RESULTS OF OPERATIONS
Our subsidiaries provide tax preparation and retail banking services. We are the
only major company offering a full range of software, online and in-office tax
preparation solutions to individual tax clients.
TAX SERVICES
This segment primarily consists of our income tax preparation businesses -
assisted, online and software, and includes our tax operations in the U.S. and
its territories, Canada, and Australia. This segment also includes the
activities of H&R Block Bank (HRB Bank) that primarily support the tax network.
Tax Services - Operating Results (in 000s)
Three months ended July 31, 2012 2011
Tax preparation fees $ 32,893 $ 34,921
Fees from Peace of Mind guarantees 26,983 27,181
Fees from Emerald Card activities 12,056 11,241
Royalties 5,851 5,703
Other 12,470 12,379
Total revenues 90,253 91,425
Compensation and benefits:
Field wages 32,408 36,847
Corporate wages 34,367 33,055
Benefits and other compensation 14,774 17,489
81,549 87,391
Occupancy and equipment 79,851 83,337
Depreciation and amortization 20,471 21,450
Marketing and advertising 7,452 6,721
Other 41,835 62,009
Total expenses 231,158 260,908
Pretax loss $ (140,905 ) $ (169,483 )
Three months ended July 31, 2012 compared to July 31, 2011
Tax Services' revenues decreased $1.2 million, or 1.3% from the prior year. Tax
preparation fees decreased $2.0 million, or 5.8%, due primarily to additional
revenue in the prior year resulting from an extension of the Canadian tax
season.
Total expenses decreased $29.8 million, or 11.4%, from the prior year.
Compensation and benefits declined $5.8 million, or 6.7%, primarily due to the
reduction in force at the end of fiscal year 2012. Occupancy and equipment
expenses decreased $3.5 million, or 4.2%, primarily due to reductions in rent
expense resulting from office closings related to our strategic realignment
announced in April 2012. Other expenses declined $20.2 million, or 32.5%,
primarily due to legal charges recorded in the prior year.
The pretax loss for the three months ended July 31, 2012 and 2011 was $140.9
million and $169.5 million, respectively.
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CORPORATE, ELIMINATIONS AND INCOME TAXES ON CONTINUING OPERATIONS
Corporate operating losses include net interest margin and gains or losses
relating to mortgage loans held for investment, real estate owned and residual
interests in securitizations, along with interest expense on borrowings and
other corporate expenses.
Corporate - Operating Results (in 000s)
Three months ended July 31, 2012 2011
Interest income on mortgage loans held for investment, net $ 4,417 $ 5,661
Other 1,819 3,537
Total revenues 6,236 9,198
Interest expense 20,668 21,018
Provision for loan losses 4,000 5,625
Other 9,932 13,673
Total expenses 34,600 40,316
Pretax loss $ (28,364 ) $ (31,118 )
Three months ended July 31, 2012 compared to July 31, 2011
The pretax loss for the three months ended July 31, 2012 totaled $28.4 million,
an improvement of $2.8 million over the prior year. Provisions for loan losses
declined $1.6 million as a result of the continued run-off of our mortgage loan
portfolio. Other expenses decreased $3.7 million from the prior year primarily
due to lower consulting expenses in the current year. These reductions in
expenses were partially offset by lower interest income and other revenues.
Income Taxes on Continuing Operations
Our effective tax rate for continuing operations was 37.6% and 40.6% for the
three months ended July 31, 2012 and 2011, respectively. Due to losses in both
quarters, a discrete tax benefit in either period increases the tax rate while
an item of discrete tax expense decreases the tax rate. During the current
quarter, a net discrete tax expense of $2.7 million was recorded compared to a
net discrete tax benefit of $2.5 million in the same period of the prior year.
This net difference in discrete tax expense primarily related to differences in
income tax reserves recorded.
DISCONTINUED OPERATIONS
Our discontinued operations include the wind-down of our previously reported
Business Services segment, and our discontinued mortgage operations.
Discontinued Operations - Operating Results (in 000s)
Three months ended July 31, 2012 2011
Revenues $ - $ 167,136
Pretax income (loss) from operations:
RSM and related businesses $ 528 $ 7,131
Mortgage (3,463 ) (2,654 )
(2,935 ) 4,477
Income taxes (benefit) (1,144 ) 2,196
Net income (loss) from operations (1,791 ) 2,281
Pretax impairment on sales of businesses - (99,697 )
Income tax benefit - (41,473 )
Net loss on sales of businesses - (58,224 )
Net loss from discontinued operations $ (1,791 ) $ (55,943 )
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Three months ended July 31, 2012 compared to July 31, 2011
The net loss from our discontinued operations totaled $1.8 million for the three
months ended July 31, 2012. The net loss in the prior year totaled $55.9
million, and included a $99.7 million pretax goodwill impairment related to the
sales of RSM McGladrey, Inc. (RSM) and McGladrey Capital Markets LLC (MCM).
Representation and Warranty Claims
SCC has accrued a liability as of July 31, 2012 for estimated contingent losses
arising from representations and warranties on loans and securities it
originated and sold, of $129.3 million, which represents SCC's estimate of the
probable loss that may occur. Losses on claims reviewed and deemed to be valid
totaled $0.8 million and $0.5 million for the three months ended July 31, 2012
and 2011, respectively. These amounts were recorded as reductions of SCC's
accrued representation and warranty liability.
See additional discussion in Item 1, note 11 to the consolidated financial
statements.
FINANCIAL CONDITION
These comments should be read in conjunction with the consolidated balance
sheets and condensed consolidated statements of cash flows found on pages 1 and
3, respectively.
CAPITAL RESOURCES AND LIQUIDITY - Our sources of capital include cash from
operations, cash from customer deposits, issuances of common stock and debt. We
use capital primarily to fund working capital, pay dividends, repurchase shares
of common stock and acquire businesses. Our operations are highly seasonal and
therefore generally require the use of cash to fund operating losses during the
period from May through mid-January.
Given the likely availability of a number of liquidity options discussed herein,
including borrowing capacity under our unsecured committed line of credit
(CLOC), we believe that in the absence of any unexpected developments, our
existing sources of capital at July 31, 2012 are sufficient to meet our
operating needs. See discussions below under "Borrowings" and "Regulatory
Environment" for details of our new CLOC and pending regulatory changes.
OPERATING ACTIVITIES- Cash used in operations totaled $373.1 million for three
months ended July 31, 2012, compared with $394.5 million for the same period
last year. This decrease is due to lower tax payments and operating losses in
the current year.
Restricted Cash. We hold certain cash balances that are restricted as to use.
Cash and cash equivalents - restricted totaled $43.1 million at July 31, 2012,
and primarily consisted of cash held by our captive insurance subsidiary that
will be used to pay claims and cash held by HRB Bank required for regulatory
compliance.
INVESTING ACTIVITIES - Cash used in investing activities totaled $6.7 million
for the current quarter, compared to $14.3 million in the same period last year.
Available-for-Sale Securities. During the three months ended July 31, 2012, HRB
Bank purchased $29.0 million in mortgage-backed securities, compared to $39.3
million in the prior year. Additionally, we received payments as a result of
maturing AFS securities of $19.9 million during the three months ended July 31,
2012 compared to $7.7 million in the prior year. See additional discussion in
Item 1, note 5 to the consolidated financial statements.
Mortgage Loans Held for Investment. We received net proceeds of $12.7 million
and $11.2 million on our mortgage loans held for investment for the first three
months of fiscal years 2013 and 2012, respectively.
Purchases of Property and Equipment. Total cash paid for property and equipment
was $13.3 million and $11.0 million for the three months ended July 31, 2012 and
2011, respectively.
Business Acquisitions. Total cash paid for acquisitions was $3.0 million and
$3.5 million during the three months ended July 31, 2012 and 2011, respectively.
Sales of Businesses. Proceeds from the sales of businesses totaled $21.2 million
for the three months ended July 31, 2011, as our former Business Services
segment sold one of their ancillary businesses for $20.3 million. We also sold
83 tax offices in the prior year. The majority of these sales were financed
through affiliate loans. We had no similar sales in the current period.
Loans Made to Franchisees. Loans made to franchisees totaled $5.1 million and
$16.5 million for the three months ended July 31, 2012 and 2011, respectively.
These amounts included both the financing of sales of tax offices and franchisee
draws under our Franchise Equity Lines of Credit.
FINANCING ACTIVITIES - Cash used in financing activities totaled $623.1 million
for the three months ended July 31, 2012, compared to $257.3 million in the same
period last year.
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Customer Banking Deposits. Customer banking deposits decreased $179.5 million
for the three months ended July 31, 2012 compared to a decrease of $186.2
million in the prior year.
Dividends. We have consistently paid quarterly dividends. Dividends paid totaled
$54.2 million and $45.9 million for the three months ended July 31, 2012 and
2011, respectively.
Repurchase and Retirement of Common Stock. We purchased and immediately retired
21.3 million shares of our common stock at a cost of $315.0 million during the
three months ended July 31, 2012. We also paid cash totaling $22.5 million
related to 1.5 million shares that had not yet settled and was accrued as of
April 30, 2012.
In June 2012, our Board of Directors extended the authorization to purchase up
to $2.0 billion of our common stock through June 2015. There was $857.5 million
remaining under this authorization at July 31, 2012.
HRB BANK - At July 31, 2012, HRB Bank had cash balances of $341.0 million.
Distribution of that cash balance would be subject to regulatory approval and it
is therefore not available for general corporate purposes.
Block Financial LLC (Block Financial) typically makes capital contributions to
HRB Bank to help meet its capital requirements. Block Financial made capital
contributions to HRB Bank of $400.0 million during fiscal year 2012. No such
contributions were made during the three months ended July 31, 2012.
ASSETS HELD BY FOREIGN SUBSIDIARIES - At July 31, 2012, cash and short-term
investment balances of $107.5 million were held by our foreign subsidiaries.
These funds would have to be repatriated to be available to fund domestic
operations, and income taxes would be accrued and paid on those amounts. We do
not currently intend to repatriate any funds held by our foreign subsidiaries.
BORROWINGS
The following chart provides the debt ratings for Block Financial as of July 31,
2012:
Short-term Long-term Outlook
Moody's P-2 Baa2 Negative
S&P A-2 BBB Negative
As described more fully in our Current Report on Form 8-K, filed with the
Securities and Exchange Commission (SEC) on August 20, 2012, we terminated our
previous CLOC agreement and we entered into a new five-year, $1.5 billion Credit
and Guarantee Agreement (2012 CLOC). Funds available under the 2012 CLOC may be
used for general corporate purposes or for working capital needs. The 2012 CLOC
bears interest at an annual rate of LIBOR plus an applicable rate ranging from
0.750% to 1.45% or PRIME plus an applicable rate ranging from 0.000% to 0.450%
(depending on the type of borrowing and our then current credit ratings) and
includes an annual facility fee ranging from 0.125% to 0.300% of the committed
amounts (also depending on our then current credit ratings). The 2012 CLOC is
subject to various conditions, triggers, events or occurrences that could result
in earlier termination and contains customary representations, warranties,
covenants and events of default, including those discussed in Item 1, note 16 to
the consolidated financial statements. In addition, the 2012 CLOC includes
provisions which allow us to cure any potential default, including an equity
cure.
There have been no other material changes in our borrowings from those reported
at April 30, 2012 in our Annual Report on Form 10-K.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
There have been no material changes in our contractual obligations and
commercial commitments from those reported at April 30, 2012 in our Annual
Report on Form 10-K.
REGULATORY ENVIRONMENT
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank
Act) made extensive changes to the laws regulating banks, holding companies and
financial services firms, and requires various federal agencies to adopt a broad
range of new implementing rules and regulations and prepare numerous studies and
reports for Congress. Among other changes, the Dodd-Frank Act imposes
consolidated capital requirements on savings and loan holding companies (SLHCs).
These requirements may have a significant long term effect on H&R Block, Inc.,
H&R Block Group, Inc. and Block Financial (our Holding Companies). The
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Dodd-Frank Act requires the Federal Reserve to promulgate minimum capital
requirements for SLHCs, including leverage (Tier 1) and risk-based capital
requirements that are no less stringent than those applicable to banks at the
time the Dodd-Frank Act was adopted.
On June 7, 2012, the Federal Reserve issued a notice of proposed rulemaking on
increased capital requirements, implementing changes required by the Dodd-Frank
Act and aspects of the Basel III regulatory capital reforms, portions of which
would apply to top-tier SLHCs including H&R Block, Inc. Later in June 2012, the
Office of the Comptroller of the Currency (OCC) and the Federal Deposit
Insurance Corporation (FDIC) joined the Federal Reserve in requesting comments
on the notice of proposed rulemaking. The proposed rules include new risk-based
capital and leverage ratios including (1) minimum common equity Tier 1
risk-based capital ratio of 4.5%; (2) minimum Tier 1 risk-based capital ratio of
6.0%; (3) minimum total risk-based capital ratio of 8.0%; and (4) minimum Tier 1
capital to adjusted average consolidated assets (leverage ratio) of 4.0%. The
proposed rules also require the subtraction of goodwill and other intangibles
from our GAAP capital for the purposes of calculating our Tier 1 capital. The
proposed capital requirements for SLHCs, if implemented as proposed, would
require us to retain additional capital, restrict our ability to pay dividends
and repurchase shares of our common stock and/or alter our strategic plans. If
implemented as proposed, these capital requirements would be phased in
incrementally beginning January 1, 2013, with full implementation to occur by
January 1, 2015.
In addition, the proposed rules add a requirement for a minimum capital
conservation buffer of 2.5% of risk-weighted assets, which would be incremental
to each of the above ratios except for the leverage ratio. If implemented as
proposed, the conservation buffer would be phased in, starting at 0.625% on
January 1, 2016, increasing by that amount each year until fully implemented
effective January 1, 2019. The capital conservation buffer would result in the
following minimum ratios: (1) a common equity Tier 1 risk-based capital ratio of
7.0%; (2) a Tier 1 risk-based capital ratio of 8.5%; and (3) a total risk-based
capital ratio of 10.5%. Failure to maintain a conservation buffer would result
in restrictions on capital distributions, which includes dividends and share
repurchase activity, and certain discretionary cash bonus payments to executive
officers.
The deadline for comment on the proposed rules was extended through October 22,
2012. Various banking associations, industry groups, and individual companies
are providing comments on the proposed rules to the regulators. We intend to
file a comment letter asking the Federal Reserve to follow the Collins
Amendment, which includes provisions that defer the effective date for new
minimum capital requirements for SLHCs until July 21, 2015, and make the
proposed capital requirements for SLHCs effective no earlier than such date.
After the comment period is closed, the regulators will review the comments and
publish final rules, which may vary substantially from the proposed rules. As
such, the regulations ultimately applicable to our Holding Companies may be
substantially different from the proposed regulations. If such regulations are
implemented as proposed, banks and their holding companies, including our
Holding Companies, will be subject to higher minimum capital requirements and
will be required to hold a greater amount of equity than currently required, as
discussed below in Part II, Item 1A, "Risk Factors." We will continue to monitor
the rulemaking process for any modifications or clarifications that may be made
prior to finalization and are conducting a thorough review and analysis of our
options. There is no assurance that the proposed rules will be adopted in their
current form, what changes may be made prior to adoption, when the final rules
will be effective, or how the final rules will ultimately affect our business.
There have been no other material changes in our regulatory environment from
those reported at April 30, 2012 in our Annual Report on Form 10-K.
FORWARD-LOOKING INFORMATION
This report and other documents filed with the SEC may contain forward-looking
statements within the meaning of the securities laws. In addition, our senior
management may make forward-looking statements orally to analysts, investors,
the media and others. Forward-looking statements can be identified by the fact
that they do not relate strictly to historical or current facts. They often
include words or variation of words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates," "projects," "forecasts," "targets,"
"would," "will," "should," "could" or "may" or other similar expressions.
Forward-looking statements provide management's current expectations or
predictions of future conditions, events or results. All statements that address
operating performance, events or developments that we expect or anticipate will
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occur in the future are forward-looking statements. They may include estimates
of revenues, income, earnings per share, capital expenditures, dividends,
liquidity, capital structure or other financial items, descriptions of
management's plans or objectives for future operations, products or services, or
descriptions of assumptions underlying any of the above. All forward-looking
statements speak only as of the date they are made and reflect the Company's
good faith beliefs, assumptions and expectations, but they are not guarantees of
future performance or events. Furthermore, the Company disclaims any obligation
to publicly update or revise any forward-looking statement to reflect changes in
underlying assumptions, factors, or expectations, new information, data or
methods, future events or other changes, except as required by law. By their
nature, forward-looking statements are subject to risks and uncertainties that
could cause actual results to differ materially from those suggested by the
forward-looking statements. Factors that might cause such differences include,
but are not limited to, a variety of economic, competitive and regulatory
factors, many of which are beyond the Company's control and which are described
in our Annual Report on Form 10-K for the fiscal year ended April 30, 2012 in
the section entitled "Risk Factors," as well as additional factors we may
describe from time to time in other filings with the Securities and Exchange
Commission. It is not possible to predict or identify all such factors and,
consequently, no such list should be considered to be a complete set of all
potential risks or uncertainties.
