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| H&R BLOCK INC filed this Form 10-Q on 09/03/08 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C.
20549
FORM
10-Q
Commission file
number 1-6089
H&R
Block, Inc.
(Exact name of registrant as
specified in its charter)
One
H&R Block Way
Kansas
City, Missouri 64105
(Address of principal executive
offices, including zip code)
(816) 854-3000
(Registrant’s telephone
number, including area code)
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):
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
July 31, 2008 was 328,088,753 shares.
Form 10-Q
for the Period Ended July 31, 2008
Table of
Contents
CONDENSED
CONSOLIDATED BALANCE
SHEETS (amounts
in 000s, except share and per share amounts)
See Notes to
Condensed Consolidated Financial Statements
See Notes to
Condensed Consolidated Financial Statements
See Notes to
Condensed Consolidated Financial Statements
See Notes to
Condensed Consolidated Financial Statements
The condensed consolidated balance sheet as of July 31,
2008, the condensed consolidated statements of operations and
comprehensive income (loss) for the three months ended
July 31, 2008 and 2007, the condensed consolidated
statements of cash flows for the three months ended
July 31, 2008 and 2007, and the condensed consolidated
statement of stockholders’ equity for the three months
ended July 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 July 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 reclassifications have been made to prior year amounts
to conform to the current year presentation. These
reclassifications had no effect on our results of operations or
stockholders’ equity as previously reported.
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, 2008
Annual Report to Shareholders on
Form 10-K.
All amounts presented herein as of April 30, 2008 or for
the year then ended, are derived from our April 30, 2008
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.
Basic and diluted 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. 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
25.7 million shares and 31.3 million shares for the
three months ended July 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 three months
ended July 31, 2008 increased to 327.1 million from
323.9 million at July 31, 2007, primarily due the
issuance of treasury shares related to our stock-based
compensation plans.
During the three months ended July 31, 2008 and 2007, we
issued 2.3 million and 1.6 million shares of common
stock, respectively, due to the exercise of stock options,
employee stock purchases and awards of nonvested shares.
During the three months ended July 31, 2008, we acquired
0.2 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 $4.1 million. During the three
months ended July 31, 2007, we acquired 0.2 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 $5.4 million.
During the three months ended July 31, 2008, we granted
4.1 million stock options and 0.9 million nonvested
shares and units in accordance with our stock-based compensation
plans. The weighted average fair value of options granted was
$3.70 for manager options and $2.83 for options granted to our
seasonal associates. At July 31, 2008, the total
unrecognized compensation cost for options and nonvested shares
and units was $19.0 million and $34.1 million,
respectively.
Changes in the carrying amount of goodwill for the three months
ended July 31, 2008 consist of the following:
(in
000s)
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 three months ended
July 31, 2008.
Intangible assets consist of the following:
Amortization of intangible assets for the three months ended
July 31, 2008 and 2007 was $5.6 million and
$15.5 million, respectively. Estimated amortization of
intangible assets for fiscal years 2009 through 2013 is
$22.8 million, $20.2 million, $18.4 million,
$15.7 million and $11.7 million, respectively.
We file a consolidated federal income tax return in the United
States and file tax returns in various state and foreign
jurisdictions. The consolidated tax returns for the years
1999 – 2005 are currently under examination by the
Internal Revenue Service (IRS). 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 three months ended July 31, 2008, we accrued an
additional $2.9 million of interest & penalties
related to our uncertain tax positions. We had unrecognized tax
benefits of $137.2 million and $137.6 million at
July 31, 2008 and April 30, 2008, respectively. There
were no significant changes in our unrealized tax positions
during the quarter. We have classified the liability for
unrecognized tax benefits, including corresponding accrued
interest, as long-term at July 31, 2008, which is included
in other noncurrent liabilities on the condensed consolidated
balance sheet. Amounts that we expect to pay, or for which
statutes expire, 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 $9 to
$10 million within twelve months of July 31, 2008.
The following table shows the components of interest income and
expense of our continuing operations. Operating interest expense
is included in cost of other revenues, and interest expense on
acquisition debt is included in other income, net on our
consolidated statements of operations.
(in
000s)
On May 1, 2008, we adopted Statement of Financial
Accounting Standards No. 157, “Fair Value
Measurements” (SFAS 157). SFAS 157 defines fair
value, establishes a framework for measuring fair value and
expands disclosure requirements for fair value measurements. We
elected to defer the application of SFAS 157 for
nonfinancial assets and nonfinancial liabilities until fiscal
year 2010, as provided for by FASB Staff Position
FAS 157-2,
“Effective Date of FASB Statement No. 157”
(FSP 157-2).
The adoption of SFAS 157 did not have an impact on our
consolidated results of operations or financial position.
Fair Value Hierarchy
SFAS 157 establishes a fair value hierarchy that
prioritizes the inputs used to measure fair value into three
broad levels, considering the relative reliability of the
inputs, as follows:
Estimation of Fair
Value
The following is a description of the valuation methodologies
used for assets and liabilities measured at fair value and the
general classification of these instruments pursuant to the fair
value hierarchy.
Assets and
Liabilities Measured at Fair Value on a Recurring Basis
The following table presents for each hierarchy level the assets
that are measured at fair value on a recurring basis at
July 31, 2008:
(dollars
in 000s)
The following table presents changes in Level 3 assets
measured at fair value on a recurring basis for the three months
ended July 31, 2008:
Trading securities and mortgage loans held for sale are included
in prepaid expenses and other current assets, and
available-for-sale
securities and residual interests in securitizations are
included in other assets on our condensed consolidated balance
sheets.
Fair Value Option
We adopted Statement of Financial Accounting Standards
No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities” (SFAS 159) on
May 1, 2008. SFAS 159 permits an instrument by
instrument irrevocable election to account for selected
financial assets and financial liabilities at fair value. We did
not elect to apply the fair value option to any eligible
financial assets or financial liabilities on May 1, 2008 or
during the three months ended July 31, 2008. Subsequent to
the initial adoption, we may elect to account for selected
financial assets and financial liabilities at fair value. Such
an election could be made at the time an eligible financial
asset, financial liability or firm commitment is recognized or
when certain specified reconsideration events occur.
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 July 31,
2008, HRBFA’s net capital of $60.4 million, which was
14.4% of aggregate debit items, exceeded its minimum required
net capital of $8.4 million by $52.0 million.
HRBFA had pledged customer-owned securities with a fair value of
$48.5 million at July 31, 2008 with a clearing
organization to satisfy margin deposit requirements of
$40.4 million.
Banking
H&R Block Bank (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
our 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.
As of July 31, 2008, HRB Bank’s leverage ratio was
12.3%.
As of June 30, 2008, 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 June 30, 2008 that management
believes have changed HRB Bank’s category.
The following table sets forth HRB Bank’s regulatory
capital requirements at June 30, 2008, as calculated in the
most recently filed TFR:
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:
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. Other 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 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 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 we will ultimately prevail in the event any such
claims are asserted, we believe the fair value of these
guarantees and indemnifications is not material as of
July 31, 2008.
Mortgage Loan
Repurchase Liability
Sand Canyon Corporation (SCC), formerly Option One Mortgage
Corporation, maintains recourse with respect to loans previously
sold or securitized under indemnification of loss provisions
relating to breach of representations and warranties made to
purchasers or insurers. As a result, SCC may be required to
repurchase loans or otherwise indemnify third-parties for
losses. These representations and warranties and corresponding
repurchase obligations generally are not subject to stated
limits or a stated term and, therefore, may continue for the
foreseeable future. SCC has established a liability related to
potential losses under these indemnifications and monitors the
adequacy of the repurchase liability on an ongoing basis. To the
extent that future claim volumes differ from current estimates,
or the value of mortgage loans and residential home prices
change, future losses may be different than these estimates and
those differences may be significant. The following table
summarizes SCC’s loan repurchase activity:
We are party to investigations, legal claims and lawsuits
arising out of our business operations. We accrue our best
estimate of the probable loss upon resolution of investigations,
legal claims and lawsuits, which totaled $10.5 million and
$11.5 million at July 31, 2008 and April 30,
2008, respectively. With respect to most of the matters
described below, we have concluded that a loss is not probable
and therefore no liability has been recorded.
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 or regarding the impact of the
RAL Cases on our financial statements. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of the currently pending RAL
Cases. There were no significant developments regarding the RAL
Cases during the three months ended July 31, 2008.
Peace of Mind
Litigation
We are defendants in lawsuits regarding our Peace of Mind
program (collectively, the “POM Cases”). The POM Cases
are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services,
Inc., et al., Case
No. 08-CV-591
in the U.S. District Court for the Southern District of
Illinois, is a class action case originally filed in the Circuit
Court of Madison County, Illinois on January 18, 2002, in
which class certification was granted 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
(1) statutory fraud by selling insurance without a license,
(2) an unfair trade practice, by omission and by
“cramming” (i.e., charging customers for the guarantee
even though they did not request it or want it), and (3) 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 (1) were charged a
separate fee for POM by “H&R Block” or a
defendant H&R Block class member; (2) 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 (3) 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
and Texas were 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 product. On
August 5, 2008, the court decertified the defendant class
and reduced the geographical scope of the plaintiff classes from
48 states to 13 states. On August 19, 2008, we
removed the case from state court in Madison County, Illinois to
the U.S. District Court for the Southern District of
Illinois. 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 pending
before the same judge that presided over the Texas RAL
Settlement, involves the same plaintiffs’ attorneys that
are involved in the Marshall litigation in Illinois, and
contains similar allegations. No class has been certified in
this case.
We believe the claims in the POM Cases are without merit, and we
intend to defend them vigorously. The amounts claimed in the POM
Cases are substantial, however, and there can be no assurances
as to the outcome of these pending actions individually or in
the aggregate. We are unable to determine an estimate of the
possible loss or range of loss, if any, in light of the early
stages of the POM Cases.
Electronic Filing
Litigation
We are a defendant in 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 (1) file tax returns
free of charge by mailing the returns, (2) electronically
file tax returns from personal computers either free of charge
or at significantly lower
fees and (3) 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. In March 2008, we reached a tentative
agreement to settle this case for an amount not to exceed
$2.5 million and have accrued $1.5 million,
representing our best estimate of ultimate loss. The settlement
was preliminarily approved on June 27, 2008, with a final
fairness hearing scheduled for September 2008.
Express IRA
Litigation
On March 15, 2006, the New York Attorney General filed a
lawsuit in the Supreme Court of the State of New York, County of
New York (Index No. 06/401110) entitled The People of
New York v. H&R Block, Inc. and H&R Block
Financial Advisors, Inc. et al. The complaint alleged
fraudulent business practices, deceptive acts and practices,
common law fraud and breach of fiduciary duty with respect to
the Express IRA product and sought equitable relief,
disgorgement of profits, damages and restitution, civil
penalties and punitive damages. On July 12, 2007, the
Supreme Court of the State of New York issued a ruling that
dismissed all defendants other than HRBFA and the claims of
common law fraud. Both the New York Attorney General and HRBFA
have appealed the adverse portions of the trial court’s
ruling. 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. The defendants have filed a
motion to dismiss. 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 product, 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 these cases are without
merit, and we intend to defend these cases vigorously, but there
are no assurances as to their outcome.
We are unable to determine an estimate of the possible loss or
range of loss, if any, in light of the early stages of the
Express IRA litigation.
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 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. On
March 11, 2008, the plaintiffs appealed the dismissal. In
addition, plaintiffs in a shareholder derivative action that was
consolidated into the securities litigation filed a separate
appeal on March 18, 2008, contending that the derivative
action was improperly consolidated. The derivative action is
Iron Workers Local 16 Pension Fund v. H&R Block, et
al., in the United States District Court for the Western
District of Missouri, Case
No. 06-cv-00466-ODS
(instituted on June 8, 2006) and was brought against
certain of our directors and officers purportedly on behalf of
the Company. The derivative action alleges breach of fiduciary
duty, abuse of control, gross mismanagement, waste, and unjust
enrichment pertaining to (1) our restatement of financial
results in
fiscal year 2006 due to errors in determining our state
effective income tax rate and (2) certain of our products
and business activities. We believe the claims in these cases
are without merit and intend to defend this litigation
vigorously. We currently do not believe that we will incur a
material loss with respect to this litigation.
RSM McGladrey
Litigation
RSM EquiCo, Inc., a subsidiary of RSM McGladrey, Inc. (RSM), is
a party to a putative class action filed on July 11, 2006
and entitled Do Right’s Plant Growers, et al. v.
RSM EquiCo, Inc., et al. Case No. 06 CC00137, in the
California Superior Court, Orange County. The complaint contains
allegations regarding business valuation services provided by
RSM EquiCo, Inc., including fraud, negligent misrepresentation,
breach of contract, breach of implied covenant of good faith and
fair dealing, breach of fiduciary duty and unfair competition
and seeks unspecified damages, restitution and equitable relief.
We intend to defend this case vigorously. The amount claimed in
this action is substantial and there can be no assurance
regarding the outcome and resolution of this matter. It is
reasonably possible that we could incur losses with respect to
this litigation, although an estimate of such losses cannot be
made in light of the early stage of the litigation.
RSM has a relationship with certain public accounting firms
(collectively, “the Attest Firms”) pursuant to which
(1) some RSM employees are also partners or employees of
the Attest Firms, (2) many clients of the Attest Firms are
also RSM clients, and (3) our RSM McGladrey brand is
closely linked to the Attest Firms. The Attest Firms are parties
to claims and lawsuits (collectively, “Attest Firm
Claims”). Judgments or settlements arising from Attest Firm
Claims, which exceed the Attest Firms’ insurance coverage,
could have a direct adverse effect on Attest Firm operations,
and could impair RSM’s ability to attract and retain
clients and quality professionals. Accordingly, although RSM is
not a direct party to significant Attest Firm Claims, such
Attest Firm Claims could 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 the Attest
Firm Claims.
Litigation and
Claims Pertaining to Discontinued Mortgage Operations
Although mortgage loan origination activities were terminated
and the loan servicing business was sold during fiscal year
2008, SCC remains subject to investigations, claims and lawsuits
pertaining to its loan origination and servicing activities that
occurred prior to such termination and sale. These
investigations, claims and lawsuits include actions by state
attorneys general, other state regulators, municipalities,
individual plaintiffs, and cases in which plaintiffs seek to
represent a class of others alleged to be similarly situated.
Among other things, these investigations, claims and lawsuits
allege discriminatory or unfair and deceptive loan origination
and servicing practices, public nuisance, fraud, and violations
of the Truth in Lending Act, Equal Credit Opportunity Act and
the Fair Housing Act. In the current non-prime mortgage
environment, the number of these investigations, claims and
lawsuits has increased over historical experience and is likely
to continue at increased levels. The amounts claimed in these
investigations, claims and lawsuits are substantial in some
instances, and the ultimate resulting liability is difficult to
predict. In the event of unfavorable outcomes, the amounts SCC
may be required to pay in the discharge of liabilities or
settlements could be substantial and, because 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)
entitled Commonwealth of Massachusetts v. H&R
Block, Inc., et al., alleging unfair, deceptive and
discriminatory origination and servicing of mortgage loans and
seeks equitable relief, disgorgement of profits, restitution and
statutory penalties. 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. We are unable to
determine an estimate of the possible loss or range of loss, if
any, in light of the early stages of this litigation.
SCC also remains subject to potential claims for indemnification
and loan repurchases pertaining to loans previously sold. In the
current non-prime mortgage environment, it is likely that the
frequency of repurchase and indemnification claims may increase
over historical experience and give rise to additional
litigation. In some instances, H&R Block, Inc. was required
to guarantee SCC’s obligations. The amounts involved in
these potential claims may be substantial, and the ultimate
resulting liability is difficult to
predict. In the event of unfavorable outcomes, the amounts SCC
may be required to pay in the discharge or settlement of these
claims 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.
Other Claims and
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. Some of these
investigations, claims and lawsuits pertain to RALs, the
electronic filing of customers’ income tax returns, the POM
guarantee program, wage and hour claims and investment products.
We believe we have meritorious defenses to each of these claims,
and we are defending or intend to defend them vigorously. The
amounts claimed in these claims and lawsuits are substantial in
some instances, however the ultimate liability with respect to
such litigation and claims is difficult to predict. In the event
of an unfavorable outcome, the amounts we may be required to pay
in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are parties
to claims and lawsuits that we consider to be ordinary, routine
litigation incidental to our business, including claims and
lawsuits (collectively, “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,
intellectual property disputes, employment matters and contract
disputes. While we cannot provide assurance that we will
ultimately prevail in each instance, we believe the amount, if
any, we are required to pay in the discharge of liabilities or
settlements in these Other Claims will not have a material
adverse effect on our consolidated operating results or
financial position.
Information concerning our operations by reportable operating
segment is as follows:
In June 2008, FASB Staff Position on
EITF 03-6-1,
“Determining Whether Instruments Granted in Share-Based
Payment Transactions are Participating Securities”
(FSP 03-6-1)
was issued.
FSP 03-6-1
addresses whether instruments granted in share-based payment
transactions are participating securities prior to vesting and,
therefore, should be included in the process of allocating
earnings for purposes of computing earnings per share. This
guidance is effective for financial statements issued for fiscal
years and interim periods beginning after December 15,
2008. Early application is not permitted. We are currently
evaluating what effect
FSP 03-6-1
will have on our consolidated financial statements.
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.
As discussed in note 6, we adopted SFAS 157 and
SFAS 159 as of May 1, 2008.
During fiscal year 2008, we exited the mortgage business
operated through a subsidiary and sold the related loan
servicing business. Our discontinued operations reflect the
wind-down of our mortgage origination business and, as a result,
our discontinued operations reported a net loss of
$3.4 million for the three months ended July 31, 2008
compared to $192.8 million in the prior year.
The financial results of discontinued operations are as follows:
Restructuring Charge
During fiscal year 2006, our mortgage business initiated a
restructuring plan to reduce costs. Restructuring activities
continued into the current year, including our previously
announced closure of all mortgage origination activities and
sale of servicing operations. We did not incur any charges
during the three months ended July 31, 2008, compared to
$16.1 million in the prior year. Changes in our
restructuring charge liability during the three months ended
July 31, 2008 are as follows:
The remaining liability related to this restructuring charge is
included in accounts payable, accrued expenses and other current
liabilities and accrued salaries, wages and payroll taxes on our
consolidated balance sheet and primarily relates to lease
obligations for vacant space resulting from branch office
closings and employee severance costs, respectively.
Contract termination costs include estimates regarding the
length of time required to sublease vacant space and expected
recovery rates. Actual results could vary from these estimates.
On August 12, 2008, we announced the signing of a
definitive agreement to sell HRBFA to Ameriprise Financial, Inc.
The transaction is subject to customary regulatory approvals,
and is expected to close in three to six months. The purchase
price is $315 million in cash, subject to working capital
and advisor retention adjustments at closing. The transaction is
not expected to result in a material gain or loss for financial
reporting purposes. The transaction involves the sale of all
outstanding common stock of HRB
Financial Corporation, HRBFA’s direct parent, and is
expected to result in a capital loss for income tax purposes. We
currently do not expect to be able to realize a benefit for this
capital loss.
This business will be presented as
held-for-sale
and as discontinued operations beginning with our quarter ending
October 31, 2008. Major classes of assets and liabilities
of HRB Financial Corporation as of July 31, 2008 are as
follows:
Had HRBFA been reported as discontinued operations as of
July 31, 2008, revenues of $67.7 million and
$87.2 million for the three months ended July 31, 2008
and 2007, respectively, and a pretax loss of $1.8 million
and pretax income of $3.9 million, respectively, would have
been included in discontinued operations on our consolidated
statements of operations. Overhead costs of a continuing nature
which would have previously been allocated to HRBFA totaled
$1.8 million and $2.5 million for the three months
ended July 31, 2008 and 2007, respectively, and will be
included in continuing operations.
On September 3, 2008 we announced the signing of a
definitive agreement to acquire our last major independent
franchise operator for approximately $278 million. This
franchise includes a network of over 600 tax offices, nearly
two-thirds
of which will convert to
company-owned
offices upon the closing of the transaction. The remaining
offices are currently operated by
sub-franchisees
and, as a result, will become our direct franchises. The
transaction is expected to close by the end of our second fiscal
quarter.
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 $500.0 million credit
facility entered into in April 2007, the Senior Notes issued on
January 11, 2008 and October 26, 2004, our unsecured
committed lines of credit (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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