10-Q 1 c19129e10vq.htm FORM 10-Q e10vq
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
FORM 10-Q
 
     
(Mark One)    
[X]
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended October 31, 2007
OR
[  ]
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
 
Commission file number 1-6089
 
(H and R BLOCK LOGO)
 
H&R Block, Inc.
(Exact name of registrant as specified in its charter)
 
     
MISSOURI   44-0607856
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
One H&R Block Way
Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
 
(816) 854-3000
(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 or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer   Ö    Accelerated filer          Non-accelerated filer        
 
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 November 30, 2007 was 325,034,129 shares.


 

 
(H and R BLOCK LOGO)
 
Form 10-Q for the Period Ended October 31, 2007
 
 
Table of Contents
 
             
        Page
 
           
PART I
 
Financial Information
       
           
      1  
           
        2  
           
        3  
           
        4  
           
        5  
           
      32  
           
      52  
           
      53  
           
         
           
      54  
           
      56  
           
      59  
           
      59  
           
      60  
       
    61  
 
 Amendment Number Nine to the Second Amended and Restated Sale and Servicing Agreement
 Kiosk License Agreement
 Omnibus Amendment
 Amendment Number Three to the Second Amended and Restated Sale and Servicing Agreement
 Amendment Number Two to the Amended and Restated Note Purchase Agreement
 Receivables Purchase Agreement
 Indenture
 Note Purchase Agreement
 Amendment Number Ten to the Amended and Restated Note Purchase Agreement
 Omnibus Amendment
 Advances, Pledge and Security Agreement
 Amendment Number One to the Indenture
 Certification of CEO Pursuant to Section 302
 Certification of CFO Pursuant to Section 302
 Certification of CEO Pursuant to Section 906
 Certification of CFO Pursuant to Section 906


Table of Contents

 
(H and R BLOCK LOGO)
 
­ ­
CONDENSED CONSOLIDATED BALANCE SHEETS (amounts in 000s, except share and per share amounts)
 
                 
    October 31, 2007     April 30, 2007  
 
    (Unaudited)        
 
ASSETS
               
Cash and cash equivalents
  $ 386,915     $ 921,838  
Cash and cash equivalents – restricted
    237,176       332,646  
Receivables from customers, brokers, dealers and clearing organizations, less allowance for doubtful accounts of $2,345 and $2,292
    414,557       410,522  
Receivables, less allowance for doubtful accounts
of $109,266 and $99,259
    486,802       556,255  
Prepaid expenses and other current assets
    219,562       208,564  
Assets of discontinued operations, held for sale
    2,236,021       1,746,959  
                 
Total current assets
    3,981,033       4,176,784  
Mortgage loans held for investment, less allowance
for loan losses of $15,492 and $3,448
    1,082,301       1,358,222  
Property and equipment, at cost less accumulated depreciation and amortization of $648,766 and $647,151
    383,930       379,066  
Intangible assets, net
    161,199       181,413  
Goodwill
    1,007,695       993,919  
Other assets
    490,613       454,646  
                 
Total assets
  $ 7,106,771     $ 7,544,050  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Liabilities:
               
Commercial paper and other short-term borrowings
  $ 500,000     $ 1,567,082  
Customer banking deposits
    886,533       1,129,263  
Accounts payable to customers, brokers and dealers
    568,122       633,189  
Accounts payable, accrued expenses and other current liabilities
    400,738       519,372  
Accrued salaries, wages and payroll taxes
    123,424       307,854  
Accrued income taxes
    22,647       439,472  
Current portion of long-term debt
    11,480       9,304  
Liabilities of discontinued operations, held for sale
    1,363,207       615,373  
                 
Total current liabilities
    3,876,151       5,220,909  
Long-term debt
    2,144,012       519,807  
Other noncurrent liabilities
    542,328       388,835  
                 
Total liabilities
    6,562,491       6,129,551  
                 
Stockholders’ equity:
               
Common stock, no par, stated value $.01 per share,
800,000,000 shares authorized, 435,890,796 shares issued at
October 31, 2007 and April 30, 2007
    4,359       4,359  
Additional paid-in capital
    678,407       676,766  
Accumulated other comprehensive income (loss)
    1,131       (1,320 )
Retained earnings
    1,981,378       2,886,440  
Less cost of 111,009,460 and 112,671,610 shares of
common stock in treasury
    (2,120,995 )     (2,151,746 )
                 
Total stockholders’ equity
    544,280       1,414,499  
                 
Total liabilities and stockholders’ equity
  $     7,106,771     $     7,544,050  
                 
 
See Notes to Condensed Consolidated Financial Statements


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Table of Contents

 
(H and R BLOCK LOGO)
 
­ ­
CONDENSED CONSOLIDATED STATEMENTS OF
INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(unaudited, amounts in 000s,
except per share amounts)
 
                                 
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
 
 
Revenues:
                               
Service revenues
  $ 373,817     $ 347,942     $ 695,480     $ 650,738  
Other revenues:
                               
Interest income
    39,599       29,975       81,437       55,685  
Product and other revenues
    21,408       18,166       39,116       32,430  
                                 
      434,824       396,083       816,033       738,853  
                                 
Operating expenses:
                               
Cost of services
    428,733       399,254       812,133       762,779  
Cost of other revenues
    58,806       25,573       102,335       43,780  
Selling, general and administrative
    180,876       162,972       326,700       312,043  
                                 
      668,415       587,799       1,241,168       1,118,602  
                                 
Operating loss
    (233,591 )     (191,716 )     (425,135 )     (379,749 )
Interest expense
    (652 )     (12,091 )     (1,247 )     (24,226 )
Other income, net
    10,507       5,188       19,066       11,382  
                                 
Loss from continuing operations before tax benefit
    (223,736 )     (198,619 )     (407,316 )     (392,593 )
Income tax benefit
    (87,631 )     (77,622 )     (161,388 )     (153,757 )
                                 
Net loss from continuing operations
    (136,105 )     (120,997 )     (245,928 )     (238,836 )
Net loss from discontinued operations
    (366,166 )     (35,463 )     (558,923 )     (49,001 )
                                 
Net loss
  $ (502,271 )   $ (156,460 )   $ (804,851 )   $ (287,837 )
                                 
Basic and diluted loss per share:
                               
Net loss from continuing operations
  $ (0.42 )   $ (0.38 )   $ (0.76 )   $ (0.74 )
Net loss from discontinued operations
    (1.13 )     (0.11 )     (1.72 )     (0.15 )
                                 
Net loss
  $ (1.55 )   $ (0.49 )   $ (2.48 )   $ (0.89 )
                                 
Basic and diluted shares
    324,694       321,742       324,279       322,706  
                                 
Dividends per share
  $ 0.143     $ 0.135     $ 0.28     $ 0.26  
                                 
Comprehensive income (loss):
                               
Net loss
  $ (502,271 )   $ (156,460 )   $ (804,851 )   $ (287,837 )
Change in unrealized gain on available-for-sale securities, net
    1,626       1,667       1,163       (844 )
Change in foreign currency translation adjustments
    (3,023 )     (329 )     1,288       489  
                                 
Comprehensive loss
  $   (503,668 )   $   (155,122 )   $   (802,400 )   $   (288,192 )
                                 
 
See Notes to Condensed Consolidated Financial Statements


2


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(H and R BLOCK LOGO)
 
­ ­
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, amounts in 000s)
 
                 
Six Months Ended October 31,   2007     2006  
 
 
Cash flows from operating activities:
               
Net loss
  $ (804,851 )   $ (287,837 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    75,246       71,964  
Stock-based compensation expense
    17,550       17,262  
Changes in assets and liabilities of discontinued operations
    243,306       (189,494 )
Other, net of business acquisitions
    (473,376 )     (783,866 )
                 
Net cash used in operating activities
    (942,125 )     (1,171,971 )
                 
Cash flows from investing activities:
               
Mortgage loans originated or purchased for investment, net
    76,889       (278,003 )
Purchases of property and equipment, net
    (48,480 )     (80,440 )
Payments made for business acquisitions, net of cash acquired
    (21,037 )     (12,670 )
Net cash provided by (used in) investing activities of discontinued operations
    9,596       (8,864 )
Other, net
    5,763       (29,274 )
                 
Net cash provided by (used in) investing activities
    22,731       (409,251 )
                 
Cash flows from financing activities:
               
Repayments of commercial paper
     (5,125,279 )      (2,295,573 )
Proceeds from issuance of commercial paper
    4,133,197       3,336,002  
Repayments of line of credit borrowings
    (1,005,000 )     -  
Proceeds from line of credit borrowings
    2,555,000       -  
Customer deposits, net
    (243,030 )     595,769  
Dividends paid
    (90,495 )     (84,225 )
Purchase of treasury shares
    -       (180,897 )
Proceeds from exercise of stock options
    13,434       10,640  
Net cash provided by (used in) financing activities of discontinued operations
    200,812       (100 )
Other, net
    (54,168 )     (71,520 )
                 
Net cash provided by financing activities
    384,471       1,310,096  
                 
Net decrease in cash and cash equivalents
    (534,923 )     (271,126 )
Cash and cash equivalents at beginning of the period
    921,838       673,827  
                 
Cash and cash equivalents at end of the period
  $ 386,915     $ 402,701  
                 
Supplementary cash flow data:
               
Income taxes paid, net of refunds received of $71,724 and $1,468
  $ (52,360 )   $ 313,016  
Interest paid on borrowings
    73,998       39,683  
Interest paid on deposits
    28,039       9,892  
 
See Notes to Condensed Consolidated Financial Statements


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­ ­
 
(H and R BLOCK LOGO)
 
­ ­
CONDENSED CONSOLIDATED STATEMENT OF
STOCKHOLDERS’ EQUITY
(unaudited, amounts in 000s,
except per share amounts)
 
                                                                                 
                                  Accumulated
                         
                Convertible
    Additional
    Other
                         
    Common Stock     Preferred Stock     Paid-in
    Comprehensive
    Retained
    Treasury Stock     Total
 
    Shares     Amount     Shares     Amount     Capital     Income (Loss)     Earnings     Shares     Amount     Equity  
 
 
Balances at April 30, 2006
    435,891     $ 4,359       -     $ -     $ 653,053     $ 21,948     $ 3,492,059       (107,378 )   $ (2,023,620 )   $ 2,147,799  
Net loss
    -       -       -       -       -       -       (287,837 )     -       -       (287,837 )
Unrealized translation gain
    -       -       -       -       -       489       -       -       -       489  
Change in net unrealized gain on available-for-sale securities
    -       -       -       -       -       (844 )     -       -       -       (844 )
Stock-based compensation
    -       -       -       -       21,955       -       -       -       -       21,955  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (1,495 )     -       -       726       13,831       12,336  
Nonvested shares
    -       -       -       -       (15,160 )     -       -       778       14,798       (362 )
ESPP
    -       -       -       -       513       -       -       258       4,915       5,428  
Acquisitions
    -       -       -       -       54       -       -       21       396       450  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (8,380 )     (186,560 )     (186,560 )
Cash dividends paid – $0.26 per share
    -       -       -       -       -       -       (84,225 )     -       -       (84,225 )
                                                                                 
Balances at October 31, 2006
      435,891     $     4,359                -     $           -     $   658,920     $     21,593     $  3,119,997        (113,975 )   $ (2,176,240 )   $  1,628,629  
                                                                                 
                                                                                 
Balances at April 30, 2007
    435,891     $ 4,359       -     $ -     $ 676,766     $ (1,320 )   $ 2,886,440       (112,672 )   $ (2,151,746 )   $ 1,414,499  
Remeasurement of uncertain tax positions upon adoption of FIN 48
    -       -       -       -       -       -       (9,716 )     -       -       (9,716 )
Net loss
    -       -       -       -       -       -       (804,851 )     -       -       (804,851 )
Unrealized translation gain
    -       -       -       -       -       1,288       -       -       -       1,288  
Change in net unrealized gain on available-for-sale securities
    -       -       -       -       -       1,163       -       -       -       1,163  
Stock-based compensation
    -       -       -       -       20,750       -       -       -       -       20,750  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (5,105 )     -       -       940       17,944       12,839  
Nonvested shares
    -       -       -       -       (14,439 )     -       -       742       14,167       (272 )
ESPP
    -       -       -       -       400       -       -       218       4,161       4,561  
Acquisitions
    -       -       -       -       35       -       -       8       151       186  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (245 )     (5,672 )     (5,672 )
Cash dividends paid – $0.28 per share
    -       -       -       -       -       -       (90,495 )     -       -       (90,495 )
                                                                                 
Balances at October 31, 2007
    435,891     $ 4,359       -     $ -     $ 678,407     $ 1,131     $ 1,981,378       (111,009 )   $ (2,120,995 )   $ 544,280  
                                                                                 
 
See Notes to Condensed Consolidated Financial Statements


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­ ­
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
1.  Basis of Presentation
The condensed consolidated balance sheet as of October 31, 2007, the condensed consolidated statements of income and comprehensive income for the three and six months ended October 31, 2007 and 2006, the condensed consolidated statements of cash flows for the six months ended October 31, 2007 and 2006, and the condensed consolidated statement of stockholders’ equity for the six months ended October 31, 2007 and 2006 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 October 31, 2007 and for all periods presented have been made. 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. Actual results could differ from those estimates.
“H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2007 Annual Report to Shareholders on Form 10-K.
Operating revenues of the Tax Services and Business Services segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
 
Discontinued Operations – Recent Developments
On April 19, 2007, we entered into an agreement to sell Option One Mortgage Corporation (OOMC) to Cerberus Capital Management (Cerberus). In conjunction with this plan, we also announced we would terminate the operations of H&R Block Mortgage Corporation (HRBMC), a wholly-owned subsidiary of OOMC.
On December 4, 2007, we agreed to terminate the agreement with Cerberus in light of the changing business environment for OOMC, as mutually acceptable alternatives for restructuring the original agreement could not be reached. We also announced that we would immediately terminate all remaining origination activities and pursue the sale of OOMC’s loan servicing activities. OOMC had existing loan applications in its pipeline of $69.4 million in gross loan principal amount at October 31, 2007. We believe that only approximately $20 million to $30 million of these loans will ultimately be funded, at which time our mortgage origination activities will cease. We believe a majority of these loans will be eligible for sale to Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).
Termination of the mortgage lending activities of OOMC is expected to result in a pretax restructuring charge of $74.8 million. The restructuring charge covers expected severance and lease termination costs, write-off of property, plant and equipment and related shutdown costs. Of the total restructuring charge, $34.9 million was incurred in our second quarter ending October 31, 2007, with the remainder to be incurred primarily in our third quarter ending January 31, 2008. This charge, combined with the restructuring activities previously announced, brings our total restructuring charges for the three and six months ended October 31, 2007 to $61.0 million and $77.1 million, respectively.
Following the termination of its loan origination activities, OOMC will continue to carry out its servicing activities and collect servicing revenues as it does today. Because of the cessation of new originations, the volume of mortgage loans serviced will gradually decline as the aggregate principal amount of existing loans being serviced declines without replacement. The majority of servicing activities are carried out with respect to loans owned by third parties.


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We have estimated the fair values of the servicing business and other assets, which resulted in an additional asset impairment for the second quarter ending October 31, 2007 of $123.0 million, bringing our total impairment recorded in discontinued operations to $146.2 million for the six months ended October 31, 2007.
During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the six months ended October 31, 2007. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services. As of October 31, 2007, these businesses are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.
 
2.  Earnings (Loss) Per Share
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 30.2 million shares and 30.7 million shares for the three and six months ended October 31, 2007, respectively, and 32.5 million shares for the three and six months ended October 31, 2006, 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 and six months ended October 31, 2007 increased to 324.7 million and 324.3 million, respectively, from 321.7 million and 322.7 million for the three and six months ended October 31, 2006, respectively, primarily due the issuance of treasury shares related to our stock-based compensation plans.
During the six months ended October 31, 2007 and 2006, we issued 1.9 million and 1.8 million shares of common stock, respectively, pursuant to the exercise of stock options, employee stock purchases and awards of nonvested shares, in accordance with our stock-based compensation plans.
During the six months ended October 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 $5.7 million. During the six months ended October 31, 2006, we acquired 8.4 million shares of our common stock, of which 8.1 million shares were purchased from third parties with the remaining shares swapped or surrendered to us, at an aggregate cost of $186.6 million.
During the six months ended October 31, 2007, we granted 5.0 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 $4.53 for manager and director options and $3.07 for options granted to our seasonal associates. At October 31, 2007, the total unrecognized compensation cost for options and nonvested shares and units was $26.2 million and $49.4 million, respectively.
 
3.  Goodwill and Intangible Assets
Changes in the carrying amount of goodwill of continuing operations for the six months ended October 31, 2007 consist of the following:
(in 000s)
                           
 
    April 30, 2007   Additions   Other     October 31, 2007
 
 
Tax Services
  $ 415,077   $ 13,334   $ 7,519     $ 435,930
Business Services
    404,888     356     (7,433 )     397,811
Consumer Financial Services
    173,954     -     -       173,954
                           
Total
  $ 993,919   $ 13,690   $ 86     $ 1,007,695
                           
 
 
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


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reduced below its carrying value. No impairments of goodwill were identified within any of our operating segments during the six months ended October 31, 2007.
Intangible assets of continuing operations consist of the following:
                                         
(in 000s)
 
    October 31, 2007   April 30, 2007
    Gross
            Gross
         
    Carrying
  Accumulated
        Carrying
  Accumulated
     
    Amount   Amortization     Net   Amount   Amortization     Net
 
 
Tax Services:
                                       
Customer relationships
  $ 45,123   $ (19,453 )   $ 25,670   $ 39,347   $ (14,654 )   $ 24,693
Noncompete agreements
    22,979     (19,344 )     3,635     21,237     (18,279 )     2,958
Purchased technology
    12,500     (1,305 )     11,195     12,500     -       12,500
Trade name
    1,025     (67 )     958     1,025     -       1,025
Business Services:
                                       
Customer relationships
    144,143     (94,464 )     49,679     142,315     (90,900 )     51,415
Noncompete agreements
    32,266     (16,309 )     15,957     31,352     (15,524 )     15,828
Trade name – amortizing
    3,290     (3,006 )     284     3,290     (2,430 )     860
Trade name – non-amortizing
    55,637     (4,868 )     50,769     55,637     (4,868 )     50,769
Consumer Financial Services:
                                       
Customer relationships
    293,000     (289,948 )     3,052     293,000     (271,635 )     21,365
                                         
Total intangible assets
  $ 609,963   $ (448,764 )   $ 161,199   $ 599,703   $ (418,290 )   $ 181,413
                                         
 
 
Amortization of intangible assets of continuing operations for the three and six months ended October 31, 2007 was $15.0 million and $30.5 million, respectively. Amortization of intangible assets of continuing operations for the three and six months ended October 31, 2006 was $13.9 million and $28.6 million, respectively. Estimated amortization of intangible assets for fiscal years 2008 through 2012 is $45.7 million, $22.0 million, $19.4 million, $17.6 million and $14.9 million, respectively.
 
4.  Borrowings
H&R Block Bank (HRB Bank) is a member of the Federal Home Loan Bank (FHLB) of Des Moines, which extends credit to member banks based on eligible collateral. At October 31, 2007, HRB Bank had FHLB advance capacity of $428.9 million, and there was $104.0 million outstanding on this facility. Mortgage loans held for investment of $1.1 billion were pledged as collateral on these advances.
At October 31, 2007, we maintained $2.0 billion in revolving credit facilities to support commercial paper issuance and for general corporate purposes. These unsecured committed lines of credit (CLOCs), and outstanding borrowings thereunder, have a maturity date of August 2010 and an annual facility fee in a range of six to fifteen basis points per annum, based on our credit ratings. Negative market conditions during our second fiscal quarter and recent credit rating downgrades continued to negatively impact the availability of commercial paper. As a result, during the current quarter we repaid our commercial paper borrowings with proceeds from the CLOCs, and had no outstanding commercial paper as of October 31, 2007. We had a combined $1.6 billion outstanding under our $2.0 billion in available CLOCs as of October 31, 2007. These borrowings are included in long-term debt on our condensed consolidated balance sheet due to their contractual maturity date. The CLOCs, among other things, require we maintain at least $650.0 million of Adjusted Net Worth, as defined in the agreement, on the last day of any fiscal quarter. On November 19, 2007, effective October 31, 2007, the CLOCs were amended to, among other things, require $450.0 million of Adjusted Net Worth, for the fiscal quarters ending October 31, 2007 and January 31, 2008. Before the end of the second quarter, we initiated efforts to seek an amendment to the Minimum Net Worth Requirement (i) in light of the possibility that we might not have met the Minimum Net Worth Requirement for the fiscal quarter ended October 31, 2007, (ii) to obtain flexibility for purposes of negotiating a sale of OOMC, and (iii) in light of the possibility that, without the amendment, we would not be in compliance with the Minimum Net Worth Covenant as of January 31, 2008 without taking steps to raise additional capital. When financial results for the six months ended October 31, 2007 were finalized, we determined that we had an Adjusted Net Worth of $544.3 million at October 31, 2007, primarily due to operating losses of our discontinued operations. Subsequent to October 31, 2007, we drew additional funds on the CLOCs to bring total borrowings to $1.8 billion as of the date of this filing.


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In April 2007, we obtained a $500.0 million credit facility to provide funding for the $500.0 million of 81/2% Senior Notes which were due April 16, 2007. This facility matures on December 20, 2007. The facility was fully drawn at closing and is subject to various covenants that are similar to our primary CLOCs. We expect to refinance this facility when it matures.
 
5.  Income Taxes
In June 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) was issued. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
We adopted the provisions of FIN 48 on May 1, 2007 and, as a result, recognized a $9.7 million decrease to retained earnings as of May 1, 2007. Total unrecognized tax benefits as of May 1, 2007 were $133.3 million, of which $89.0 million, on a gross basis, were tax positions that, if recognized, would impact the effective tax rate. Net unrecognized tax benefits that would impact the effective tax rate totaled $50.0 million as of May 1, 2007.
We recognize interest and, if applicable, penalties related to unrecognized tax benefits as a component of income tax expense. As of May 1, 2007 we accrued $36.6 million for the potential payment of interest and penalties. Interest was estimated by applying the applicable statutory rate of interest of each of the jurisdictions identified on uncertain tax positions.
In the second quarter, we accrued an additional $2.4 million of interest & penalties related to our uncertain tax positions. As of October 31, 2007 we had unrecognized tax benefits of $130.8 million. The primary change during the quarter was related to the expiration of statutes of limitations for various jurisdictions during the quarter. We have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at October 31, 2007, which is included in other noncurrent liabilities on the condensed consolidated balance sheet. Amounts that we expect to pay within the next twelve months have been included in accounts payable, accrued expenses and other current liabilities on the condensed consolidated balance sheet.
Based upon the expiration of statutes of limitations, payments of tax and other factors in several jurisdictions, we believe it is reasonably possible that the total amount of previously unrecognized tax benefits may decrease by approximately $8 million to $9 million within twelve months of October 31, 2007.
We file a consolidated federal tax return in the United States and income tax returns in various state and foreign jurisdictions. We are no longer subject to U.S. federal income tax audits for years before 1999. The U.S. federal audit for years 1999 through 2003 is in its final stages. The Internal Revenue Service (IRS) has commenced an audit for the years 2004 and 2005. With respect to our Canadian operations, audits for tax years 1996 through 2001 have been completed and are in the final stages, and tax years 2002 and 2003 are currently under audit. With respect to state and local jurisdictions, with limited exceptions, H&R Block, Inc. and its subsidiaries are no longer subject to income tax audits for years before 1999.
 
6.  Regulatory Requirements
 
Registered Broker-Dealer
H&R Block Financial Advisors, Inc. (HRBFA) is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. At October 31, 2007, HRBFA’s net capital of $91.2 million, which was 20.0% of aggregate debit items, exceeded its minimum required net capital of $9.1 million by $82.0 million. During the three months ended October 31, 2007, HRBFA paid a dividend of $37.5 million to Block Financial Corporation (BFC), its direct corporate parent.
The fair value of pledged securities at October 31, 2007 totaled $57.9 million, an excess of $6.0 million over the margin requirement.


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Banking
HRB Bank and the Company are subject to various regulatory capital guidelines and requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HRB Bank and the consolidated financial statements. All savings associations are subject to the capital adequacy guidelines and the regulatory framework for prompt corrective action. HRB Bank must meet specific capital guidelines that involve quantitative measures of HRB Bank’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. HRB Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. HRB Bank files its regulatory Thrift Financial Report (TFR) on a calendar quarter basis.
Quantitative measures established by regulation to ensure capital adequacy require HRB Bank to maintain minimum amounts and ratios of tangible equity, total risk-based capital and Tier 1 capital, as set forth in the table below. In addition to these minimum ratio requirements, HRB Bank is required to continually maintain a 12.0% minimum leverage ratio as a condition of its charter-approval order through fiscal year 2009. This condition was extended through fiscal year 2012 as a result of a Supervisory Directive issued on May 29, 2007. See further discussion of the Supervisory Directive below. As of October 31, 2007, HRB Bank’s leverage ratio was 14.8%.
As of September 30, 2007, our most recent TFR filing with the Office of Thrift Supervision (OTS), HRB Bank was a “well capitalized” institution under the prompt corrective action provisions of the Federal Deposit Insurance Corporation (FDIC). The five capital categories are: (1) “well capitalized” (total risk-based capital ratio of 10%, Tier 1 Risk-based capital ratio of 6% and leverage ratio of 5%); (2) “adequately capitalized”; (3) “undercapitalized”; (4) “significantly undercapitalized”; and (5) “critically undercapitalized.” There are no conditions or events since September 30, 2007 that management believes have changed HRB Bank’s category.
The following table sets forth HRB Bank’s regulatory capital requirements at September 30, 2007, as calculated in the most recently filed TFR:
(dollars in 000s)
                                     
 
            To Be Well
            Capitalized
            Under Prompt
        For Capital Adequacy
  Corrective Action
    Actual   Purposes   Provisions
    Amount   Ratio   Amount   Ratio   Amount   Ratio
 
 
Total risk-based capital ratio(1)
  $ 186,851     28.5%   $ 52,519     8.0%   $ 65,649     10.0%
Tier 1 risk-based capital ratio(2)
  $ 178,638     27.2%     n/a     n/a   $ 39,389     6.0%
Tier 1 capital ratio (leverage)(3)
  $ 178,638     14.6%   $ 147,074     12.0%   $ 61,281     5.0%
Tangible equity ratio(4)
  $ 178,638     14.6%   $ 18,384     1.5%     n/a     n/a
 
 
  (1)  Total risk-based capital divided by risk-weighted assets.
  (2)  Tier 1 (core) capital less deduction for low-level recourse and residual interest divided by risk-weighted assets.
  (3)  Tier 1 (core) capital divided by adjusted total assets.
  (4)  Tangible capital divided by tangible assets.
In conjunction with H&R Block, Inc.’s application with the OTS for HRB Bank, H&R Block, Inc. made commitments as part of our charter approval order (Master Commitment) which included, but were not limited to: (1) H&R Block, Inc. to maintain a three percent minimum ratio of adjusted tangible capital to adjusted total assets, as defined by the OTS; (2) maintain all HRB Bank capital within HRB Bank in accordance with the submitted three-year business plan; and (3) follow federal regulations surrounding intercompany transactions and approvals. H&R Block, Inc. fell below the three percent minimum ratio at April 30, 2007. We notified the OTS of our failure to meet this requirement, and on May 29, 2007, the OTS issued a Supervisory Directive. We submitted a revised capital plan to the OTS on July 19, 2007, in which we expected to meet the three percent minimum ratio at April 30, 2008. The OTS accepted our revised capital plan.
The Supervisory Directive included additional conditions that we will be required to meet in addition to the Master Commitment. The significant additional conditions included in the Supervisory Directive are as


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follows: (1) requires HRB Bank to extend its compliance with a minimum 12.0% leverage ratio through fiscal year 2012; (2) requires H&R Block, Inc. to comply with the Master Commitment at all times, except for the projected capital levels and compliance with the three percent minimum ratio, as provided in the fiscal year 2008 and 2009 capital adequacy projections presented to the OTS on July 19, 2007; (3) institutes reporting requirements to the OTS quarterly and monthly by the Board of Directors and management, respectively; and (4) requires HRB Bank’s Board of Directors to have an independent chairperson and at least the same number of outside directors as inside directors.
Operating losses of our discontinued operations for the first six months of fiscal year 2008 were higher than projected in our revised capital plan that was submitted to the OTS in July 2007. As a result, our capital levels are lower than those projections. H&R Block, Inc. continued to be below the three percent minimum ratio during our second quarter, and had adjusted tangible capital of negative $644.4 million, and a requirement of $177.5 million to be in compliance at October 31, 2007.
In November 2007, the OTS directed us to submit a new revised capital plan no later than January 15, 2008. At this time, we do not expect to be in compliance with the three percent minimum ratio at April 30, 2008. We do not expect to be in a position to repurchase treasury shares until sometime after fiscal year 2009. Achievement of the capital plan depends on future events and circumstances, the outcome of which cannot be assured. If we are not in a position to cure deficiencies and if operating results continue to be below our plan, a resulting failure could impair our ability to repurchase shares of our common stock, acquire businesses or pay dividends.
Failure to meet the conditions under the Master Commitment and the Supervisory Directive, including capital levels of H&R Block, Inc., could result in the OTS taking further regulatory actions, such as a supervisory agreement, cease-and-desist orders and civil monetary penalties. The OTS could also require us to sell assets, which could negatively impact our financial statements. At this time, the financial impact, if any, of additional regulatory actions cannot be determined.
 
7.  Commitments and Contingencies
Changes in the deferred revenue liability related to our Peace of Mind (POM) program, the current portion of which is included in accounts payable, accrued expenses and other current liabilities and the long-term portion of which is included in other noncurrent liabilities in the condensed consolidated balance sheets, are as follows:
                     
(in 000s)
 
Six Months Ended October 31,   2007     2006      
 
 
Balance, beginning of period
  $ 142,173     $ 141,684      
Amounts deferred for new guarantees issued
    1,067       1,178      
Revenue recognized on previous deferrals
    (46,388 )     (48,694 )    
                     
Balance, end of period
  $ 96,852     $ 94,168      
                     
 
 
The following table summarizes certain of our other contractual obligations and commitments:
                 
(in 000s)
 
As of   October 31, 2007   April 30, 2007    
 
 
Commitment to fund Franchise
               
Equity Lines of Credit
  $ 81,484   $ 79,628    
Media advertising purchase obligation
    37,749     37,749    
Contingent business acquisition obligations
    30,376     19,891    
 
 
On November 1, 2006 we entered into an agreement to purchase $57.2 million in media advertising between November 1, 2006 and June 30, 2009. We expect to make payments totaling $20.6 million and $17.2 million during fiscal years 2008 and 2009, respectively.
We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees, including obligations to protect counterparties from losses arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) litigation involving our directors and officers; and (d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to


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these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance that such claims will not be successfully asserted, we believe the fair value of these guarantees and indemnifications is not material as of October 31, 2007.
 
8.  Litigation and Related Contingencies
 
RAL Litigation
We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things, disclosures in the RAL applications were inadequate, misleading and untimely; the RAL interest rates were usurious and unconscionable; we did not disclose that we would receive part of the finance charges paid by the customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act and unfair competition regarding debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial in some instances. We have successfully defended against numerous RAL Cases, some of which were dismissed on our motions for dismissal or summary judgment, and others were dismissed voluntarily by the plaintiffs after denial of class certification. Other cases have been settled, 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 (the “2006 Settlements”).
We believe we have meritorious defenses to the remaining RAL Cases and we intend to defend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Likewise, there can be no assurances regarding the impact of the RAL Cases on our financial statements. There were no significant developments regarding the RAL Cases during the fiscal quarter ended October 31, 2007.
 
Peace of Mind Litigation.
We are defendants in lawsuits regarding our Peace of Mind (POM) program (the “POM Cases”). The POM Cases are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Civil Action 2003L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2002, that was granted class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POM program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (i) statutory fraud by selling insurance without a license, (ii) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (iii) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (i) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (ii) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (iii) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama are excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated or associated with H&R Block Tax Services, Inc., and that sold or sells the POM product. The trial court subsequently denied the defendants’ motion to certify class certification issues for interlocutory appeal. Discovery is proceeding. No trial date has been set.
There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is being tried before the same judge that presided over the Texas RAL Settlement, involves the


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same plaintiffs’ attorneys that are involved in the Marshall litigation in Illinois, and contains similar allegations. No class has been certified in this case.
We believe the claims in the POM actions are without merit, and we intend to defend them vigorously. The amounts claimed in the POM actions are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate. Likewise, there can be no assurances regarding the impact of these actions on our consolidated financial statements.
 
Electronic Filing Litigation
We are a defendant to a class action filed on August 30, 2002 and entitled Erin M. McNulty and Brian J. Erzar v. H&R Block, Inc., et al., Case No. 02-CIV-4654 in the Court of Common Please of Lackawanna County, Pennsylvania, in which the plaintiffs allege that the defendants deceptively portray electronic filing fees as a necessary and required component of standard tax preparation services and do not inform tax preparation clients that they may (i) file tax returns free of charge by mailing the returns, (ii) electronically file tax returns from personal computers either free of charge are at significantly lower fees and (iii) be eligible to electronically file tax returns free of charge via telephone. The plaintiffs seek unspecified damages and disgorgement of all electronic filing, tax preparation and related fees collected during the applicable class period. Class certification was granted in this case on September 5, 2007. We believe the claims in this case are without merit, and we intend to defend them vigorously, but there can be no assurances as to its outcome.
 
Express IRA Litigation
On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York (Index No. 06/401110) entitled The People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. On July 12, 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than H&R Block Financial Advisors, Inc. and the claims of common law fraud. We intend to defend this case vigorously, but there are no assurances as to its outcome.
In addition to the New York Attorney General action, a number of civil actions were filed against us concerning the Express IRA matter, the first of which was filed on March 17, 2006. Except for two cases pending in state court, all of the civil actions have been consolidated by the panel for Multi-District Litigation into a single action styled In re H&R Block, Inc. Express IRA Marketing Litigation in the United States District Court for the Western District of Missouri. We intend to defend these cases vigorously, but there are no assurances as to their outcome.
 
Securities Litigation
On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation was filed against the Company and certain of its officers in the United States District Court for the Western District of Missouri. The complaint alleged, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of 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. We intend to defend this litigation vigorously, but there are no assurances as to its outcome.
 
HRBFA Litigation
As reported previously, the NASD brought charges against HRBFA regarding the sale by HRBFA of Enron debentures in 2001. The hearing for this matter was concluded in August 2007, and post-hearing briefs were submitted in October 2007. We intend to defend the NASD charges vigorously, although there can be no assurances regarding the outcome and resolution of the matter.


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RSM McGladrey Litigation
As part of an industry-wide review, the IRS is investigating tax-planning strategies that certain RSM McGladrey (RSM) clients utilized during fiscal years 2000 through 2003. Specifically, the IRS is examining these strategies to determine whether RSM complied with tax shelter reporting and listing regulations and whether such strategies were abusive as defined by the IRS. The IRS has indicated that it will assess a fine against RSM for RSM’s alleged failure to comply with the tax shelter reporting and listing regulations. RSM is in discussions with the IRS regarding this penalty, which we believe will not have a material adverse effect on RSM’s operations or on our consolidated financial statements. If the IRS were to determine that the tax planning strategies were inappropriate, clients that utilized the strategies could face penalties and interest for underpayment of taxes. Some of these clients are seeking or may attempt to seek recovery from RSM. There can be no assurance regarding the outcome and resolution of this matter.
RSM EquiCo, Inc., a subsidiary of RSM, is a party to a putative class action filed on July 11, 2006 and entitled Do Right’s Plant Growers v. RSM EquiCo, Inc., RSM McGladrey, Inc., H&R Block, Inc. and Does 1-100, inclusive, Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations regarding business valuation services provided by RSM EquiCo, Inc., including fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition and seeks unspecified damages, restitution and equitable relief. There can be no assurance regarding the outcome and resolution of this matter.
 
Other Litigation
We have from time to time been party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others similarly situated. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. Some of these investigations, claims and lawsuits pertain to RALs, the origination and servicing of mortgage loans, the electronic filing of customers’ income tax returns, the POM guarantee program, and our Express IRA program and other investment products and RSM EquiCo, Inc. business valuation services. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously, although there is no assurance as to their outcome. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could have a material adverse effect on our consolidated financial statements.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (Other Claims) concerning investment products, the preparation of customers’ income tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage foreclosures, other aspects of the mortgage business, intellectual property disputes, employment matters and contract disputes. We believe we have meritorious defenses to each of the Other Claims, and we are defending them vigorously. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material adverse effect on our consolidated financial statements.


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9.  Segment Information
Information concerning our operations by reportable operating segment is as follows:
 
                                 
(in 000s)  
   
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
   
 
Revenues:
                               
Tax Services
  $ 90,804     $ 81,984     $ 160,667     $ 147,642  
Business Services
    239,048       228,714       431,871       424,171  
Consumer Financial Services
    101,254       81,548       215,626       160,377  
Corporate
    3,718       3,837       7,869       6,663  
                                 
    $ 434,824     $ 396,083     $ 816,033     $ 738,853  
                                 
Pretax income (loss):
                               
Tax Services
  $ (199,149)     $ (166,893)     $ (371,438)     $ (319,947)  
Business Services
    11,781       1,024       9,875       (5,943)  
Consumer Financial Services
    (9,081)       (2,318)       (2,875)       (5,387)  
Corporate
    (27,287)       (30,432)       (42,878)       (61,316)  
                                 
Loss of continuing operations before tax benefit
  $ (223,736)     $ (198,619)     $ (407,316)     $ (392,593)  
                                 
 
 
As of October 31, 2007, the related financial results of OOMC, HRBMC and other smaller lines of business are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. See note 11 for additional information.
 
10.  New Accounting Pronouncements
In February 2007, Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115,” (SFAS 159), was issued. This standard allows a company to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on a contract-by-contract basis, with changes in fair value recognized in earnings. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of SFAS 159 will have on our consolidated financial statements.
In September 2006, Statement of Financial Accounting Standards No. 157, “Fair Value Instruments,” (SFAS 157), was issued. The provisions of this standard include guidelines about the extent to which companies measure assets and liabilities at fair value, the effect of fair value measurements on earnings, and establishes a fair value hierarchy that prioritizes the information used in developing assumptions used when valuing an asset or liability. The standard also requires increased disclosure of these fair value estimates. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of SFAS 157 will have on our consolidated financial statements.
In September 2006, Emerging Issues Task Force Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4) was issued. EITF 06-4 requires the recognition of a liability for an agreement with an employee to provide future postretirement benefits, as this obligation is not effectively settled upon entering into an insurance arrangement. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of EITF 06-4 will have on our consolidated financial statements.
In March 2006, Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140,” (SFAS 156), was issued. The provisions of this standard require mortgage servicing rights to be initially valued at fair value. SFAS 156 allows servicers to choose to subsequently measure their servicing rights at fair value or to continue using the “amortization method” under SFAS 140. We adopted SFAS 156 on May 1, 2007. Upon adoption we


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identified mortgage servicing rights (MSRs) relating to all existing residential mortgage loans as a class of servicing rights and elected to continue to use the “amortization method” for these MSRs. Presently, this class represents all of our MSRs. See note 11 for additional information on our MSRs. The adoption of SFAS 156 did not have a material impact on our condensed consolidated financial statements.
In February 2006, Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments – An Amendment of FASB Statements No. 133 and 140” (SFAS 155), was issued. The provisions of this standard establish a requirement to evaluate all newly acquired interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. The standard permits a hybrid financial instrument required to be bifurcated to be accounted for in its entirety if the holder irrevocably elects to measure the hybrid financial instrument at fair value, with changes in fair value recognized currently in earnings. We adopted SFAS 155 on May 1, 2007. Our residual interests typically have interests in derivative instruments embedded within the securitization trusts, which were previously excluded from evaluation. Concurrent with the adoption of SFAS 155, we elected to account for all newly-acquired residual interests on a fair value basis as trading securities, with changes in fair value recorded in earnings in the period in which the change occurs. Prior to adoption, we accounted for our residual interests as available-for-sale (AFS) securities with unrealized gains recorded in other comprehensive income. For residual interests recorded prior to the adoption of SFAS 155, we continue to record unrealized gains as a component of other comprehensive income. The adoption of SFAS 155 did not have a material impact on our condensed consolidated financial statements.
As discussed in note 5, we adopted the provisions of FIN 48 effective May 1, 2007.
 
11.  Discontinued Operations
On April 19, 2007, we entered into an agreement to sell OOMC to Cerberus. In conjunction with this plan, we also announced we would terminate the operations of HRBMC, a wholly-owned subsidiary of OOMC. On December 4, 2007, we agreed to terminate the agreement in light of the changing business environment for OOMC, as mutually acceptable alternatives for restructuring the original agreement could not be reached. We also announced that we would immediately terminate all remaining origination activities and pursue the sale of OOMC’s loan servicing activities. See additional discussion of recent developments in note 1.
During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the six months ended October 31, 2007. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services. As of October 31, 2007, these businesses are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.
 
Financial Statement Presentation
We recorded impairments relating to the disposition of our mortgage business during the six months ended October 31, 2007 of $144.7 million. We also recorded impairments relating to other discontinued businesses of $1.5 million during the six months ended October 31. 2007. Additionally, during fiscal year 2007 we recorded impairments relating to the disposition of our mortgage businesses of $345.8 million. At October 31, 2007, we had fully impaired the carrying value of goodwill and long-lived assets of our mortgage businesses. Cumulative impairments in excess of amounts related to the write-off of goodwill are reflected below as a valuation allowance as of October 31, 2007 relating to remaining assets held-for-sale. A similar amount, which totaled $193.4 million, is included in the table below in other liabilities at April 30, 2007, as it represented an obligation under the April  2007 agreement with Cerberus.
Overhead costs previously allocated to discontinued businesses, which totaled $1.4 million and $2.7 million for the three and six months ended October 31, 2007, respectively, and $3.4 million and $6.4 million for the three and six months ended October 31, 2006, respectively, are now included in continuing operations.


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As provided by in EITF No. 87-24, “Allocation of Interest to Discontinued Operations,” we have allocated interest expense to our discontinued operations based on borrowings that are specifically attributable to these operations at a rate of LIBOR plus 250 basis points. Interest expense of $24.3 million and $42.8 million was allocated to discontinued operations for the three and six months ended October 31, 2007, respectively. Interest expense of $5.0 million and $8.7 million was allocated to discontinued operations for the three and six months ended October 31, 2006, respectively. The increase over the prior year is due to the significant operating losses, increased servicing advances and other working capital needs of our mortgage operations during the last nine months.
The major classes of assets and liabilities reported as held-for-sale are as follows:
 
                   
(in 000s)
 
    October 31, 2007     April 30, 2007    
 
 
Cash and cash equivalents
  $ 27,075     $ 65,019    
Cash and cash equivalents – restricted
    3,342       43,754    
Residual interests in securitizations – trading
    1,367       72,691    
Mortgage loans held for sale
    70,214       101,567    
Mortgage loans – repurchase option
    927,364       121,243    
Servicing and related assets
    821,387       445,354    
Beneficial interest in Trusts
    -       41,057    
Residual interests in securitizations – AFS
    36,791       90,283    
Mortgage servicing rights
    199,596       253,067    
Deferred tax assets, net
    427,132       299,559    
Prepaid expenses and other assets
    59,845       213,365    
Valuation allowance
    (338,092 )     -    
                   
Assets held for sale
  $ 2,236,021     $ 1,746,959    
                   
Accounts payable, accrued expenses and deposits
  $ 119,243     $ 248,983    
Servicing advance facility
    286,646       -    
Mortgage loan repurchase liability
    927,364       121,243    
Other liabilities
    29,954       245,147    
                   
Liabilities directly associated with
assets held for sale
  $ 1,363,207     $ 615,373    
                   
 
 
 
The financial results of discontinued operations are as follows:
 
                                 
(in 000s)  
   
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
   
 
Revenue:
                               
Gains (losses) on sales of mortgage assets, net
  $ (314,006 )   $ 37,908     $ (556,021 )   $ 102,514  
Interest income
    11,528       14,624       26,627       29,924  
Loan servicing revenue
    93,016       113,579       190,415       222,503  
Other
    5,389       354       11,516       10,226  
                                 
    $ (204,073 )   $ 166,465     $ (327,463 )   $ 365,167  
                                 
Loss from operations before income tax benefit
  $ (428,169 )   $ (64,173 )   $ (740,337 )   $ (88,858 )
Impairment related to the disposition of businesses
    (123,000 )     -       (146,229 )     -  
                                 
Pretax loss
    (551,169 )     (64,173 )     (886,566 )     (88,858 )
Income tax benefit
    (185,003 )     (28,710 )     (327,643 )     (39,857 )
                                 
Net loss from discontinued operations
  $   (366,166 )   $   (35,463 )   $   (558,923 )   $   (49,001 )
                                 
 
 


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Mortgage Loans
We have entered into servicing agreements for loans we have securitized which include a “removal of accounts provision” that gives us the right, but not the obligation, to repurchase mortgage loans from the securitization trust. Rights under this provision can generally be exercised for loans that are 90 to 119 days delinquent. At the time this right becomes exercisable by us, Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140) requires that we record both the mortgage loans on our balance sheet and an offsetting mortgage loan repurchase liability. Mortgage loans, and the corresponding liability, recorded pursuant to this accounting requirement totaled $927.4 million at October 31, 2007 and $121.2 million at April 30, 2007. We do not intend to exercise our right under these provisions and, therefore, these do not represent mortgage loans that we are required to sell or repurchase obligations we are required to fulfill.
The gross principal amount of mortgage loans actually held for sale at October 31, 2007, totaled $134.8 million. We have recorded valuation adjustments relating to these loans totaling $64.6 million, resulting in net loans held for sale of $70.2 million.
 
Mortgage Banking Activities
We originate mortgage loans and sell most non-prime loans the same day the loans are funded to qualifying special purpose entities (QSPEs or Trusts). The Trusts are not consolidated. The sale is recorded in accordance with SFAS 140. The Trusts purchase the loans from us using warehouse facilities. The total principal amount of mortgage loans held by the Trusts as of October 31, 2007 and April 30, 2007 was $57.4 million and $1.5 billion, respectively. The beneficial interest in Trusts was written down to zero October 31, 2007 compared to a balance of $41.1 million at April 30, 2007.
Activity related to trading residual interests in securitizations consists of the following:
 
                     
(in 000s)
 
Six Months Ended October 31,   2007     2006      
 
 
Balance, beginning of period
  $ 72,691     $ -      
Additions (resulting from securitization of mortgage loans)
    39,417       119,669      
Cash received
    -       (8,103 )    
Accretion
    -       1,766      
Change in fair value
    2,367       (161 )    
                     
      114,475       113,171      
Residuals securitized in NIM transactions
    (114,475 )     (56,814 )    
Additions (resulting from NIM transactions)
    41,705       -      
Accretion
    4,685       -      
Change in fair value
    (45,023 )     -      
                     
Balance, end of period
  $ 1,367     $ 56,357      
                     
 
 
We adopted SFAS 155 on May 1, 2007 and concurrently elected to account for all newly-acquired residual interests on a fair value basis, with changes in fair value recorded in earnings in the period in which the change occurs. Residual interests existing prior to the adoption of SFAS 155 will continue to be accounted for with unrealized gains recorded in other comprehensive income.
Activity related to AFS residual interests in securitizations consists of the following:
 
                     
(in 000s)
 
Six Months Ended October 31,   2007     2006      
 
 
Balance, beginning of period
  $ 90,283     $ 159,058      
Additions (resulting from NIM transactions)
    -       4,234      
Cash received
    (950 )     (6,422 )    
Accretion
    11,992       24,621      
Impairments of fair value
    (66,273 )     (29,502 )    
Other
    (460 )     (1,672 )    
Change in unrealized holding gains or losses arising during the period
    2,199       (1,351 )    
                     
Balance, end of period
  $ 36,791     $ 148,966      
                     
 
 


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We did not securitize any mortgage loans during the second quarter of fiscal year 2008. Cash flows from AFS residual interests of $1.0 million and $6.4 million were received from the securitization trusts for the six months ended October 31, 2007 and 2006, respectively, and are included in investing activities of discontinued operations in the condensed consolidated statements of cash flows.
The following transactions were treated as non-cash investing activities in the condensed consolidated statement of cash flows:
 
                 
(in 000s)
 
Six Months Ended October 31,   2007   2006    
 
 
Residual interest mark-to-market
  $ 2,602   $ 8,157    
Additions to residual interests
    -     4,234    
Transfer of loans from held for investment to held for sale
    191,658     -    
 
 
For residual interests recorded prior to the adoption of SFAS 155, aggregate unrealized gains on AFS residual interests not yet recognized in income totaled $3.5 million at October 31, 2007, compared to $1.3 million at April 30, 2007. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and recognized in income either through accretion or upon further securitization or sale of the related residual interest. See additional discussion of our adoption of SFAS 155 in note 10.
Activity related to MSRs, which are initially measured at fair value and subsequently amortized and assessed for impairment, consists of the following:
 
                     
(in 000s)
 
Six Months Ended October 31,   2007     2006      
 
 
Balance, beginning of period
  $ 253,067     $ 272,472      
Additions
    28,954       92,914      
Amortization
    (82,251 )     (95,707 )    
Impairment of fair value
    (174 )     -      
                     
Balance, end of period
  $ 199,596     $ 269,679      
                     
 
 
Estimated amortization of MSRs for fiscal years 2008 through 2012 is $61.0 million, $74.5 million, $35.0 million, $14.7 million and $5.9 million, respectively. The fair value of MSRs at October 31, 2007 and April 30, 2007 was $344.7 million and $397.5 million, respectively.
In conjunction with our adoption of SFAS 156, we identified all of our residential mortgage loans as a class of servicing rights and elected to continue the amortization method. See additional discussion of our adoption of SFAS 156 in note 10. Servicing fees earned during the six months ended October 31, 2007 and 2006 totaled $194.5 million and $209.6 million, respectively, and are included in discontinued operations on our condensed consolidated income statements.
As part of our loan servicing responsibilities, we are required to advance funds to cover delinquent scheduled principal and interest payments to security holders, as well as to cover delinquent tax and insurance payments and other costs required to protect the investors’ interest in the collateral securing the loans. Generally, servicing advances are recoverable from either the mortgagor, the insurer of the loan or the investor through the non-recourse provision of the loan servicing contract. During the three months ended October 31, 2007 we entered into a facility to fund servicing advances. See additional discussion under “Warehouse Facilities.”
The key weighted average assumptions we used to estimate the cash flows and values of the residual interests initially recorded during the six months ended October 31, 2007 and 2006 are as follows:
 
                 
 
Six Months Ended October 31,   2007   2006    
 
 
Estimated credit losses
    6.36%     3.33%    
Discount rate
    28.00%     18.24%    
Variable returns to third-party beneficial interest holders
  LIBOR forward curve at closing date
 
 


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The key weighted average assumptions we used to estimate the cash flows and values of the residual interests and MSRs at October 31, 2007 and April 30, 2007 are as follows:
 
                 
 
    October 31, 2007   April 30, 2007    
 
 
Estimated credit losses – residual interests
    12.79%     5.04%    
Discount rate – residual interests
    30.00%     24.82%    
Discount rate – MSRs
    20.00%     20.00%    
Variable returns to third-party beneficial interest holders
  LIBOR forward curve at valuation date
 
 
Estimated credit losses in the table above includes residual interests from all fiscal years with outstanding underlying loan balances using unpaid principal balances as part of the weighted average calculation. See credit losses table below for detailed information by fiscal year.
We originate both adjustable- and fixed-rate mortgage loans. A key assumption used to estimate the cash flows and values of the residual interests and MSRs is average annualized prepayment speeds. Prepayment speeds include voluntary prepayments, involuntary prepayments and scheduled principal payments. Prepayment rate assumptions used during the current fiscal quarter are as follows:
 
                   
 
        Months Outstanding After
    Prior to Initial
  Initial Rate Reset Date
    Rate Reset Date   Zero - 3   Remaining Life
 
 
Adjustable rate mortgage loans:
                 
With prepayment penalties
    18%     38%     23%
Without prepayment penalties
    18%     38%     23%
Fixed rate mortgage loans:
                 
With prepayment penalties
    19%     22%     22%
 
 
For fixed-rate mortgages without prepayment penalties, we use an average prepayment rate of 22% over the life of the loans. Prepayment rate is projected based on actual paydown including voluntary, involuntary and scheduled principal payments.
Expected static pool credit losses are as follows:
 
                                           
 
    Mortgage Loans Securitized in Fiscal Year
 
    Prior to 2002   2003   2004   2005   2006   2007   2008
 
 
As of:
                                         
October 31, 2007
    -%     -%     -%     -%     -%     12.51%     13.59%
April 30, 2007
    5.11%     2.57%     3.45%     5.48%     6.79%     6.41%     -
April 30, 2006
    4.22%     2.13%     2.18%     2.48%     3.05%     -     -
April 30, 2005
    4.01%     2.08%     2.30%     2.83%     -     -     -
 
 
Static pool credit losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets.
At October 31, 2007, the sensitivities of the current fair value of the residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are as presented in the following table. These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without


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changing any other assumptions; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
 
                     
(dollars in 000s)
 
    Residual Interests
           
    Securitizations     MSRs      
 
 
Carrying amount/fair value
  $ 38,158     $ 199,596      
Weighted average remaining life (in years)
    8.7       1.5      
Dollar impact on fair value:
                   
Prepayments (including defaults):
                   
Adverse 10%
  $ (2,698 )   $ (11,878 )    
Adverse 20%
    (4,147 )     (22,906 )    
Credit losses:
                   
Adverse 10%
  $ (12,475 )     Not applicable      
Adverse 20%
    (16,158 )     Not applicable      
Discount rate:
                   
Adverse 10%
  $ (4,310 )   $ (8,334 )    
Adverse 20%
    (7,787 )     (16,038 )    
Variable interest rates:
                   
Adverse 10%
  $ 1,398       Not applicable      
Adverse 20%
    1,224       Not applicable      
 
 
Increases in prepayment rates can generate a positive impact to fair value when reductions in estimated credit losses and increases in prepayment penalties exceed the adverse impact to accretion from accelerating the life of the residual interest. Given the current market volatility, the change in credit losses or discount rate could exceed the ranges in the table above and result in little or no value to the residuals interests.
Mortgage loans that have been securitized and mortgage loans held for sale at October 31, 2007 and April 30, 2007, past due sixty days or more and the related credit losses incurred are presented below:
 
                                     
(in 000s)
 
    Total Principal
  Principal Amount of
  Credit Losses
    Amount of Loans
  Loans 60 Days or
  (net of recoveries)
    Outstanding   More Past Due   Three Months Ended
 
    October 31,
  April 30,
  October 31,
  April 30,
  October 31,
  April 30,
    2007   2007   2007   2007   2007   2007
 
 
Securitized mortgage loans
  $ 19,561,391   $ 18,434,940   $ 2,951,195   $ 1,383,832   $ 63,535   $ 41,235
Mortgage loans in warehouse Trusts
    57,378     1,456,078     -     -     -     -
Mortgage loans held for sale
    1,062,142     295,208     988,275     202,941     36,855     104,972
                                     
Total loans
  $ 20,680,911   $ 20,186,226   $ 3,939,470   $ 1,586,773   $ 100,390   $ 146,207
                                     
 
 


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Derivative Instruments
A summary of our derivative instruments as of October 31, 2007 and April 30, 2007, and gains or losses incurred during the three and six months ended October 31, 2007 and 2006 is as follows:
 
                                                 
(in 000s)  
   
          Gain (Loss) For the Three
    Gain (Loss) For the Six
 
    Asset (Liability) Balance at     Months Ended     Months Ended  
   
    October 31,
    April 30,
    October 31,     October 31,  
    2007     2007     2007     2006     2007     2006  
   
 
Rate-lock equivalents
  $ (516 )   $ (987 )   $ 7,973     $ (3,716 )   $ 472     $ 4,030  
Interest rate swaps
    57       10,774       (2,669 )     (33,447 )     (21 )     (20,267 )
Put options on Eurodollar futures
    -       1,212       -       (2,019 )     942       (2,058 )
Prime short sales
    -       75       (546 )     1,556       (448 )     995  
Forward loan sale commitments
    -       -       (26,072 )     9,576       -       2,493  
                                                 
    $ (459 )   $ 11,074     $ (21,314 )   $ (28,050 )   $ 945     $ (14,807 )
                                                 
 
 
We discontinued our hedging activities during our second quarter, and therefore derivative instruments to which we were a party at October 31, 2007 were limited to loan applications deemed to be rate-lock equivalents.
None of our derivative instruments were designated for hedge accounting treatment as of October 31, 2007 or April 30, 2007.
 
Commitments and Contingencies
We have commitments to fund mortgage loans to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Commitments to fund mortgage loans totaled $69.4 million at October 31, 2007 and $2.4 billion at April 30, 2007. External market forces impact the probability of commitments being exercised, and therefore, total commitments outstanding do not necessarily represent future cash requirements. As of December 4, 2007, OOMC and HRBMC stopped accepting mortgage loan applications. Of the loan applications in our pipeline at October 31, 2007, we estimate only $20 million to $30 million will ultimately fund.
In the normal course of business, we maintain recourse with standard representations and warranties. Violations of these representations and warranties or early payment defaults by borrowers may require us to repurchase loans previously sold. Repurchased loans are normally sold in subsequent sale transactions. The following table summarizes our loan repurchase activity:
 
                               
(dollars in 000s)
 
                    Fiscal Year Ended
    Three Months Ended October 31,   Six Months Ended October 31,   April 30,
    2007   2006   2007   2006   2007
 
 
Loans repurchased from third parties
  $ 92,982   $ 316,453   $ 189,784   $ 408,791   $ 978,756
Repurchase reserves added
during the period
  $ 172,670   $ 47,225   $ 329,966   $ 139,962   $ 388,733
Repurchase reserves added as a
percent of originations
    23.96%     0.68%     8.24%     0.93%     1.44%
 
 
A liability has been established related to the potential loss on repurchase of loans previously sold of $85.9 million and $38.4 million at October 31, 2007 and April 30, 2007, respectively. This reserve relates to potential losses that could be incurred as a result of early payment defaults or breaches of representations and warranties customary to the mortgage banking industry. On an ongoing basis, we monitor the adequacy of our repurchase liability, which is established upon the initial sale of the loans, and is included in liabilities held-for-sale in the condensed consolidated balance sheets. During the six months ended October 31, 2007, we increased our reserve for losses on representations and warranties repurchases as a result of rising repurchase trends. The portion of our reserve balance related to losses on representation and warrant repurchases totaled $47.3 million and $5.6 million at October 31, 2007 and April 30, 2007, respectively. We also continued to experience high levels of early payment defaults, resulting in significant


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actual and expected loan repurchase activity. In establishing our reserve for early payment defaults, we’ve assumed all loans that are currently delinquent and subject to contractual repurchase terms will be repurchased, and that approximately 6% of loans previously sold but not yet subject to contractual repurchase terms will be repurchased. Based on historical experience, we assumed an average 42% loss severity at October 31, 2007, compared to 38% at July 31, 2007 and 26% at April 30, 2007, on all loans repurchased and expected to be repurchased. At October 31, 2007, our repurchase reserve of $85.9 million covered estimated future losses on the repurchase of loans with an outstanding principal balance of $197.0 million.
OOMC has guaranteed up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts before ultimate disposition of the loans by the Trusts. This obligation can be called upon in the event adequate proceeds are not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. We have not funded any amounts under this guarantee, however we have provided additional margin as the fair value of the loans has declined and subsequently written the beneficial interest in Trusts down to fair value. The total principal amount of Trust obligations outstanding as of October 31, 2007, April 30, 2007 and October 31, 2006 was $57.4 million, $1.5 billion and $4.7 billion, respectively. The fair value of mortgage loans held by the Trusts as of October 31, 2007, April 30, 2007 and October 31, 2006 was $42.8 million, $1.5 billion and $4.8 billion, respectively. At October 31, 2007 and April 30, 2007 we recorded liabilities of $52,000 and $30,000, respectively, for the estimated fair value of this guarantee obligation, which are included in liabilities held-for-sale in the condensed consolidated balance sheets. Under the warehouse agreements, we may be required to provide funds in the event of declining loan values, but only to the extent of the 10% guaranteed amount. Funds provided as a result of declining loan values at October 31, 2007 and 2006 totaled $26.3 million and $16.2 million, respectively. Of the amount provided as of October 31, 2007, $11.3 million relates to our off-balance sheet warehouse facilities while the remaining $15.0 million relates to our on-balance sheet facility.
 
Warehouse Facilities
Substantially all non-prime mortgage loans we originate are sold daily to the Trusts. The Trusts purchase the loans from us using committed off-balance sheet warehouse facilities, arranged by us, totaling $1.5 billion in the aggregate. We also had an on-balance sheet facility with capacity of $75.0 million, as discussed below. These facilities are subject to various OOMC performance triggers, limits and financial covenants, including tangible net worth, income and leverage ratios and may be subject to margin calls. We hold an interest in the Trusts equal to the difference between the fair value of the assets and cash proceeds, adjusted for contractual advance rates, received from the Trusts. This interest was valued at zero as of October 31, 2007. In addition to the margin call feature, loans sold to the Trust are subject to repurchase if certain criteria are not met, including loan default provisions. Unfavorable fluctuations in loan value are guaranteed up to 10% of the original principal.
Several warehouse lines were terminated during the second quarter of fiscal year 2008. As a result, OOMC had two committed warehouse facilities available as of October 31, 2007, representing aggregate borrowing capacity of $1.5 billion. In November 2007 one facility was canceled, reducing our aggregate borrowing capacity to $750.0 million. The remaining warehouse facility expires June 12, 2008, and will be sufficient to meet our loan origination funding needs through the expected termination date of our remaining origination activities.
OOMC is party to an on-balance sheet facility that may be used to fund delinquent and repurchased loans. During fiscal year 2008, this facility was amended to reduce the total capacity to $75.0 million and extend the maturity to November 15, 2007. Loans totaling $33.2 million were held on this facility at October 31, 2007, with the related loans and liability reported in assets and liabilities held-for-sale. OOMC was not in compliance with certain restrictive covenants relative to this facility and obtained waivers through November 15, 2007. This facility matured on November 15, 2007, and the outstanding balance was repaid.
On October 1, 2007, OOMC entered into a facility to fund servicing advances (the “Servicing Advance Facility”), in which the servicing advances are collateral for the facility. The Servicing Advance Facility provides funding of up to $400.0 million to fund servicing advances through October 1, 2008, subject to


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various triggers, events or occurrences that could result in earlier termination, and bears interest at one-month LIBOR plus an additional margin rate. The Servicing Advance Facility is subject to a cross-default feature in which a default under OOMC’s warehouse financing arrangement with the lender to fund non-prime originations would trigger a default under the Servicing Advance Facility. In addition, the Servicing Advance Facility terminates upon a “change in control” of OOMC, in which (i) a party or parties acting in concert acquire a 20% or more equity interest in OOMC or (ii) the Company does not own more than a 50% equity interest in OOMC. This on-balance sheet facility had a balance of $286.6 million at October 31, 2007, with the related liability reported in liabilities held-for-sale. On November 16, 2007, this agreement was amended to increase the amount of funding available from $400.0 million to $750.0 million. We expect the volume of servicing advances to increase and, as a result, may need to increase the funding capacity of this facility or obtain other servicing advance financing.
 
Restructuring Charge
During fiscal year 2006, we initiated a restructuring plan to reduce costs within our mortgage operations. Restructuring activities continued through fiscal year 2008. On December 4, 2007, we announced the closure of our mortgage origination activities and expect to incur $74.8 million in restructuring charges related to the closure. We incurred $34.9 million of these costs in our second quarter, with the remainder to be incurred primarily in our third quarter of fiscal year 2008. Charges incurred during the six months ended October 31, 2007 totaled $77.1 million, which included $33.9 million in fixed asset write-offs, with the remainder included in “other adjustments” in the table below. These charges are included in the net loss from discontinued operations on our condensed consolidated income statements. Changes in our restructuring charge liability during the six months ended October 31, 2007 are as follows:
 
                                 
(in 000s)  
   
    Accrual Balance as of
    Cash
    Other
    Accrual Balance as of
 
    April 30, 2007     Payments     Adjustments     October 31, 2007  
   
 
Employee severance costs
  $ 3,688     $ (25,189 )   $ 30,335     $ 8,834  
Contract termination costs
    10,919       (3,526 )     11,862       19,255  
                                 
    $ 14,607     $ (28,715 )   $ 42,197     $ 28,089  
                                 
 
 
The remaining liability related to this restructuring charge is included in liabilities held-for-sale on our condensed consolidated balance sheet and relates to lease obligations for vacant space resulting from branch office closings and employee severance costs.


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12.  Condensed Consolidating Financial Statements
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 October 26, 2004, the CLOCs and other indebtedness issued from time to time. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions.
 
                                         
   
Condensed Consolidating Income Statements     (in 000s)  
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 103,751     $ 332,596     $ (1,523 )   $ 434,824  
                                         
Cost of services
    -       53,156       375,665       (88 )     428,733  
Cost of other revenues
    -       49,639       9,167       -       58,806  
Selling, general and administrative
    -       49,645       132,833       (1,602 )     180,876  
                                         
Total expenses
    -       152,440       517,665       (1,690 )     668,415  
                                         
Operating loss
    -       (48,689 )     (185,069 )     167       (233,591 )
Interest expense
    -       -       (652 )     -       (652 )
Other income, net
    (223,736 )     (16 )     10,523       223,736       10,507  
                                         
Loss from continuing operations before tax benefit
    (223,736 )     (48,705 )     (175,198 )     223,903       (223,736 )
Income tax benefit
    (87,631 )     (18,227 )     (69,472 )     87,699       (87,631 )
                                         
Net loss from continuing operations
    (136,105 )     (30,478 )     (105,726 )     136,204       (136,105 )
Net loss from discontinued operations
    (366,166 )     (363,867 )     (667 )     364,534       (366,166 )
                                         
Net loss
  $ (502,271 )   $ (394,345 )   $ (106,393 )   $ 500,738     $ (502,271 )
                                         
 
 
 
                                         
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2006   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 149,420     $ 247,016     $ (353 )   $ 396,083  
                                         
Cost of services
    -       45,770       353,483       1       399,254  
Cost of other revenues
    -       23,096       2,477       -       25,573  
Selling, general and administrative
    -       49,802       114,695       (1,525 )     162,972  
                                         
Total expenses
    -       118,668       470,655       (1,524 )     587,799  
                                         
Operating income (loss)
    -       30,752       (223,639 )     1,171       (191,716 )
Interest expense
    -       (11,810 )     (281 )     -       (12,091 )
Other income, net
    (198,619 )     1,193       3,995       198,619       5,188  
                                         
Income (loss) from continuing operations before tax (benefit)
    (198,619 )     20,135       (219,925 )     199,790       (198,619 )
Income tax (benefit)
    (77,622 )     13,055       (90,677 )     77,622       (77,622 )
                                         
Net income (loss) from continuing operations
    (120,997 )     7,080       (129,248 )     122,168       (120,997 )
Net loss from discontinued operations
    (35,463 )     (21,439 )     (12,853 )     34,292       (35,463 )
                                         
Net loss
  $ (156,460 )   $ (14,359 )   $ (142,101 )   $ 156,460     $ (156,460 )
                                         
 
 
 


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Six Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 292,851     $ 526,951     $ (3,769 )   $ 816,033  
                                         
Cost of services
    -       114,970       697,218       (55 )     812,133  
Cost of other revenues
    -       87,276       15,059             102,335  
Selling, general and administrative
    -       96,829       233,368       (3,497 )     326,700  
                                         
Total expenses
    -       299,075       945,645       (3,552 )     1,241,168  
                                         
Operating loss
    -       (6,224 )     (418,694 )     (217 )     (425,135 )
Interest expense
    -             (1,247 )           (1,247 )
Other income, net
    (407,316 )     (21 )     19,087       407,316       19,066  
                                         
Loss from continuing operations before tax benefit
    (407,316 )     (6,245 )     (400,854 )     407,099       (407,316 )
Income tax benefit
    (161,388 )     (3,605 )     (157,697 )     161,302       (161,388 )
                                         
Net loss from continuing operations
    (245,928 )     (2,640 )     (243,157 )     245,797       (245,928 )
Net loss from discontinued operations
    (558,923 )     (554,010 )     (3,590 )     557,600       (558,923 )
                                         
Net loss
  $ (804,851 )   $ (556,650 )   $ (246,747 )   $ 803,397     $ (804,851 )
                                         
 
 
 
                                         
   
Six Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2006   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 285,123     $ 456,701     $ (2,971 )   $ 738,853  
                                         
Cost of services
    -       92,880       669,866       33       762,779  
Cost of other revenues
    -       38,587       5,193       -       43,780  
Selling, general and administrative
    -       98,328       216,719       (3,004 )     312,043  
                                         
Total expenses
    -       229,795       891,778       (2,971 )     1,118,602  
                                         
Operating income (loss)
    -       55,328       (435,077 )     -       (379,749 )
Interest expense
    -       (23,618 )     (608 )     -       (24,226 )
Other income, net
    (392,593 )     3,963       7,419       392,593       11,382  
                                         
Income (loss) from continuing operations before tax (benefit)
    (392,593 )     35,673       (428,266 )     392,593       (392,593 )
Income tax (benefit)
    (153,757 )     19,110       (172,409 )     153,299       (153,757 )
                                         
Net income (loss) from continuing operations
    (238,836 )     16,563       (255,857 )     239,294       (238,836 )
Net loss from discontinued operations
    (49,001 )     (31,810 )     (16,733 )     48,543       (49,001 )
                                         
Net loss
  $ (287,837 )   $ (15,247 )   $ (272,590 )   $ 287,837     $ (287,837 )
                                         
 
 
 

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Condensed Consolidating Balance Sheets     (in 000s)
 
    H&R Block, Inc.
  BFC
    Other
          Consolidated
October 31, 2007   (Guarantor)   (Issuer)     Subsidiaries     Elims     H&R Block
 
 
Cash & cash equivalents
  $ -   $ 112,978     $ 273,937     $ -     $ 386,915
Cash & cash equivalents – restricted
    -     235,472       1,704       -       237,176
Receivables from customers, brokers and dealers, net
    -     414,557       -       -       414,557
Receivables, net
    294     130,550       355,958       -       486,802
Mortgage loans held for investment
    -     1,082,301       -       -       1,082,301
Intangible assets and goodwill, net
    -     179,508       989,386       -       1,168,894
Investments in subsidiaries
    3,678,796     -       552       (3,678,796 )     552
Assets held for sale
    -     2,219,071       16,950       -       2,236,021
Other assets
    -     11,422       1,082,131             1,093,553
                                     
Total assets
  $ 3,679,090   $ 4,385,859     $ 2,720,618     $ (3,678,796 )   $ 7,106,771
                                     
Commercial paper and other short-term borrowings
  $ -   $ 500,000     $ -     $ -     $ 500,000
Customer deposits
    -     886,533       -       -       886,533
Accts. payable to customers, brokers and dealers
    -     568,122       -       -       568,122
Long-term debt
    -     2,127,354       16,658       -       2,144,012
Liabilities held for sale
    -     1,361,557       1,650       -       1,363,207
Other liabilities
    2     233,552       866,998       65       1,100,617
Net intercompany advances
    3,134,808     (1,842,535 )     (1,292,425 )     152       -
Stockholders’ equity
    544,280     551,276       3,127,737       (3,679,013 )     544,280
                                     
Total liabilities and stockholders’ equity
  $ 3,679,090   $ 4,385,859     $ 2,720,618     $ (3,678,796 )   $ 7,106,771
                                     
 
 
 
                                     
 
    H&R Block, Inc.
  BFC
    Other
          Consolidated
April 30, 2007   (Guarantor)   (Issuer)     Subsidiaries     Elims     H&R Block
 
 
Cash & cash equivalents
  $ -   $ 165,118     $ 756,720     $ -     $ 921,838
Cash & cash equivalents – restricted
    -     329,000       3,646       -       332,646
Receivables from customers, brokers and dealers, net
    -     410,522       -       -       410,522
Receivables, net
    233     154,060       401,962       -       556,255
Mortgage loans held for investment
    -     1,358,222       -       -       1,358,222
Intangible assets and goodwill, net
    -     197,914       977,418       -       1,175,332
Investments in subsidiaries
    4,586,474     -       414       (4,586,474 )     414
Assets held for sale
    -     1,720,984       25,975       -       1,746,959
Other assets
    -     129,879       911,976       7       1,041,862
                                     
Total assets
  $ 4,586,707   $ 4,465,699     $ 3,078,111     $ (4,586,467 )   $ 7,544,050
                                     
Commercial paper and other short-term borrowings
  $ -   $ 1,567,082     $ -     $ -     $ 1,567,082
Customer deposits
    -     1,129,263       -       -       1,129,263
Accts. payable to customers, brokers and dealers
    -     633,189       -       -       633,189
Long-term debt
    -     502,236       17,571       -       519,807
Liabilities held for sale
    -     610,391       4,982       -       615,373
Other liabilities
    2     254,906       1,409,929       -       1,664,837
Net intercompany advances
    3,172,206     (1,341,912 )     (1,830,294 )     -       -
Stockholders’ equity
    1,414,499     1,110,544       3,475,923       (4,586,467 )     1,414,499
                                     
Total liabilities and stockholders’ equity
  $ 4,586,707   $ 4,465,699     $ 3,078,111     $ (4,586,467 )   $ 7,544,050
                                     
 
 

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Condensed Consolidating Statements of Cash Flows     (in 000s)  
   
Six Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Net cash provided by (used in) operating activities:
  $ 19,051     $ (275,503 )   $ (685,673 )   $ -     $ (942,125 )
                                         
Cash flows from investing:
                                       
Mortgage loans originated for investment, net
    -       76,889       -       -       76,889  
Purchase property & equipment
    -       (7,367 )     (41,113 )     -       (48,480 )
Payments for business acquisitions
    -       -       (21,037 )     -       (21,037 )
Net intercompany advances
    58,196       -       -       (58,196 )     -  
Investing cash flows from discontinued operations
    -       5,923       3,673       -       9,596  
Other, net
    -       5,849       (86 )     -       5,763  
                                         
Net cash provided by (used in) investing activities
    58,196       81,294       (58,563 )     (58,196 )     22,731  
                                         
Cash flows from financing:
                                       
Repayments of commercial paper
    -       (5,125,279 )     -       -       (5,125,279 )
Proceeds from commercial paper
    -       4,133,197       -       -       4,133,197  
Repayments of other borrowings
    -       (1,005,000 )     -       -       (1,005,000 )
Proceeds from other borrowings
    -       2,555,000       -       -       2,555,000  
Customer deposits
    -       (243,030 )     -       -       (243,030 )
Dividends paid
    (90,495 )     -       -       -       (90,495 )
Proceeds from issuance of common stock
    13,434       -       -       -       13,434  
Net intercompany advances
    -       (382,897 )     324,701       58,196       -  
Financing cash flows from discontinued operations
    -       200,812       -       -       200,812  
Other, net
    (186 )     9,266       (63,248 )     -       (54,168 )
                                         
Net cash provided by (used in) financing activities
    (77,247 )     142,069       261,453       58,196       384,471  
                                         
Net decrease in cash
    -       (52,140 )     (482,783 )     -       (534,923 )
Cash – beginning of period
    -       165,118       756,720       -       921,838  
                                         
Cash – end of period
  $ -     $ 112,978     $ 273,937     $ -     $ 386,915  
                                         
 
 
 


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Six Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
October 31, 2006   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Net cash provided by (used in) operating activities:
  $ 29,170     $ (65,283 )   $ (1,135,858 )   $ -     $ (1,171,971 )
                                         
Cash flows from investing:
                                       
Mortgage loans originated for investment, net
    -       (278,003 )     -       -       (278,003 )
Purchase property & equipment
    -       2,218       (82,658 )     -       (80,440 )
Payments for business acquisitions
    -       -       (12,670 )     -       (12,670 )
Net intercompany advances
    216,983       -       -       (216,983 )     -  
Investing cash flows from discontinued operations
    -       (8,081 )     (783 )     -       (8,864 )
Other, net
    -       (37,362 )     8,088       -       (29,274 )
                                         
Net cash provided by (used in) investing activities
    216,983       (321,228 )     (88,023 )     (216,983 )     (409,251 )
                                         
Cash flows from financing:
                                       
Repayments of commercial paper
    -       (2,295,573 )     -       -       (2,295,573 )
Proceeds from issuance of commercial paper
    -       3,336,002       -       -       3,336,002  
Dividends paid
    (84,225 )     -       -       -       (84,225 )
Payments to acquire treasury shares
    (180,897 )     -       -       -       (180,897 )
Proceeds from issuance of common stock
    10,640       -       -       -       10,640  
Net intercompany advances
    -       (1,202,514 )     985,531       216,983       -  
Customer deposits
    -       595,769       -       -       595,769  
Financing cash flows from discontinued operations
    -       -       (100 )     -       (100 )
Other, net
    8,329       (17,126 )     (62,723 )     -       (71,520 )
                                         
Net cash provided by (used in) financing activities
    (246,153 )     416,558       922,708       216,983       1,310,096  
                                         
Net increase (decrease) in cash
    -       30,047       (301,173 )     -       (271,126 )
Cash – beginning of period
    -       134,407       539,420       -       673,827  
                                         
Cash – end of period
  $ -     $ 164,454     $ 238,247     $ -     $ 402,701  
                                         
 
 

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­ ­
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
RESULTS OF OPERATIONS
H&R Block is a diversified company delivering tax services and financial advice, investment, and banking services, and business and consulting services. For more than 50 years, we have been developing relationships with millions of tax clients and our strategy is to expand on these relationships. Our Tax Services segment provides income tax return preparation services, electronic filing services and other services and products related to income tax return preparation to the general public primarily in the United States, Canada and Australia. RSM McGladrey Business Services, Inc. (RSM) is a national accounting, tax and business consulting firm primarily serving midsized businesses. Our Consumer Financial Services segment offers investment services through H&R Block Financial Advisors, Inc. (HRBFA) and full-service banking through H&R Block Bank (HRB Bank).
Discontinued Operations – Recent Developments. On April 19, 2007, we entered into an agreement to sell Option One Mortgage Corporation (OOMC) to Cerberus Capital Management (Cerberus). In conjunction with this plan, we also announced we would terminate the operations of H&R Block Mortgage Corporation (HRBMC), a wholly-owned subsidiary of OOMC.
On December 4, 2007, we agreed to terminate the agreement with Cerberus in light of the changing business environment for OOMC, as mutually acceptable alternatives for restructuring the original agreement could not be reached. We also announced that we would immediately terminate all remaining origination activities and pursue the sale of OOMC’s loan servicing activities. OOMC had existing loan applications in its pipeline of $69.4 million in gross loan principal amount at October 31, 2007. We believe that only approximately $20 million to $30 million of these loans will ultimately be funded, at which time our mortgage origination activities will cease. We believe a majority of these loans will be eligible for sale to Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).
Termination of the mortgage lending activities of OOMC is expected to result in a pretax restructuring charge of $74.8 million. The restructuring charge covers expected severance and lease termination costs, write-off of property, plant and equipment and related shutdown costs. Of the total restructuring charge, $34.9 million was incurred in our second quarter ending October 31, 2007, with the remainder to be incurred primarily in our third quarter ending January 31, 2008. This charge, combined with the restructuring activities previously announced, brings our total restructuring charges for the three and six months ended October 31, 2007 to $61.0 million and $77.1 million, respectively.
Following the termination of its loan origination activities, OOMC will continue to carry out its servicing activities and collect servicing revenues as it does today. Because of the cessation of new originations, the volume of mortgage loans serviced will gradually decline as the aggregate principal amount of existing loans being serviced declines without replacement. The majority of servicing activities are carried out with respect to loans owned by third parties.
We have estimated the fair values of the servicing business and other assets, which resulted in an additional asset impairment for the second quarter ending October 31, 2007 of $123.0 million, bringing our total impairment recorded in discontinued operations to $146.2 million for the six months ended October 31, 2007.
During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the six months ended October 31, 2007. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services. As of October 31, 2007, these businesses are presented as discontinued operations and the assets and liabilities of the businesses being sold are presented as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.
See discussion of operating results under “Discontinued Operations.”


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TAX SERVICES
This segment primarily consists of our income tax preparation businesses – retail, online and software. Additionally, this segment includes commercial tax businesses, which provide tax preparation software and educational materials to CPAs and other tax preparers.
 
                                 
   
Tax Services – Operating Results     (in 000s)  
   
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
   
 
Service revenues:
                               
Tax preparation fees
  $ 49,463     $ 44,247     $ 74,387     $ 69,572  
Other services
    31,578       31,199       68,927       66,211  
                                 
      81,041       75,446       143,314       135,783  
Royalties
    4,919       4,458       7,761       7,381  
Other
    4,844       2,080       9,592       4,478  
                                 
Total revenues
    90,804       81,984       160,667       147,642  
                                 
Cost of services:
                               
Compensation and benefits
    61,473       58,864       107,613       104,447  
Occupancy
    80,108       70,102       155,068       137,682  
Depreciation
    8,450       9,706       16,610       18,957  
Other
    46,302       42,139       101,467       90,311  
                                 
      196,333       180,811       380,758       351,397  
Cost of other revenues, selling, general and administrative
    93,620       68,066       151,347       116,192  
                                 
Total expenses
    289,953       248,877       532,105       467,589  
                                 
Pretax loss
  $ (199,149 )   $ (166,893 )   $ (371,438 )   $ (319,947 )
                                 
 
 
 
Three months ended October 31, 2007 compared to October 31, 2006
Tax Services’ revenues increased $8.8 million, or 10.8%, for the three months ended October 31, 2007 compared to the prior year.
Tax preparation fees increased $5.2 million, or 11.8%, primarily due to improved performance in our Australian operations. This improvement was due to an increase in clients served and favorable changes in foreign currency exchange rates.
Other revenues increased $2.8 million, primarily due to revenues resulting from commercial tax acquisitions.
Total expenses increased $41.1 million, or 16.5%, for the three months ended October 31, 2007. Cost of services increased $15.5 million, or 8.6%, from the prior year, primarily due to higher occupancy expenses. Occupancy expenses increased $10.0 million, or 14.3%, primarily as a result of higher rent and utilities expenses due to a 3.6% increase in company-owned offices under lease and a 5.0% increase in the average rent. Other cost of services increased $4.2 million, or 9.9%, due to additional supplies expense, related primarily to tax training schools.
Cost of other revenues, selling, general and administrative expenses increased $25.6 million, or 37.5%. This increase was primarily due to $12.5 million of incremental bad debt expense related to our refund anticipation loan (RAL) program, which resulted from a larger number of refund claims denied by the Internal Revenue Service (IRS). The IRS made changes to its taxpayer fraud detection system and penalty collection practices for the 2007 tax season, both of which contributed to the increased expense. Corporate wages and amortization of intangible assets increased $4.4 million and $1.3 million, respectively, over the prior year due primarily to acquisitions.
The pretax loss for the three months ended October 31, 2007 was $199.1 million, compared to a loss of $166.9 million in the prior year.
 
Six months ended October 31, 2007 compared to October 31, 2006
Tax Services’ revenues increased $13.0 million, or 8.8%, for the six months ended October 31, 2007 compared to the prior year.
Tax preparation fees increased $4.8 million, or 6.9%, primarily due to improved performance in our Australian operations. Other service revenues increased $2.7 million, or 4.1%, primarily due to customer


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fees earned in connection with an agreement with HRB Bank for the H&R Block Emerald Prepaid MasterCard® program, under which, this segment shares in the revenues and expenses associated with the program. This increase was partially offset by a decline in revenues from our Peace of Mind (POM) guarantee, resulting from lower claims in the current year.
Other revenues increased $5.1 million, primarily due to revenues resulting from commercial tax acquisitions.
Total expenses increased $64.5 million, or 13.8%, for the six months ended October 31, 2007. Cost of services increased $29.4 million, or 8.4%, from the prior year, primarily due to higher occupancy expenses. Occupancy expenses increased $17.4 million, or 12.6%, primarily as a result of higher rent and utilities expenses due to a 4.2% increase in company-owned offices under lease and a 4.0% increase in the average rent. Other cost of services increased $11.2 million, or 12.4%, due primarily to $5.2 million in additional corporate shared services, primarily related to information technology projects related to the upcoming tax season. In addition, we incurred $4.6 million of additional supplies expense, related primarily to tax training schools.
Cost of other revenues, selling, general and administrative expenses increased $35.2 million, or 30.3%. This increase was primarily due to $12.5 million of incremental bad debt expense related to our RAL program, which resulted from a larger number of refund claims denied by the IRS. The IRS made changes to its taxpayer fraud detection system and penalty collection practices for the 2007 tax season, both of which contributed to the increased expense. Corporate wages and amortization of intangible assets increased $10.2 million and $3.0 million, respectively, over the prior year due primarily to acquisitions.
The pretax loss for the six months ended October 31, 2007 was $371.4 million, compared to a loss of $319.9 million in the prior year.
 
BUSINESS SERVICES
This segment offers middle-market companies accounting, tax and consulting services.
 
                                 
   
Business Services – Operating Statistics        
   
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
   
 
Accounting, tax and consulting:
                               
Chargeable hours
    1,273,112       1,219,720       2,312,302       2,283,331  
Chargeable hours per person
    325       312       599       587  
Net billed rate per hour
  $ 147     $ 148     $ 146     $ 145  
Average margin per person
  $ 29,824     $ 28,647     $ 49,049     $ 48,584  
 
 
 
                                 
   
Business Services – Operating Results     (in 000s)  
   
    Three Months Ended October 31,     Six Months Ended October 31,  
    2007     2006     2007     2006  
   
 
Service revenues:
                               
Accounting, tax and consulting
  $ 203,585     $ 193,360     $ 366,400     $ 358,149  
Other services
    21,682       23,289       40,269       44,727  
                                 
      225,267       216,649       406,669       402,876  
Other
    13,781       12,065       25,202       21,295  
                                 
Total revenues
    239,048       228,714       431,871       424,171  
                                 
Cost of services:
                               
Compensation and benefits
    136,471       133,969       246,323       248,747  
Occupancy
    17,814       17,419       35,676       34,622  
Other
    24,811       23,459       43,231       41,390  
                                 
      179,096       174,847       325,230       324,759  
Amortization of intangible assets
    3,574       3,769       7,200       8,277  
Cost of other revenues, selling, general and administrative
    44,597       49,074       89,566       97,078  
                                 
Total expenses
    227,267       227,690       421,996       430,114  
                                 
Pretax income (loss)
  $ 11,781     $ 1,024     $ 9,875     $ (5,943 )
                                 
 
 


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Three months ended October 31, 2007 compared to October 31, 2006
Business Services’ revenues for the three months ended October 31, 2007 increased $10.3 million, or 4.5%, over the prior year. Accounting, tax and consulting service revenues totaled $203.6 million, up $10.2 million, or 5.3%, from the prior year primarily due to a 4.2% increase in chargeable hours per person.
Total expenses were essentially flat for the three months ended October 31, 2007 compared to the prior year. Cost of services increased $4.2 million, due primarily to an increase in compensation and benefits, which resulted from increases in both the number of employees and the average wage.
Cost of other revenues, selling, general and administrative expenses decreased $4.5 million, or 9.1%, primarily due to decreases of $3.4 million and $2.4 million in external consulting and legal fees, respectively, partially offset by increased costs associated with our business development and marketing initiatives and corporate shared services.