee which is included with our
standard tax preparation services.
The following table summarizes certain of our other contractual
obligations and commitments:
We routinely enter into contracts that include embedded
indemnifications that have characteristics similar to
guarantees. Guarantees and indemnifications of the Company and
its subsidiaries include obligations to protect counterparties
from losses arising from the following: (1) tax, legal and
other risks
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related to the purchase or disposition of businesses;
(2) penalties and interest assessed by federal and state
taxing authorities in connection with tax returns prepared for
clients; (3) indemnification of our directors and officers;
and (4) 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 terms
of the indemnities may vary and in many cases are 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 we will ultimately prevail in
the event any such claims are asserted, we believe the fair
value of guarantees and indemnifications relating to our
continuing operations is not material as of January 31,
2011.
Discontinued
Operations
SCC, previously known as Option One Mortgage Corporation, ceased
originating mortgage loans in December 2007 and, in April 2008,
sold its servicing assets and discontinued its remaining
operations. The sale of servicing assets did not include the
sale of any mortgage loans.
In connection with the securitization and sale of loans, SCC
made certain representations and warranties, including, but not
limited to, representations relating to matters such as
ownership of the loan, validity of lien securing the loan, and
the loan’s compliance with SCC’s underwriting
criteria. Representations and warranties in whole loan sale
transactions to institutional investors included a
“knowledge qualifier” which limits SCC liability for
borrower fraud to those instances where SCC had knowledge of the
fraud at the time the loans were sold. In the event that there
is a breach of a representation and warranty and such breach
materially and adversely affects the value of a mortgage loan,
SCC may be obligated to repurchase a loan or otherwise indemnify
certain parties for losses incurred as a result of loan
liquidation. Generally, these representations and warranties are
not subject to a stated term, but would be subject to statutes
of limitation applicable to the contractual provisions.
Claims received by SCC have primarily related to alleged
breaches of representations and warranties related to a
loan’s compliance with the underwriting standards
established by SCC at origination, borrower fraud and credit
exceptions without sufficient compensating factors. Claims
received since May 1, 2008 follows:
Note: The table above excludes amounts related to an indemnity
agreement dated April 2008, which is discussed below.
For those claims determined to be valid, SCC has complied with
its obligations by either repurchasing the mortgage loans or REO
properties, providing for the reimbursement of losses in
connection with liquidated REO properties, or reaching other
settlements. SCC has denied approximately 85% of all claims
received, excluding resolution reached under other settlements.
Counterparties could reassert claims that SCC has denied. Of
claims determined to be valid, approximately 23% resulted in
loan repurchases, and 77% resulted in indemnification or
settlement payments. Losses on loan repurchase, indemnification
and settlement payments totaled approximately $88 million
for the period May 1, 2008 through January 31, 2011.
Loss severity rates on repurchases and indemnification have
approximated 60% and SCC has not observed any material trends
related to average losses by counterparty. Repurchased loans are
considered held for sale and are included in prepaid expenses
and other current assets on the condensed consolidated balance
sheets. The net balance of all mortgage loans held for sale by
SCC was $13.8 million at January 31, 2011.
SCC generally has 60 to 120 days to respond to
representation and warranty claims and performs a
loan-by-loan
review of all repurchase claims during this time. SCC has
completed its review of all claims, with the exception of claims
totaling approximately $14 million, which remained subject
to review as of
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January 31, 2011. Of the claims still subject to review,
approximately $2 million are from private-label
securitizations related to rescissions of mortgage insurance,
and $10 million are from monoline insurers, with the
remainder from government sponsored entities.
All claims asserted against SCC since May 1, 2008 relate to
loans originated during calendar years 2005 through 2007, of
which, approximately 89% relate to loans originated in calendar
years 2006 and 2007. During calendar year 2005 through 2007, SCC
originated approximately $84 billion in loans, of which
less than 1% were sold to government sponsored entities. SCC is
not subject to loss on loans that have been paid in full,
repurchased, or were sold without recourse.
The majority of claims asserted since May 1, 2008, which
have been determined by SCC to represent a valid breach of its
representations and warranties, relate to loans that became
delinquent within the first two years following the origination
of the mortgage loan. SCC believes the longer a loan performs
prior to an event of default, the less likely the default will
be related to a breach of a representation and warranty. The
balance of loans originated in 2005, 2006 and 2007 which
defaulted in the first two years is $4.0 billion,
$6.3 billion and $2.9 billion, respectively, at
January 31, 2011.
SCC estimates losses relating to representation and warranty
claims by estimating loan repurchase and indemnification
obligations on both known claims and projections of future
claims. Projections of future claims are based on an analysis
that includes a combination of reviewing repurchase demands and
actual defaults and loss severities by counterparty, inquiries
from various third-parties, the terms and provisions of related
agreements and the historical rate of repurchase and
indemnification obligations related to breaches of
representations and warranties. SCC’s methodology for
calculating this liability considers the probability that
individual counterparties (whole-loan purchasers, private label
securitization trustees and monoline insurers) will assert
future claims.
SCC has recorded a liability for estimated contingent losses
related to representation and warranty claims as of
January 31, 2011, of $155.0 million, which represents
SCC’s best estimate of the probable loss that may occur.
This overall liability amount includes $24.2 million that
was established under an indemnity agreement dated April 2008
with a specific counterparty in exchange for a full and complete
release of such party’s ability to assert representation
and warranty claims. This indemnity agreement was given as part
of obtaining the counterparty’s consent to SCC’s sale
of its mortgage servicing business in 2008. During the current
year, payments totaling $25.6 million were made under this
agreement. We expect the remaining obligation of
$24.2 million to be paid in the fourth quarter of this
fiscal year.
The recorded liability represents SCC’s estimate of losses
from future claims where assertion of a claim and a related
contingent loss are both deemed probable. Because the rate at
which future claims may be deemed valid and loss severity rates
may differ significantly from historical experience, SCC is not
able to estimate reasonably possible loss outcomes in excess of
its current accrual. A 1% increase in both assumed validity
rates and loss severities would result in losses above
SCC’s accrual of approximately $21 million. This
sensitivity is hypothetical and is intended to provide an
indication of the impact of a change in key assumptions on the
representations and warranties liability. In reality, changes in
one assumption may result in changes in other assumptions, which
may or may not counteract the sensitivity.
While SCC uses the best information available to it in
estimating its liability, assessing the likelihood that claims
will be asserted in the future and estimating probable losses
are inherently difficult to estimate and require considerable
management judgment. Although net losses on settled claims since
May 1, 2008 have been within initial loss estimates, to the
extent that the level of claims asserted, the level of valid
claim volumes, the counterparties asserting claims, the nature
of claims, or the value of residential home prices differ in the
future from current estimates, future losses may be greater than
the current estimates and those differences may be significant.
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A rollforward of our liability for losses on repurchases for the
nine months ended January 31, 2011 and 2010 is as follows:
The repurchase liability is included in accounts payable,
accrued expenses and other current liabilities on our condensed
consolidated balance sheets. There have been no provisions for
additional losses included in the income statement since
April 30, 2008; however, loss provisions would be recorded
net of tax in discontinued operations.
We are party to investigations, legal claims and lawsuits
arising out of our business operations. As required, we accrue
our best estimate of loss contingencies when we believe a loss
is probable and we can reasonably estimate the amount of any
such loss. Amounts accrued, including obligations under
indemnifications, totaled $43.9 million and
$35.5 million at January 31, 2011 and April 30,
2010, respectively. Litigation is inherently unpredictable and
it is difficult to project the outcome of particular matters
with reasonable certainty and, therefore, the actual amount of
any loss may prove to be larger or smaller than the amounts
reflected in our consolidated financial statements.
RAL Litigation
We have been named in multiple lawsuits as defendants in
litigation regarding our refund anticipation loan program in
past years. All of those lawsuits have been settled or otherwise
resolved, except for one.
The sole remaining case is a putative class action styled
Sandra J. Basile, et al. v. H&R Block, Inc., et
al., April Term 1992 Civil Action No. 3246 in the Court
of Common Pleas, First Judicial District Court of Pennsylvania,
Philadelphia County, instituted on April 23, 1993. The
plaintiffs allege inadequate disclosures with respect to the RAL
product and assert claims for violation of consumer protection
statutes, negligent misrepresentation, breach of fiduciary duty,
common law fraud, usury, and violation of the Truth In Lending
Act. Plaintiffs seek unspecified actual and punitive damages,
injunctive relief, attorneys’ fees and costs. A
Pennsylvania class was certified, but later decertified by the
trial court in December 2003. An appellate court subsequently
reversed the decertification decision. We are appealing the
reversal. We have not concluded that a loss related to this
matter is probable nor have we accrued a loss contingency
related to this matter. Plaintiffs have not provided a dollar
amount of their claim and we are not able to estimate a possible
range of loss. We believe we have meritorious defenses to this
case and intend to defend it vigorously. There can be no
assurances, however, as to the outcome of this case or its
impact on our consolidated results of operations.
Express IRA
Litigation
We have been named defendants in lawsuits regarding our former
Express IRA product. All of those lawsuits have been settled or
otherwise resolved, except for one.
The one remaining case was filed on January 2, 2008 by the
Mississippi Attorney General in the Chancery Court of Hinds
County, Mississippi First Judicial District (Case No. G
2008 6 S 2) and is styled Jim Hood, Attorney for the
State of Mississippi v. H&R Block, Inc., H&R
Block Financial Advisors, Inc., et al. The complaint
alleges fraudulent business practices, deceptive acts and
practices, common law
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fraud and breach of fiduciary duty with respect to the sale of
the product in Mississippi and seeks equitable relief,
disgorgement of profits, damages and restitution, civil
penalties and punitive damages. We are not able to estimate a
possible range of loss. We believe we have meritorious defenses
to the claims in this case, and we intend to defend this case
vigorously, but there can be no assurances as to its outcome or
its impact on our consolidated results of operations.
Although we sold H&R Block Financial Advisors, Inc. (HRBFA)
effective November 1, 2008, we remain responsible for any
liabilities relating to the Express IRA litigation, among other
things, through an indemnification agreement. A portion of our
accrual is related to these indemnity obligations.
RSM McGladrey
Litigation
RSM EquiCo, its parent and certain of its subsidiaries and
affiliates, are parties to a class action filed on July 11,
2006 and styled Do Right’s Plant Growers, et al. v.
RSM EquiCo, Inc., et al. (the “RSM Parties”), Case
No. 06 CC00137, in the California Superior Court, Orange
County. The complaint contains allegations relating to business
valuation services provided by RSM EquiCo, including allegations
of fraud, negligent misrepresentation, breach of contract,
conversion and unfair competition. Plaintiffs seek unspecified
actual and punitive damages, in addition to pre-judgment
interest and attorneys’ fees. On March 17, 2009, the
court granted plaintiffs’ motion for class certification on
all claims. The defendants filed two requests for interlocutory
review of the decision, the last of which was denied by the
Supreme Court of California on September 30, 2009. A trial
date has been set for May 2011.
The certified class consists of RSM EquiCo’s
U.S. clients who signed platform agreements and for whom
RSM EquiCo did not ultimately market their business for sale. A
portion of our loss contingency accrual is related to this
matter for the amount of loss that we consider probable and
estimable, although it is possible that our losses could exceed
the amount we have accrued. The fees paid to RSM EquiCo in
connection with these agreements total approximately
$185 million, a number which substantially exceeds the
equity of RSM EquiCo. Plaintiffs seek to recover restitution in
an amount equal to the fees paid, in addition to punitive
damages and attorney fees. We believe the RSM Parties have
meritorious defenses to the case and intend to defend the case
vigorously. The amount claimed in this action is substantial and
could have a material adverse impact on our consolidated results
of operations. There can be no assurance regarding the outcome
of this matter.
On December 7, 2009, a lawsuit was filed in the Circuit
Court of Cook County, Illinois (2010-L-014920) against M&P,
RSM and H&R Block styled Ronald R. Peterson ex rel.
Lancelot Investors Fund, L.P., et al. v.
McGladrey & Pullen LLP, et al. The case was
removed to the United States District Court for the Northern
District of Illinois on December 28, 2009 (Case
No. 1:10-CV-00274).
The complaint, which was filed by the trustee for certain
bankrupt investment funds, seeks unspecified damages and asserts
claims against RSM for vicarious liability and alter ego
liability and against H&R Block for equitable restitution
relating to audit work performed by M&P. The amount claimed
in this case is substantial. On November 3, 2010, the court
dismissed the case against all defendants in its entirety with
prejudice. The trustee has filed an appeal to the Seventh
Circuit Court of Appeals, which remains pending.
RSM and M&P operate in an alternative practice structure
(“APS”). Accordingly, certain claims and lawsuits
against M&P could have an impact on RSM. More specifically,
any judgments or settlements arising from claims and lawsuits
against M&P that exceed its insurance coverage could have a
direct adverse effect on M&P’s operations. Although
RSM is not responsible for the liabilities of M&P,
significant M&P litigation and claims could impair the
profitability of the APS and impair the ability to attract and
retain clients and quality professionals. This could, in turn,
have a material adverse effect on RSM’s operations and
impair the value of our investment in RSM. There is no assurance
regarding the outcome of any claims or litigation involving
M&P.
Litigation and
Claims Pertaining to Discontinued Mortgage Operations
Although mortgage loan origination activities were terminated
and the loan servicing business was sold during fiscal year
2008, SCC and HRB remain subject to investigations, claims and
lawsuits pertaining to its loan origination and servicing
activities that occurred prior to such termination and sale.
These investigations, claims and lawsuits include actions by
state attorneys general, other state and federal regulators,
municipalities, individual plaintiffs, and cases in which
plaintiffs seek to represent a class of others alleged to be
similarly situated. Among other things, these investigations,
claims and lawsuits allege
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discriminatory or unfair and deceptive loan origination and
servicing practices, public nuisance, fraud, and violations of
securities laws, the Truth in Lending Act, Equal Credit
Opportunity Act and the Fair Housing Act. In the current
non-prime mortgage environment, the number of these
investigations, claims and lawsuits has increased over
historical experience and is likely to continue at increased
levels. The amounts claimed in these investigations, claims and
lawsuits are substantial in some instances, and the ultimate
resulting liability is difficult to predict and thus cannot be
reasonably estimated. In the event of unfavorable outcomes, the
amounts that may be required to pay in the discharge of
liabilities or settlements could be substantial and, because
SCC’s operating results are included in our consolidated
financial statements, could have a material adverse impact on
our consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a
lawsuit in the Superior Court of Suffolk County, Massachusetts
(Case
No. 08-2474-BLS)
styled Commonwealth of Massachusetts v. H&R Block,
Inc., et al., alleging unfair, deceptive and discriminatory
origination and servicing of mortgage loans and seeking
equitable relief, disgorgement of profits, restitution and
statutory penalties. In November 2008, the court granted a
preliminary injunction limiting the ability of the owner of
SCC’s former loan servicing business to initiate or advance
foreclosure actions against certain loans originated by SCC or
its subsidiaries without (1) advance notice to the
Massachusetts Attorney General and (2) if the Attorney
General objects to foreclosure, approval by the court. An appeal
of the preliminary injunction was denied. A trial date has been
set for June 2011. A portion of our loss contingency accrual is
related to this matter for the amount of loss that we consider
probable and estimable. We do not believe losses in excess of
our accrual would be material to our financial statements,
although it is possible that our losses could exceed the amount
we have accrued. We and SCC believe we have meritorious defenses
to the claims presented and intend to defend them vigorously.
There can be no assurances, however, as to its outcome or its
impact on our consolidated results of operations.
On October 15, 2010, the Federal Home Loan Bank of Chicago
filed a lawsuit in the Circuit Court of Cook County, Illinois
(Case No. 10CH45033) styled Federal Home Loan Bank of
Chicago v. Bank of America Funding Corporation, et al.
against multiple defendants, including various SCC related
entities and H&R Block, Inc. related entities, arising out
of FHLB’s purchase of mortgage-backed securities. Plaintiff
asserts claims for rescission and damages under Illinois
securities law and for common law negligent misrepresentation in
connection with its purchase of two securities originated and
securitized by SCC. These two securities had a total initial
principal amount of approximately $50 million, of which
approximately $42 million remains outstanding. We have not
concluded that a loss related to this matter is probable nor
have we established a loss contingency related to this matter.
We believe the claims in this case are without merit and we
intend to defend them vigorously. There can be no assurances,
however, as to its outcome or its impact on our consolidated
results of operations.
Other Claims and
Litigation
We have been named in several wage and hour class action
lawsuits throughout the country, respectively styled Alice
Williams v. H&R Block Enterprises LLC, Case
No.RG08366506 (Superior Court of California, County of Alameda,
filed January 17, 2008) (alleging improper classification
of office managers in California); Arabella Lemus v.
H&R Block Enterprises LLC, et al., Case
No. CGC-09-489251
(United States District Court, Northern District of
California, filed June 9, 2009) (alleging failure to timely
pay compensation to tax professionals in California and to
include itemized information on wage statements); Delana
Ugas v. H&R Block Enterprises LLC, et al., Case
No. BC417700 (United States District Court, Central
District of California, filed July 13, 2009) (alleging
failure to compensate tax professionals in California and
eighteen other states for all hours worked and to provide meal
periods); and Barbara Petroski v. H&R Block Eastern
Enterprises, Inc., et al., Case
No. 10-CV-00075
(United States District Court, Western District of Missouri,
filed January 25, 2010) (alleging failure to compensate tax
professionals nationwide for off-season training). A class was
certified in the Lemus case in December 2010 consisting
of all tax professionals who worked in company-owned offices in
California from 2007 to 2010. The plaintiffs in the wage and
hour class action lawsuits seek actual damages, pre-judgment
interest and attorneys’ fees, in addition to statutory
penalties under California and federal law, which could equal up
to 30 days of wages per tax season for class members who
worked in California. The potential loss related to the wage and
hour class action lawsuits cannot be reasonably estimated, but
our losses could
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exceed the amount we have accrued. We believe we have
meritorious defenses to the claims in these cases and intend to
defend them vigorously. The amounts claimed in these matters are
substantial in some instances and the ultimate liability with
respect to these matters is difficult to predict. There can be
no assurances as to the outcome of these cases or their impact
on our consolidated results of operations, individually or in
the aggregate.
In addition, we are from time to time party to investigations,
claims and lawsuits not discussed herein arising out of our
business operations. These investigations, claims and lawsuits
include actions by state attorneys general, other state
regulators, individual plaintiffs, and cases in which plaintiffs
seek to represent a class of others similarly situated. We
believe we have meritorious defenses to each of these
investigations, claims and lawsuits, and we are defending or
intend to defend them vigorously. The amounts claimed in these
matters are substantial in some instances, however, the ultimate
liability with respect to such matters is difficult to predict.
In the event of an unfavorable outcome, the amounts we may be
required to pay in the discharge of liabilities or settlements
could have a material adverse impact on our consolidated results
of operations.
We are also party to claims and lawsuits that we consider to be
ordinary, routine litigation incidental to our business,
including claims and lawsuits (collectively, “Other
Claims”) concerning the preparation of customers’
income tax returns, the fees charged customers for various
products and services, relationships with franchisees,
intellectual property disputes, employment matters and contract
disputes. While we cannot provide assurance that we will
ultimately prevail in each instance, we believe the amount, if
any, we are required to pay in the discharge of liabilities or
settlements in these Other Claims will not have a material
adverse impact on our consolidated results of operations.
Results of our continuing operations by reportable operating
segment are as follows:
In July 2010 the FASB issued Accounting Standards Update
2010-20,
“Disclosures About Credit Quality of Financing Receivables
and Allowance for Credit Losses.” This guidance requires
enhanced disclosures about the allowance for credit losses and
the credit quality of financing receivables and would apply to
financing receivables held by all creditors. The requirements
for period end disclosures are effective beginning with the
first interim or annual reporting period ending after
December 15, 2010. We have included all required
disclosures in notes 1, 4 and 5. The requirements for
activity-based disclosures will be adopted as of April 30,
2011. The requirements for TDR disclosures will be adopted when
finalized by the FASB.
In October 2009, the FASB issued Accounting Standards Update
2009-13,
“Revenue Recognition (Topic 605) –
Multiple-Deliverable Revenue Arrangements.” This guidance
amends the criteria for separating consideration in
multiple-deliverable arrangements to enable vendors to account
for products or
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services (deliverables) separately rather than as a combined
unit. This guidance establishes a selling price hierarchy for
determining the selling price of a deliverable, which is based
on: (1) vendor-specific objective evidence;
(2) third-party evidence; or (3) estimates. This
guidance also eliminates the residual method of allocation and
requires that arrangement consideration be allocated at the
inception of the arrangement to all deliverables using the
relative selling price method. In addition, this guidance
significantly expands required disclosures related to a
vendor’s multiple-deliverable revenue arrangements. This
guidance is effective prospectively for revenue arrangements
entered into or materially modified beginning with our fiscal
year 2012. We believe this guidance will not have a material
effect on our consolidated financial statements.
In December 2010, the FASB issued Accounting Standards Update
2010-28,
“Intangibles – Goodwill and Other (Topic 350):
When to Perform Step 2 of the Goodwill Impairment Test for
Reporting Units with Zero or Negative Carrying Amounts.”
The amendments affect reporting units whose carrying amount is
zero or negative, and require performance of Step 2 of the
goodwill impairment test if it is more likely than not that a
goodwill impairment exists. In determining whether it is more
likely than not that a goodwill impairment exists, a reporting
unit would consider whether there are any adverse qualitative
factors indicating that an impairment may exist. The qualitative
factors are consistent with existing guidance. The reporting
unit would evaluate if an event occurs or circumstances change
that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. This guidance is
effective beginning with our fiscal year 2012. We believe this
guidance will not have a material effect on our consolidated
financial statements.
In June 2009, the FASB issued guidance, under Topic
860 – Transfers and Servicing. This guidance requires
more disclosure about transfers of financial assets, including
securitization transactions, and where entities have continuing
exposure to the risks related to transferred financial assets.
It eliminates the concept of a qualifying special purpose entity
and changes the requirements for derecognizing financial assets.
We adopted this guidance as of May 1, 2010 and it did not
have a material effect on our consolidated financial statements.
Block Financial LLC (BFC) is an indirect, wholly-owned
consolidated subsidiary of the Company. BFC is the Issuer and
the Company is the Guarantor of the Senior Notes issued on
January 11, 2008 and October 26, 2004, our 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.
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