10-Q 1 c35251e10vq.htm FORM 10-Q e10vq
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 July 31, 2008
OR
[  ]
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
 
Commission file number 1-6089
 
(H and R BLOCK LOGO)
 
H&R Block, Inc.
(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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer Ö 
  Accelerated filer        Non-accelerated filer         Smaller Reporting company     
     
    (Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes          No   Ö  
 
The number of shares outstanding of the registrant’s Common Stock, without par value, at the close of business on July 31, 2008 was 328,088,753 shares.


 

 
(H and R BLOCK LOGO)
 
Form 10-Q for the Period Ended July 31, 2008
 
 
Table of Contents
 
             
        Page
 
           
PART I
 
Financial Information
       
           
Item 1.
 
Condensed Consolidated Balance Sheets
July 31, 2008 and April 30, 2008
    1  
           
   
Condensed Consolidated Statements of Operations and
Comprehensive Income (Loss)
Three Months Ended July 31, 2008 and 2007
    2  
           
   
Condensed Consolidated Statements of Cash Flows
Three Months Ended July 31, 2008 and 2007
    3  
           
   
Condensed Consolidated Statement of Stockholders’ Equity
July 31, 2008 and 2007
    4  
           
   
Notes to Condensed Consolidated Financial Statements
    5  
           
Item 2.
 
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
    20  
           
Item 3.
 
Quantitative and Qualitative Disclosures about Market Risk
    29  
           
Item 4.
 
Controls and Procedures
    29  
           
PART II
 
Other Information
       
           
Item 1.
 
Legal Proceedings
    30  
           
Item 1A.
 
Risk Factors
    33  
           
Item 2.
 
Unregistered Sales of Equity Securities
    33  
           
Item 6.
 
Exhibits
    33  
       
SIGNATURES
    34  
 


 

 
(H and R BLOCK LOGO)
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS (amounts in 000s, except share and per share amounts)
 
                 
    July 31, 2008     April 30, 2008  
 
    (Unaudited)        
 
ASSETS
               
Cash and cash equivalents
  $ 355,998     $ 726,845  
Cash and cash equivalents – restricted
    221,338       219,031  
Receivables from customers, brokers, dealers and clearing organizations, less
allowance for doubtful accounts of $2,077 and $2,119
    401,859       438,899  
Receivables, less allowance for doubtful accounts of
$123,685 and $123,849
    383,224       552,871  
Prepaid expenses and other current assets
    438,872       443,934  
                 
Total current assets
    1,801,291       2,381,580  
Mortgage loans held for investment, less allowance for
loan losses of $46,853 and $45,401
    868,603       966,301  
Property and equipment, at cost, less accumulated depreciation and
amortization of $677,357 and $670,008
    380,804       380,738  
Intangible assets, net
    142,533       147,368  
Goodwill
    1,006,207       1,005,268  
Other assets
    704,044       742,170  
                 
Total assets
  $ 4,903,482     $ 5,623,425  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities:
               
Short-term borrowings
  $     $ 25,000  
Customer banking deposits
    777,080       785,624  
Accounts payable to customers, brokers and dealers
    592,688       559,658  
Accounts payable, accrued expenses and other current liabilities
    665,973       782,280  
Accrued salaries, wages and payroll taxes
    142,690       393,148  
Accrued income taxes
    263,784       439,380  
Current portion of long-term debt
    108,839       111,286  
                 
Total current liabilities
    2,551,054       3,096,376  
Long-term debt
    1,034,117       1,031,784  
Other noncurrent liabilities
    481,589       507,447  
                 
Total liabilities
    4,066,760       4,635,607  
                 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, no par, stated value $.01 per share,
800,000,000 shares authorized, 435,890,796 shares issued at
July 31, 2008 and April 30, 2008
    4,359       4,359  
Additional paid-in capital
    686,802       695,959  
Accumulated other comprehensive income
    833       2,486  
Retained earnings
    2,204,940       2,384,449  
Less treasury shares, at cost
    (2,060,212 )     (2,099,435 )
                 
Total stockholders’ equity
    836,722       987,818  
                 
Total liabilities and stockholders’ equity
  $ 4,903,482     $ 5,623,425  
                 
 
See Notes to Condensed Consolidated Financial Statements


1


 

 
(H and R BLOCK LOGO)
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(unaudited, amounts in 000s,
except per share amounts)
 
                 
    Three Months Ended
 
    July 31,  
    2008     2007  
 
 
Revenues:
               
Service revenues
  $ 301,521     $ 325,090  
Other revenues:
               
Interest income
    25,238       41,838  
Product and other revenues
    12,879       14,281  
                 
      339,638       381,209  
                 
Operating expenses:
               
Cost of services
    369,606       385,115  
Cost of other revenues
    42,823       43,529  
Selling, general and administrative
    140,470       144,109  
                 
      552,899       572,753  
                 
Operating loss
    (213,261 )     (191,544 )
Other income (expense), net
    (1,355 )     7,964  
                 
Loss from continuing operations before tax benefit
    (214,616 )     (183,580 )
Income tax benefit
    (85,247 )     (73,757 )
                 
Net loss from continuing operations
    (129,369 )     (109,823 )
Net loss from discontinued operations
    (3,350 )     (192,757 )
                 
Net loss
  $ (132,719 )   $ (302,580 )
                 
Basic and diluted loss per share:
               
Net loss from continuing operations
  $ (0.40 )   $ (0.34 )
Net loss from discontinued operations
    (0.01 )     (0.59 )
                 
Net loss
  $ (0.41 )   $ (0.93 )
                 
Basic and diluted shares
    327,141       323,864  
                 
Dividends per share
  $ 0.143     $ 0.136  
                 
Comprehensive income (loss):
               
Net loss
  $ (132,719 )   $ (302,580 )
Change in unrealized gain on available-for-sale securities, net
    (1,967 )     (463 )
Change in foreign currency translation adjustments
    314       4,311  
                 
Comprehensive loss
  $ (134,372 )   $ (298,732 )
                 
 
See Notes to Condensed Consolidated Financial Statements


2


 

 
(H and R BLOCK LOGO)
 
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, amounts in 000s)
 
                 
Three Months Ended July 31,   2008     2007  
 
 
Cash flows from operating activities:
               
Net loss
  $ (132,719 )   $ (302,580 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    29,556       37,075  
Stock-based compensation
    5,487       7,398  
Operating cash flows of discontinued operations
    -       212,323  
Other, net of business acquisitions
    (218,660 )     (289,562 )
                 
Net cash used in operating activities
    (316,336 )     (335,346 )
                 
Cash flows from investing activities:
               
Principal repayments on mortgage loans held for investment, net
    31,619       14,327  
Purchases of property and equipment, net
    (16,189 )     (14,497 )
Payments made for business acquisitions, net of cash acquired
    (2,251 )     (20,887 )
Net cash provided by investing activities of discontinued operations
    -       3,068  
Other, net
    2,891       6,699  
                 
Net cash provided by (used in) investing activities
    16,070       (11,290 )
                 
Cash flows from financing activities:
               
Repayments of commercial paper
    -       (3,463,719 )
Proceeds from issuance of commercial paper
    -       3,622,874  
Repayments of other short-term borrowings
    (40,000 )     (560,000 )
Proceeds from other short-term borrowings
    15,000       485,000  
Customer deposits, net
    (8,795 )     (90,378 )
Dividends paid
    (46,790 )     (43,937 )
Acquisition of treasury shares
    (4,116 )     (5,372 )
Proceeds from exercise of stock options
    20,520       9,788  
Net cash used in financing activities of discontinued operations
    -       (47,535 )
Other, net
    (6,400 )     (44,252 )
                 
Net cash used in financing activities
    (70,581 )     (137,531 )
                 
Net decrease in cash and cash equivalents
    (370,847 )     (484,167 )
Cash and cash equivalents at beginning of the period
    726,845       921,838  
                 
Cash and cash equivalents at end of the period
  $ 355,998     $ 437,671  
                 
Supplementary cash flow data:
               
Income taxes paid, net of refunds received of $1,198 and $1,867
  $ 83,111     $ 9,653  
Interest paid on borrowings
    27,258       27,833  
Interest paid on deposits
    4,048       15,792  
 
See Notes to Condensed Consolidated Financial Statements


3


 

 
(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, 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
    -       -       -       -       -       -       (302,580 )     -       -       (302,580 )
Unrealized translation gain (loss)
    -       -       -       -       -       4,311       -       -       -       4,311  
Change in net unrealized gain on available-for-sale securities
    -       -       -       -       -       (463 )     -       -       -       (463 )
Stock-based compensation
    -       -       -       -       9,226       -       -       -       -       9,226  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (1,431 )     -       -       668       12,758       11,327  
Nonvested shares
    -       -       -       -       (13,349 )     -       -       663       12,669       (680 )
ESPP
    -       -       -       -       400       -       -       218       4,161       4,561  
Acquisitions
    -       -       -       -       35       -       -       8       151       186  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (230 )     (5,372 )     (5,372 )
Cash dividends paid – $0.14 per share
    -       -       -       -       -       -       (43,937 )     -       -       (43,937 )
                                                                                 
                                                                                 
Balances at July 31, 2007
    435,891     $ 4,359       -     $ -     $ 671,647     $ 2,528     $ 2,530,207       (111,345 )   $ (2,127,379 )   $ 1,081,362  
                                                                                 
Balances at April 30, 2008
    435,891     $ 4,359       -     $ -     $ 695,959     $ 2,486     $ 2,384,449       (109,880 )   $ (2,099,435 )   $ 987,818  
Net loss
    -       -       -       -       -       -       (132,719 )     -       -       (132,719 )
Unrealized translation gain
    -       -       -       -       -       314       -       -       -       314  
Change in net unrealized gain (loss) on available-for-sale securities
    -       -       -       -       -       (1,967 )     -       -       -       (1,967 )
Stock-based compensation
    -       -       -       -       5,487       -       -       -       -       5,487  
Shares issued for:
                                                                               
Option exercises
    -       -       -       -       (3,760 )     -       -       1,557       29,759       25,999  
Nonvested shares
    -       -       -       -       (10,456 )     -       -       510       9,749       (707 )
ESPP
    -       -       -       -       (453 )     -       -       192       3,668       3,215  
Acquisitions
    -       -       -       -       25       -       -       9       163       188  
Acquisition of treasury shares
    -       -       -       -       -       -       -       (190 )     (4,116 )     (4,116 )
Cash dividends paid – $0.14 per share
    -       -       -       -       -       -       (46,790 )     -       -       (46,790 )
                                                                                 
Balances at July 31, 2008
    435,891     $ 4,359       -     $ -     $ 686,802     $ 833     $ 2,204,940       (107,802 )   $ (2,060,212 )   $ 836,722  
                                                                                 
 
See Notes to Condensed Consolidated Financial Statements


4


 

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
1.  Basis of Presentation
The condensed consolidated balance sheet as of July 31, 2008, the condensed consolidated statements of operations and comprehensive income (loss) for the three months ended July 31, 2008 and 2007, the condensed consolidated statements of cash flows for the three months ended July 31, 2008 and 2007, and the condensed consolidated statement of stockholders’ equity for the three months ended July 31, 2008 and 2007 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations, cash flows and changes in stockholders’ equity at July 31, 2008 and for all periods presented have been made. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
“H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.
Certain reclassifications have been made to prior year amounts to conform to the current year presentation. These reclassifications had no effect on our results of operations or stockholders’ equity as previously reported.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2008 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of April 30, 2008 or for the year then ended, are derived from our April 30, 2008 Annual Report to Shareholders on Form 10-K.
Operating revenues of the Tax Services and Business Services segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
 
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 25.7 million shares and 31.3 million shares for the three months ended July 31, 2008 and 2007, respectively, as the effect would be antidilutive due to the net loss from continuing operations during each period.
The weighted average shares outstanding for the three months ended July 31, 2008 increased to 327.1 million from 323.9 million at July 31, 2007, primarily due the issuance of treasury shares related to our stock-based compensation plans.
During the three months ended July 31, 2008 and 2007, we issued 2.3 million and 1.6 million shares of common stock, respectively, due to the exercise of stock options, employee stock purchases and awards of nonvested shares.
During the three months ended July 31, 2008, we acquired 0.2 million shares of our common stock, which represent shares swapped or surrendered to us in connection with the vesting of nonvested shares and the exercise of stock options, at an aggregate cost of $4.1 million. During the three months ended July 31, 2007, we acquired 0.2 million shares of our common stock, which represent shares swapped or surrendered to us in connection with the vesting of nonvested shares and the exercise of stock options, at an aggregate cost of $5.4 million.
During the three months ended July 31, 2008, we granted 4.1 million stock options and 0.9 million nonvested shares and units in accordance with our stock-based compensation plans. The weighted average fair value of options granted was $3.70 for manager options and $2.83 for options granted to our


5


 

seasonal associates. At July 31, 2008, the total unrecognized compensation cost for options and nonvested shares and units was $19.0 million and $34.1 million, respectively.
 
3.   Goodwill and Intangible Assets
Changes in the carrying amount of goodwill for the three months ended July 31, 2008 consist of the following:
(in 000s)
                                 
   
    April 30, 2008     Additions     Other     July 31, 2008  
   
 
Tax Services
  $ 431,981     $ 2,350     $ (915 )   $ 433,416  
Business Services
    399,333       -       (496 )     398,837  
Consumer Financial Services
    173,954       -       -       173,954  
                                 
Total
  $ 1,005,268     $ 2,350     $ (1,411 )   $ 1,006,207  
                                 
 
 
We test goodwill for impairment annually at the beginning of our fourth quarter, or more frequently if events occur indicating it is more likely than not the fair value of a reporting unit’s net assets has been reduced below its carrying value. No impairments of goodwill were identified within any of our operating segments during the three months ended July 31, 2008.
Intangible assets consist of the following:
                                                 
(in 000s)  
   
    July 31, 2008     April 30, 2008  
   
    Gross
                Gross
             
    Carrying
    Accumulated
          Carrying
    Accumulated
       
    Amount     Amortization     Net     Amount     Amortization     Net  
   
 
Tax Services:
                                               
Customer relationships
  $ 46,465     $ (23,315 )   $ 23,150     $ 46,479     $ (22,007 )   $ 24,472  
Noncompete agreements
    22,966       (20,329 )     2,637       22,966       (19,981 )     2,985  
Purchased technology
    12,500       (2,773 )     9,727       12,500       (2,283 )     10,217  
Trade name
    1,025       (142 )     883       1,025       (117 )     908  
Business Services:
                                               
Customer relationships
    144,031       (103,143 )     40,888       143,402       (100,346 )     43,056  
Noncompete agreements
    32,442       (18,193 )     14,249       32,303       (17,589 )     14,714  
Trade name – amortizing
    3,290       (3,060 )     230       3,290       (3,043 )     247  
Trade name – non-amortizing
    55,637       (4,868 )     50,769       55,637       (4,868 )     50,769  
Consumer Financial Services:
                                               
Customer relationships
    -       -       -       293,000       (293,000 )     -  
                                                 
    $ 318,356     $ (175,823 )   $ 142,533     $ 610,602     $ (463,234 )   $ 147,368  
                                                 
 
 
Amortization of intangible assets for the three months ended July 31, 2008 and 2007 was $5.6 million and $15.5 million, respectively. Estimated amortization of intangible assets for fiscal years 2009 through 2013 is $22.8 million, $20.2 million, $18.4 million, $15.7 million and $11.7 million, respectively.
 
4.   Income Taxes
We file a consolidated federal income tax return in the United States and file tax returns in various state and foreign jurisdictions. The consolidated tax returns for the years 1999 – 2005 are currently under examination by the Internal Revenue Service (IRS). Tax years prior to 1999 are closed by statute. Historically, tax returns in various foreign and state jurisdictions are examined and settled upon completion of the exam.
During the three months ended July 31, 2008, we accrued an additional $2.9 million of interest & penalties related to our uncertain tax positions. We had unrecognized tax benefits of $137.2 million and $137.6 million at July 31, 2008 and April 30, 2008, respectively. There were no significant changes in our unrealized tax positions during the quarter. We have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at July 31, 2008, which is included in other noncurrent liabilities on the condensed consolidated balance sheet. Amounts that we expect to pay, or for which statutes expire, within the next twelve months have been included in accounts payable, accrued expenses and other current liabilities on the condensed consolidated balance sheet.


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Based upon the expiration of statutes of limitations, payments of tax and other factors in several jurisdictions, we believe it is reasonably possible that the total amount of previously unrecognized tax benefits may decrease by approximately $9 to $10 million within twelve months of July 31, 2008.
 
5.   Interest Income and Expense
The following table shows the components of interest income and expense of our continuing operations. Operating interest expense is included in cost of other revenues, and interest expense on acquisition debt is included in other income, net on our consolidated statements of operations.
(in 000s)
                     
 
Three Months Ended July 31,   2008     2007      
 
 
Interest income:
                   
Mortgage loans, net
  $ 13,265     $ 22,491      
Margin receivables
    5,025       7,437      
Other
    6,948       11,910      
                     
      25,238       41,838      
                     
Operating interest expense:
                   
Borrowings
    18,430       12,360      
Deposits
    4,043       14,243      
Federal Home Loan Bank (FHLB) advances
    1,328       1,890      
                     
      23,801       28,493      
                     
Interest expense – acquisition debt
    413       595      
                     
Net interest income
  $ 1,024     $ 12,750      
                     
 
 
 
6.   Fair Value
On May 1, 2008, we adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements for fair value measurements. We elected to defer the application of SFAS 157 for nonfinancial assets and nonfinancial liabilities until fiscal year 2010, as provided for by FASB Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP 157-2). The adoption of SFAS 157 did not have an impact on our consolidated results of operations or financial position.
 
Fair Value Hierarchy
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels, considering the relative reliability of the inputs, as follows:
  n      Level 1 – Quoted prices in active markets for identical assets or liabilities. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
  n      Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market.
  n      Level 3 – Valuation is modeled using significant inputs that are unobservable in the market. These unobservable inputs reflect our own estimates of assumptions that market participants would use in pricing the asset or liability.
 
Estimation of Fair Value
The following is a description of the valuation methodologies used for assets and liabilities measured at fair value and the general classification of these instruments pursuant to the fair value hierarchy.
  n      Trading and available-for-sale securities – Trading and available-for-sale securities are carried at fair value on a recurring basis. When available, fair value is based on quoted prices in an active market and as such, would be classified as Level 1. If quoted market prices are not available, fair values are estimated using quoted prices of securities with similar characteristics, discounted cash flows or other pricing models. Trading and available- for-sale securities that we classify as Level 2 include certain agency and non-agency mortgage-backed securities, U.S. states and political subdivisions debt securities and other debt and equity securities.


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  n      Mortgage loans held for sale – The fair values of loans held for sale are generally based on observable market prices of securities that have loan collateral or interests in loans that are similar to the held-for-sale loans or whole loan sale prices if formally committed. These loans are classified as Level 2.
 
 
  n      Residual interests in securitizations – Determination of the fair value of residual interests in securitizations requires the use of unobservable inputs. We value these securities using a discounted cash flow approach that incorporates expectations of prepayment speeds and expectations of delinquencies and losses. Risk-adjusted discount rates are based on quotes from third party sources. These assets are classified as Level 3.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents for each hierarchy level the assets that are measured at fair value on a recurring basis at July 31, 2008:
(dollars in 000s)
                                 
   
    Total     Level 1     Level 2     Level 3  
   
 
Trading securities
  $ 11,664     $ 1,542     $ 10,122     $ -  
Available-for-sale securities
    52,438       4,994       47,444       -  
Mortgage loans held for sale
    8,804       -       8,804       -  
Residual interests in securitizations
    8,466       -       -       8,466  
                                 
    $ 81,372     $ 6,536     $ 66,370     $ 8,466  
                                 
As a percentage of total assets
    1.7%       0.1%       1.4%       0.2%  
 
 
The following table presents changes in Level 3 assets measured at fair value on a recurring basis for the three months ended July 31, 2008:
             
(in 000s)
 
Fair value, beginning of period
  $ 16,678      
Losses:
           
Included in earnings
    (4,953 )    
Included in other comprehensive income (loss)
    (2,320 )    
Cash received
    (939 )    
             
Fair value, end of period
  $ 8,466      
             
 
 
Trading securities and mortgage loans held for sale are included in prepaid expenses and other current assets, and available-for-sale securities and residual interests in securitizations are included in other assets on our condensed consolidated balance sheets.
 
Fair Value Option
We adopted Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159) on May 1, 2008. SFAS 159 permits an instrument by instrument irrevocable election to account for selected financial assets and financial liabilities at fair value. We did not elect to apply the fair value option to any eligible financial assets or financial liabilities on May 1, 2008 or during the three months ended July 31, 2008. Subsequent to the initial adoption, we may elect to account for selected financial assets and financial liabilities at fair value. Such an election could be made at the time an eligible financial asset, financial liability or firm commitment is recognized or when certain specified reconsideration events occur.
 
7.   Regulatory Requirements
 
Registered Broker-Dealer
H&R Block Financial Advisors, Inc. (HRBFA) is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. At July 31, 2008, HRBFA’s net capital of $60.4 million, which was 14.4% of aggregate debit items, exceeded its minimum required net capital of $8.4 million by $52.0 million.
HRBFA had pledged customer-owned securities with a fair value of $48.5 million at July 31, 2008 with a clearing organization to satisfy margin deposit requirements of $40.4 million.


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Banking
H&R Block Bank (HRB Bank) and the Company are subject to various regulatory capital guidelines and requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HRB Bank and our consolidated financial statements. All savings associations are subject to the capital adequacy guidelines and the regulatory framework for prompt corrective action. HRB Bank must meet specific capital guidelines that involve quantitative measures of HRB Bank’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. HRB Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. HRB Bank files its regulatory Thrift Financial Report (TFR) on a calendar quarter basis.
Quantitative measures established by regulation to ensure capital adequacy require HRB Bank to maintain minimum amounts and ratios of tangible equity, total risk-based capital and Tier 1 capital, as set forth in the table below. In addition to these minimum ratio requirements, HRB Bank is required to continually maintain a 12.0% minimum leverage ratio as a condition of its charter-approval order through fiscal year 2009. This condition was extended through fiscal year 2012 as a result of a Supervisory Directive issued on May 29, 2007. As of July 31, 2008, HRB Bank’s leverage ratio was 12.3%.
As of June 30, 2008, our most recent TFR filing with the Office of Thrift Supervision (OTS), HRB Bank was a “well capitalized” institution under the prompt corrective action provisions of the Federal Deposit Insurance Corporation (FDIC). The five capital categories are: (1) “well capitalized” (total risk-based capital ratio of 10%, Tier 1 Risk-based capital ratio of 6% and leverage ratio of 5%); (2) “adequately capitalized”; (3) “undercapitalized”; (4) “significantly undercapitalized”; and (5) “critically undercapitalized.” There are no conditions or events since June 30, 2008 that management believes have changed HRB Bank’s category.
The following table sets forth HRB Bank’s regulatory capital requirements at June 30, 2008, as calculated in the most recently filed TFR:
                                                 
(dollars in 000s)  
   
                To Be Well
 
                Capitalized
 
          For Capital Adequacy
    Under Prompt
 
    Actual     Purposes     Corrective Action Provisions  
   
    Amount     Ratio     Amount     Ratio     Amount     Ratio  
   
 
Total risk-based capital ratio(1)
  $ 147,747       23.4%     $ 50,557       8.0%     $ 63,197       10.0%  
Tier 1 risk-based capital ratio(2)
  $ 139,558       22.1%       n/a       n/a     $ 37,918       6.0%  
Tier 1 capital ratio (leverage)(3)
  $ 139,558       13.1%     $ 128,177       12.0%     $ 53,407       5.0%  
Tangible equity ratio(4)
  $ 139,558       13.1%     $ 16,022       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.
 
8.   Commitments and Contingencies
Changes in the deferred revenue liability related to our Peace of Mind (POM) program, the current portion of which is included in accounts payable, accrued expenses and other current liabilities and the long-term portion of which is included in other noncurrent liabilities in the condensed consolidated balance sheets, are as follows:
 
                     
(in 000s)
 
Three Months Ended July 31,   2008     2007      
 
 
Balance, beginning of period
  $ 140,583     $ 142,173      
Amounts deferred for new guarantees issued
    513       470      
Revenue recognized on previous deferrals
    (27,241 )     (27,237 )    
                     
Balance, end of period
  $ 113,855     $ 115,406      
                     
 
 


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The following table summarizes certain of our other contractual obligations and commitments:
 
                     
(in 000s)
 
As of   July 31, 2008     April 30, 2008      
 
 
Commitment to fund Franchise Equity
Lines of Credit
  $ 78,915     $ 79,134      
Contingent business acquisition obligations
    24,214       24,288      
Media advertising purchase obligation
    19,043       19,043      
 
 
We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Other guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counterparties from losses arising from the following: (1) tax, legal and other risks related to the purchase or disposition of businesses; (2) penalties and interest assessed by federal and state taxing authorities in connection with tax returns prepared for clients; (3) indemnification of our directors and officers; and (4) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the terms of the indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance we will ultimately prevail in the event any such claims are asserted, we believe the fair value of these guarantees and indemnifications is not material as of July 31, 2008.
 
Mortgage Loan Repurchase Liability
Sand Canyon Corporation (SCC), formerly Option One Mortgage Corporation, maintains recourse with respect to loans previously sold or securitized under indemnification of loss provisions relating to breach of representations and warranties made to purchasers or insurers. As a result, SCC may be required to repurchase loans or otherwise indemnify third-parties for losses. These representations and warranties and corresponding repurchase obligations generally are not subject to stated limits or a stated term and, therefore, may continue for the foreseeable future. SCC has established a liability related to potential losses under these indemnifications and monitors the adequacy of the repurchase liability on an ongoing basis. To the extent that future claim volumes differ from current estimates, or the value of mortgage loans and residential home prices change, future losses may be different than these estimates and those differences may be significant. The following table summarizes SCC’s loan repurchase activity:
 
                             
(in 000s)
 
    Three Months Ended     Year Ended
     
    July 31, 2008     July 31, 2007     April 30, 2008      
 
 
Loan repurchase liability at end of period
  $ 238,123     $ 72,199     $ 243,066      
Loans repurchased and indemnification payments during the period
    6,913       193,640       515,370      
Repurchase reserves added during the period
    -       157,296       582,373      
 
 
 
9.   Litigation and Related Contingencies
We are party to investigations, legal claims and lawsuits arising out of our business operations. We accrue our best estimate of the probable loss upon resolution of investigations, legal claims and lawsuits, which totaled $10.5 million and $11.5 million at July 31, 2008 and April 30, 2008, respectively. With respect to most of the matters described below, we have concluded that a loss is not probable and therefore no liability has been recorded.
 
RAL Litigation
We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things: disclosures in the RAL applications were inadequate, misleading and untimely; the RAL interest rates were usurious and unconscionable; we did not disclose that we would receive part of the finance charges paid by the


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customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act and unfair competition regarding debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial in some instances, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”) and other settlements resulting in a combined pretax expense in fiscal year 2006 of $70.2 million.
We believe we have meritorious defenses to the remaining RAL Cases and we intend to defend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate or regarding the impact of the RAL Cases on our financial statements. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the currently pending RAL Cases. There were no significant developments regarding the RAL Cases during the three months ended July 31, 2008.
 
Peace of Mind Litigation
We are defendants in lawsuits regarding our Peace of Mind program (collectively, the “POM Cases”). The POM Cases are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Case No. 08-CV-591 in the U.S. District Court for the Southern District of Illinois, is a class action case originally filed in the Circuit Court of Madison County, Illinois on January 18, 2002, in which class certification was granted on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POM program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (1) statutory fraud by selling insurance without a license, (2) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (3) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (1) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (2) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (3) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama and Texas were excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated or associated with H&R Block Tax Services, Inc., and that sold or sells the POM product. On August 5, 2008, the court decertified the defendant class and reduced the geographical scope of the plaintiff classes from 48 states to 13 states. On August 19, 2008, we removed the case from state court in Madison County, Illinois to the U.S. District Court for the Southern District of Illinois. No trial date has been set.
There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is pending before the same judge that presided over the Texas RAL Settlement, involves the same plaintiffs’ attorneys that are involved in the Marshall litigation in Illinois, and contains similar allegations. No class has been certified in this case.
We believe the claims in the POM Cases are without merit, and we intend to defend them vigorously. The amounts claimed in the POM Cases are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the POM Cases.
 
Electronic Filing Litigation
We are a defendant in a class action filed on August 30, 2002 and entitled Erin M. McNulty and Brian J. Erzar v. H&R Block, Inc., et al., Case No. 02-CIV-4654 in the Court of Common Pleas of Lackawanna County, Pennsylvania, in which the plaintiffs allege that the defendants deceptively portray electronic filing fees as a necessary and required component of standard tax preparation services and do not inform tax preparation clients that they may (1) file tax returns free of charge by mailing the returns, (2) electronically file tax returns from personal computers either free of charge or at significantly lower


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fees and (3) be eligible to electronically file tax returns free of charge via telephone. The plaintiffs seek unspecified damages and disgorgement of all electronic filing, tax preparation and related fees collected during the applicable class period. Class certification was granted in this case on September 5, 2007. In March 2008, we reached a tentative agreement to settle this case for an amount not to exceed $2.5 million and have accrued $1.5 million, representing our best estimate of ultimate loss. The settlement was preliminarily approved on June 27, 2008, with a final fairness hearing scheduled for September 2008.
 
Express IRA Litigation
On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York (Index No. 06/401110) entitled The People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc. et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. On July 12, 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than HRBFA and the claims of common law fraud. Both the New York Attorney General and HRBFA have appealed the adverse portions of the trial court’s ruling. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
On January 2, 2008, the Mississippi Attorney General filed a lawsuit in the Chancery Court of Hinds County, Mississippi First Judicial District (Case No. G 2008 6 S 2) entitled Jim Hood, Attorney for the State of Mississippi v. H&R Block, Inc., et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. The defendants have filed a motion to dismiss. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
In addition to the New York and Mississippi Attorney General actions, a number of civil actions were filed against us concerning the Express IRA product, the first of which was filed on March 17, 2006. Except for two cases pending in state court, all of the civil actions have been consolidated by the panel for Multi-District Litigation into a single action styled In re H&R Block, Inc. Express IRA Marketing Litigation in the United States District Court for the Western District of Missouri. We believe the claims in these cases are without merit, and we intend to defend these cases vigorously, but there are no assurances as to their outcome.
We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the Express IRA litigation.
 
Securities Litigation
On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation was filed against the Company and certain of its officers in the United States District Court for the Western District of Missouri. The complaint alleged, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of the Company’s operations. The complaint sought unspecified damages and equitable relief. On October 5, 2007, the court dismissed the complaint and granted the plaintiffs leave to re-file the portion of the complaint pertaining to the Company’s financial statements. On November 19, 2007, the plaintiffs re-filed the complaint, alleging, among other things, deceptive, material and misleading financial statements and failure to prepare financial statements in accordance with generally accepted accounting principles. The court dismissed the re-filed complaint on February 19, 2008. On March 11, 2008, the plaintiffs appealed the dismissal. In addition, plaintiffs in a shareholder derivative action that was consolidated into the securities litigation filed a separate appeal on March 18, 2008, contending that the derivative action was improperly consolidated. The derivative action is Iron Workers Local 16 Pension Fund v. H&R Block, et al., in the United States District Court for the Western District of Missouri, Case No. 06-cv-00466-ODS (instituted on June 8, 2006) and was brought against certain of our directors and officers purportedly on behalf of the Company. The derivative action alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste, and unjust enrichment pertaining to (1) our restatement of financial results in


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fiscal year 2006 due to errors in determining our state effective income tax rate and (2) certain of our products and business activities. We believe the claims in these cases are without merit and intend to defend this litigation vigorously. We currently do not believe that we will incur a material loss with respect to this litigation.
 
RSM McGladrey Litigation
RSM EquiCo, Inc., a subsidiary of RSM McGladrey, Inc. (RSM), is a party to a putative class action filed on July 11, 2006 and entitled Do Right’s Plant Growers, et al. v. RSM EquiCo, Inc., et al. Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations regarding business valuation services provided by RSM EquiCo, Inc., including fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition and seeks unspecified damages, restitution and equitable relief. We intend to defend this case vigorously. The amount claimed in this action is substantial and there can be no assurance regarding the outcome and resolution of this matter. It is reasonably possible that we could incur losses with respect to this litigation, although an estimate of such losses cannot be made in light of the early stage of the litigation.
RSM has a relationship with certain public accounting firms (collectively, “the Attest Firms”) pursuant to which (1) some RSM employees are also partners or employees of the Attest Firms, (2) many clients of the Attest Firms are also RSM clients, and (3) our RSM McGladrey brand is closely linked to the Attest Firms. The Attest Firms are parties to claims and lawsuits (collectively, “Attest Firm Claims”). Judgments or settlements arising from Attest Firm Claims, which exceed the Attest Firms’ insurance coverage, could have a direct adverse effect on Attest Firm operations, and could impair RSM’s ability to attract and retain clients and quality professionals. Accordingly, although RSM is not a direct party to significant Attest Firm Claims, such Attest Firm Claims could have a material adverse effect on RSM’s operations and impair the value of our investment in RSM. There is no assurance regarding the outcome of the Attest Firm Claims.
 
Litigation and Claims Pertaining to Discontinued Mortgage Operations
Although mortgage loan origination activities were terminated and the loan servicing business was sold during fiscal year 2008, SCC remains subject to investigations, claims and lawsuits pertaining to its loan origination and servicing activities that occurred prior to such termination and sale. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, municipalities, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others alleged to be similarly situated. Among other things, these investigations, claims and lawsuits allege discriminatory or unfair and deceptive loan origination and servicing practices, public nuisance, fraud, and violations of the Truth in Lending Act, Equal Credit Opportunity Act and the Fair Housing Act. In the current non-prime mortgage environment, the number of these investigations, claims and lawsuits has increased over historical experience and is likely to continue at increased levels. The amounts claimed in these investigations, claims and lawsuits are substantial in some instances, and the ultimate resulting liability is difficult to predict. In the event of unfavorable outcomes, the amounts SCC may be required to pay in the discharge of liabilities or settlements could be substantial and, because SCC’s operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a lawsuit in the Superior Court of Suffolk County, Massachusetts (Case No. 08-2474-BLS) entitled Commonwealth of Massachusetts v. H&R Block, Inc., et al., alleging unfair, deceptive and discriminatory origination and servicing of mortgage loans and seeks equitable relief, disgorgement of profits, restitution and statutory penalties. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of this litigation.
SCC also remains subject to potential claims for indemnification and loan repurchases pertaining to loans previously sold. In the current non-prime mortgage environment, it is likely that the frequency of repurchase and indemnification claims may increase over historical experience and give rise to additional litigation. In some instances, H&R Block, Inc. was required to guarantee SCC’s obligations. The amounts involved in these potential claims may be substantial, and the ultimate resulting liability is difficult to


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predict. In the event of unfavorable outcomes, the amounts SCC may be required to pay in the discharge or settlement of these claims could be substantial and, because SCC’s operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
 
Other Claims and Litigation
We have from time to time been party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others similarly situated. Some of these investigations, claims and lawsuits pertain to RALs, the electronic filing of customers’ income tax returns, the POM guarantee program, wage and hour claims and investment products. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously. The amounts claimed in these claims and lawsuits are substantial in some instances, however the ultimate liability with respect to such litigation and claims is difficult to predict. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (collectively, “Other Claims”) concerning investment products, the preparation of customers’ income tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, intellectual property disputes, employment matters and contract disputes. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material adverse effect on our consolidated operating results or financial position.
 
10.  Segment Information
Information concerning our operations by reportable operating segment is as follows:
 
                     
(in 000s)
 
Three Months Ended July 31,   2008     2007      
 
 
Revenues:
                   
Tax Services
  $ 75,265     $ 69,863      
Business Services
    174,651       192,823      
Consumer Financial Services
    86,679       114,372      
Corporate
    3,043       4,151      
                     
    $ 339,638     $ 381,209      
                     
Pretax income (loss):
                   
Tax Services
  $ (163,923 )   $ (172,289 )    
Business Services
    (295 )     (1,906 )    
Consumer Financial Services
    (17,736 )     6,206      
Corporate
    (32,662 )     (15,591 )    
                     
Loss from continuing
operations before tax
benefit
  $ (214,616 )   $ (183,580 )    
                     
 
 
 
11.  Accounting Pronouncements
In June 2008, FASB Staff Position on EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (FSP 03-6-1) was issued. FSP 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, should be included in the process of allocating earnings for purposes of computing earnings per share. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early application is not permitted. We are currently evaluating what effect FSP 03-6-1 will have on our consolidated financial statements.


14


 

In December 2007, Statement of Financial Accounting Standards No. 141(R), “Business Combinations,” (SFAS 141R), and Statement of Financial Accounting Standards No. 160, “Non-Controlling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51” (SFAS 160) were issued. These standards will require an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction, including non-controlling interests, at the acquisition-date fair value with limited exceptions. The provisions of these standards are effective as of the beginning of our fiscal year 2010. We are currently evaluating what effect the adoption of SFAS 141R and SFAS 160 will have on our consolidated financial statements.
As discussed in note 6, we adopted SFAS 157 and SFAS 159 as of May 1, 2008.
 
12.  Discontinued Operations
During fiscal year 2008, we exited the mortgage business operated through a subsidiary and sold the related loan servicing business. Our discontinued operations reflect the wind-down of our mortgage origination business and, as a result, our discontinued operations reported a net loss of $3.4 million for the three months ended July 31, 2008 compared to $192.8 million in the prior year.
The financial results of discontinued operations are as follows:
                     
(in 000s)
 
Three Months Ended July 31,   2008     2007      
 
Net revenue
  $ 1,137     $ (123,390 )    
                     
Loss from operations before income tax benefit
    (3,957 )     (312,168 )    
Impairment related to the disposition of businesses
    -       (23,229 )    
                     
Pretax loss
    (3,957 )     (335,397 )    
Income tax benefit
    (607 )     (142,640 )    
                     
Net loss from discontinued operations
  $ (3,350 )   $ (192,757 )    
                     
 
 
 
Restructuring Charge
During fiscal year 2006, our mortgage business initiated a restructuring plan to reduce costs. Restructuring activities continued into the current year, including our previously announced closure of all mortgage origination activities and sale of servicing operations. We did not incur any charges during the three months ended July 31, 2008, compared to $16.1 million in the prior year. Changes in our restructuring charge liability during the three months ended July 31, 2008 are as follows:
                                     
(in 000s)
 
    Accrual Balance as of
    Cash
    Other
    Accrual Balance as of
     
    April 30, 2008     Payments     Adjustments     July 31, 2008      
 
Employee severance costs
  $ 4,807     $ (2,453 )   $ 1,219     $ 3,573      
Contract termination costs
    23,113       (3,931 )     157       19,339      
                                     
    $ 27,920     $ (6,384 )   $ 1,376     $ 22,912      
                                     
 
 
 
The remaining liability related to this restructuring charge is included in accounts payable, accrued expenses and other current liabilities and accrued salaries, wages and payroll taxes on our consolidated balance sheet and primarily relates to lease obligations for vacant space resulting from branch office closings and employee severance costs, respectively.
Contract termination costs include estimates regarding the length of time required to sublease vacant space and expected recovery rates. Actual results could vary from these estimates.
 
13.  Subsequent Events
On August 12, 2008, we announced the signing of a definitive agreement to sell HRBFA to Ameriprise Financial, Inc. The transaction is subject to customary regulatory approvals, and is expected to close in three to six months. The purchase price is $315 million in cash, subject to working capital and advisor retention adjustments at closing. The transaction is not expected to result in a material gain or loss for financial reporting purposes. The transaction involves the sale of all outstanding common stock of HRB


15


 

Financial Corporation, HRBFA’s direct parent, and is expected to result in a capital loss for income tax purposes. We currently do not expect to be able to realize a benefit for this capital loss.
This business will be presented as held-for-sale and as discontinued operations beginning with our quarter ending October 31, 2008. Major classes of assets and liabilities of HRB Financial Corporation as of July 31, 2008 are as follows:
 
         
(in 000s)  
   
 
Cash and cash equivalents
  $ 110,535  
Cash and cash equivalents – restricted
    219,000  
Accounts receivable from customers, brokers and dealers
    401,859  
Prepaid expenses and other assets
    73,699  
Goodwill
    173,954  
         
Total assets
  $ 979,047  
         
Accounts payable to customers, brokers and dealers
  $ 592,688  
Accounts payable, accrued expenses and deposits
    38,486  
Other liabilities
    52,268  
         
Total liabilities
  $ 683,422  
         
 
 
 
Had HRBFA been reported as discontinued operations as of July 31, 2008, revenues of $67.7 million and $87.2 million for the three months ended July 31, 2008 and 2007, respectively, and a pretax loss of $1.8 million and pretax income of $3.9 million, respectively, would have been included in discontinued operations on our consolidated statements of operations. Overhead costs of a continuing nature which would have previously been allocated to HRBFA totaled $1.8 million and $2.5 million for the three months ended July 31, 2008 and 2007, respectively, and will be included in continuing operations.
 
On September 3, 2008 we announced the signing of a definitive agreement to acquire our last major independent franchise operator for approximately $278 million. This franchise includes a network of over 600 tax offices, nearly two-thirds of which will convert to company-owned offices upon the closing of the transaction. The remaining offices are currently operated by sub-franchisees and, as a result, will become our direct franchises. The transaction is expected to close by the end of our second fiscal quarter.
 


16


 

14.  Condensed Consolidating Financial Statements
Block Financial LLC (BFC) is an indirect, wholly-owned consolidated subsidiary of the Company. BFC is the Issuer and the Company is the Guarantor of the $500.0 million credit facility entered into in April 2007, the Senior Notes issued on January 11, 2008 and October 26, 2004, our unsecured committed lines of credit (CLOCs) and other indebtedness issued from time to time. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders’ equity and other intercompany balances and transactions.
 
                                         
   
Condensed Consolidating Income Statements     (in 000s)  
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
July 31, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 88,504     $ 252,572     $ (1,438 )   $ 339,638  
                                         
                                         
Cost of services
    -       52,033       317,569       4       369,606  
Cost of other revenues
    -       39,620       3,203       -       42,823  
Selling, general and administrative
    -       37,829       104,083       (1,442 )     140,470  
                                         
Total expenses
    -       129,482       424,855       (1,438 )     552,899  
                                         
Operating loss
    -       (40,978 )     (172,283 )     -       (213,261 )
Other income, net
    (214,616 )     (4,350 )     2,995       214,616       (1,355 )
                                         
Loss from continuing operations
before tax benefit
    (214,616 )     (45,328 )     (169,288 )     214,616       (214,616 )
Income tax benefit
    (85,247 )     (17,712 )     (67,535 )     85,247       (85,247 )
                                         
Net loss from continuing operations
    (129,369 )     (27,616 )     (101,753 )     129,369       (129,369 )
Net loss from discontinued operations
    (3,350 )     (3,350 )     -       3,350       (3,350 )
                                         
Net loss
  $ (132,719 )   $ (30,966 )   $ (101,753 )   $ 132,719     $ (132,719 )
                                         
 
 
 
                                         
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
July 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Total revenues
  $ -     $ 189,100     $ 194,355     $ (2,246 )   $ 381,209  
                                         
                                         
Cost of services
    -       63,529       321,553       33       385,115  
Cost of other revenues
    -       37,637       5,892       -       43,529  
Selling, general and administrative
    -       45,469       100,535       (1,895 )     144,109  
                                         
Total expenses
    -       146,635       427,980       (1,862 )     572,753  
                                         
Operating income (loss)
    -       42,465       (233,625 )     (384 )     (191,544 )
Other income, net
    (183,580 )     (5 )     7,969       183,580       7,964  
                                         
Income (loss) from continuing operations before tax (benefit)
    (183,580 )     42,460       (225,656 )     183,196       (183,580 )
Income tax (benefit)
    (73,757 )     14,622       (88,225 )     73,603       (73,757 )
                                         
Net income (loss) from continuing operations
    (109,823 )     27,838       (137,431 )     109,593       (109,823 )
Net loss from discontinued operations
    (192,757 )     (190,143 )     (2,923 )     193,066       (192,757 )
                                         
Net loss
  $ (302,580 )   $ (162,305 )   $ (140,354 )   $ 302,659     $ (302,580 )
                                         
 
 
 


17


 

                                         
   
Condensed Consolidating Balance Sheets     (in 000s)  
   
    H&R Block, Inc.
    BFC
    Other
          Consolidated
 
July 31, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Cash & cash equivalents
  $ -     $ 148,374     $ 208,102     $ (478 )   $ 355,998  
Cash & cash equivalents – restricted
    -       220,516       822       -       221,338  
Receivables from customers, brokers and dealers, net
    -       401,859       -       -       401,859  
Receivables, net
    3,346       116,914       262,964       -       383,224  
Mortgage loans held for investment
    -       868,603       -       -       868,603  
Intangible assets and goodwill, net
    -       173,954       974,786       -       1,148,740  
Investments in subsidiaries
    3,987,649       -       352       (3,987,649 )     352  
Other assets
    -       568,663       954,694       11       1,523,368  
                                         
Total assets
  $ 3,990,995     $ 2,498,883     $ 2,401,720     $ (3,988,116 )   $ 4,903,482  
                                         
Accts. payable to customers, brokers and dealers
  $ -     $ 592,688     $ -     $ -     $ 592,688  
Customer deposits
    -       777,558       -       (478 )     777,080  
Long-term debt
    -       1,101,975       40,981       -       1,142,956  
Other liabilities
    2       501,563       1,052,419       52       1,554,036  
Net intercompany advances
    3,154,271       (683,051 )     (2,471,179 )     (41 )     -  
Stockholders’ equity
    836,722       208,150       3,779,499       (3,987,649 )     836,722  
                                         
Total liabilities and stockholders’ equity
  $ 3,990,995     $ 2,498,883     $ 2,401,720     $ (3,988,116 )   $ 4,903,482  
                                         
 
 
 
                                         
   
    H&R Block, Inc.
    BFC
    Other
          Consolidated
 
April 30, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Cash & cash equivalents
  $ -     $ 96,559     $ 630,933     $ (647 )   $ 726,845  
Cash & cash equivalents – restricted
    -       218,214       817       -       219,031  
Receivables from customers, brokers and dealers, net
    -       438,899       -       -       438,899  
Receivables, net
    139       141,398       411,334       -       552,871  
Mortgage loans held for investment
    -       966,301       -       -       966,301  
Intangible assets and goodwill, net
    -       173,954       978,682       -       1,152,636  
Investments in subsidiaries
    4,131,345       -       322       (4,131,345 )     322  
Other assets
    -       596,612       969,896       12       1,566,520  
                                         
Total assets
  $ 4,131,484     $ 2,631,937     $ 2,991,984     $ (4,131,980 )   $ 5,623,425  
                                         
Short-term borrowings
  $ -     $ 25,000     $ -     $ -     $ 25,000  
Customer deposits
    -       786,271       -       (647 )     785,624  
Accts. payable to customers, brokers and dealers
    -       559,658       -       -       559,658  
Long-term debt
    -       1,101,885       41,185       -       1,143,070  
Other liabilities
    2       551,024       1,571,178       51       2,122,255  
Net intercompany advances
    3,143,664       (632,522 )     (2,511,103 )     (39 )     -  
Stockholders’ equity
    987,818       240,621       3,890,724       (4,131,345 )     987,818  
                                         
Total liabilities and stockholders’ equity
  $ 4,131,484     $ 2,631,937     $ 2,991,984     $ (4,131,980 )   $ 5,623,425  
                                         
 
 
 

18


 

                                         
   
Condensed Consolidating Statements of Cash Flows     (in 000s)  
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
July 31, 2008   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Net cash provided by (used in) operating activities:
  $ (11,615 )   $ 107,012     $ (411,733 )   $ -     $ (316,336 )
                                         
Cash flows from investing:
                                       
Mortgage loans originated for investment, net
    -       31,619       -       -       31,619  
Purchase property & equipment
    -       (1,727 )     (14,462 )     -       (16,189 )
Payments for business acquisitions
    -       -       (2,251 )     -       (2,251 )
Net intercompany advances
    29,630       -       -       (29,630 )     -  
Other, net
    -       2,906       (15 )     -       2,891  
                                         
Net cash provided by (used in) investing activities
    29,630       32,798       (16,728 )     (29,630 )     16,070  
                                         
Cash flows from financing:
                                       
Repayments of short-term borrowings
    -       (40,000 )     -       -       (40,000 )
Proceeds from short-term borrowings
    -       15,000       -       -       15,000  
Customer deposits
    -       (8,964 )     -       169       (8,795 )
Dividends paid
    (46,790 )     -       -       -       (46,790 )
Proceeds from stock options
    20,520       -       -       -       20,520  
Net intercompany advances
    -       (50,203 )     20,573       29,630       -  
Other, net
    8,255       (3,828 )     (14,943 )     -       (10,516 )
                                         
Net cash provided by (used in) financing activities
    (18,015 )     (87,995 )     5,630       29,799       (70,581 )
                                         
Net increase (decrease) in cash
    -       51,815       (422,831 )     169       (370,847 )
Cash – beginning of period
    -       96,559       630,933       (647 )     726,845  
                                         
Cash – end of period
  $ -     $ 148,374     $ 208,102     $ (478 )   $ 355,998  
                                         
 
 
 
                                         
   
Three Months Ended
  H&R Block, Inc.
    BFC
    Other
          Consolidated
 
July 31, 2007   (Guarantor)     (Issuer)     Subsidiaries     Elims     H&R Block  
   
 
Net cash provided by (used in) operating activities:
  $ 8,194     $ (10,196 )   $ (333,344 )   $ -     $ (335,346 )
                                         
Cash flows from investing:
                                       
Mortgage loans originated for investment, net
    -       14,327       -       -       14,327  
Purchase property & equipment
    -       (5,124 )     (9,373 )     -       (14,497 )
Payments for business acquisitions
    -       -       (20,887 )     -       (20,887 )
Net intercompany advances
    24,566       -       -       (24,566 )     -  
Investing cash flows from discontinued operations
    -       (557 )     3,625       -       3,068  
Other, net
    -       (295 )     6,994       -       6,699  
                                         
Net cash provided by (used in) investing activities
    24,566       8,351       (19,641 )     (24,566 )     (11,290 )
                                         
Cash flows from financing:
                                       
Repayments of commercial paper
    -       (3,463,719 )     -       -       (3,463,719 )
Proceeds from commercial paper
    -       3,622,874       -       -       3,622,874  
Repayments of short-term borrowings
    -       (560,000 )     -       -       (560,000 )
Proceeds from short-term borrowings
    -       485,000       -       -       485,000  
Customer deposits
    -       (90,378 )     -       -       (90,378 )
Dividends paid
    (43,937 )     -       -       -       (43,937 )
Proceeds from issuance of common stock
    9,788       -       -       -       9,788  
Net intercompany advances
    -       44,132       (68,698 )     24,566       -  
Financing cash flows from discontinued operations
    -       (47,535 )     -       -       (47,535 )
Other, net
    1,389       (9,495 )     (41,518 )     -       (49,624 )
                                         
Net cash used in financing activities
    (32,760 )     (19,121 )     (110,216 )     24,566       (137,531 )
                                         
Net decrease in cash
    -       (20,966 )     (463,201 )     -       (484,167 )
Cash – beginning of period
    -       165,118       756,720       -       921,838  
                                         
Cash – end of period
  $ -     $ 144,152     $ 293,519     $ -     $ 437,671  
                                         
 
 

19


 

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
RESULTS OF OPERATIONS
H&R Block provides tax services, certain financial and banking services, and business and consulting services. 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, 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 retail banking through H&R Block Bank (HRB Bank).
On August 12, 2008, we announced the signing of a definitive agreement to sell HRBFA to Ameriprise Financial, Inc. See additional discussion in note 13 to our condensed consolidated financial statements.
 
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 to CPAs and other tax preparers.
 
                 
   
Tax Services – Operating Results     (in 000s)  
   
Three Months Ended July 31,   2008     2007  
   
 
Service revenues:
               
Tax preparation fees
  $ 29,432     $ 24,924  
Other services
    38,783       37,349  
                 
      68,215       62,273  
Royalties
    3,684       2,842  
Other
    3,366       4,748  
                 
Total revenues
    75,265       69,863  
                 
Cost of services:
               
Compensation and benefits
    44,197       46,140  
Occupancy
    79,350       74,960  
Depreciation
    8,019       8,160  
Other
    47,677       55,165  
                 
      179,243       184,425  
Cost of other revenues, selling,
general and administrative
    59,945       57,727  
                 
Total expenses
    239,188       242,152  
                 
Pretax loss
  $ (163,923 )   $ (172,289 )
                 
 
 
 
Three months ended July 31, 2008 compared to July 31, 2007
Tax Services’ revenues increased $5.4 million, or 7.7%, for the three months ended July 31, 2008 compared to the prior year. Tax preparation fees increased $4.5 million, or 18.1%, primarily due to an increase of 14.2% in our U.S. retail clients served in company-owned offices.
Total expenses decreased $3.0 million, or 1.2%, for the three months ended July 31, 2008. Cost of services decreased $5.2 million, or 2.8%, from the prior year, as lower corporate shared services were partially offset by higher occupancy expenses. Occupancy expenses increased $4.4 million, or 5.9%, primarily as a result of higher rent expenses due to a 1.9% increase in company-owned offices under lease and a 2.7% increase in the average rent. Other cost of services decreased $7.5 million, or 13.6%, due primarily to a $5.4 million reduction in corporate shared services, primarily related to fewer information technology projects.
The pretax loss for the three months ended July 31, 2008 was $163.9 million, compared to a loss of $172.3 million in the prior year.


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BUSINESS SERVICES
This segment offers accounting, tax and consulting services to middle-market companies.
 
                 
   
Business Services – Operating Statistics  
   
Three Months Ended July 31,   2008     2007  
   
 
Accounting, tax and business consulting:
               
Chargeable hours
    960,300       1,039,190  
Chargeable hours per person
    284       274  
Net billed rate per hour
  $ 140     $ 144  
Average margin per person
  $ 18,564     $ 19,225  
 
 
 
                 
   
Business Services – Operating Results     (in 000s)  
   
Three Months Ended July 31,   2008     2007  
   
 
Tax services
  $ 76,301     $ 75,172  
Business consulting
    50,757       51,248  
Accounting services
    12,960       14,925  
Capital markets
    5,818       10,734  
Leased employee revenue
    18       11,371  
Reimbursed expenses
    4,205       5,848  
Other
    24,592       23,525  
                 
Total revenues
    174,651       192,823  
                 
Compensation and benefits
    97,757       114,655  
Occupancy
    18,660       17,862  
Other
    15,166       18,648  
                 
Cost of revenues
    131,583       151,165  
Amortization of intangible assets
    3,419       3,626  
Selling, general and administrative
    39,944       39,938  
                 
Total expenses
    174,946       194,729  
                 
Pretax loss
  $ (295 )   $ (1,906 )
                 
 
 
 
Three months ended July 31, 2008 compared to July 31, 2007
Business Services’ revenues for the three months ended July 31, 2008 declined $18.2 million, or 9.4% from the prior year.
Leased employee revenue decreased primarily due to a change in organizational structure between the businesses we acquired from American Express Tax and Business Services, Inc. (AmexTBS) and the attest firms that, while not affiliates of our company, also serve our clients. Employees we previously leased to the attest firms have now been transferred to the separate attest practices. As a result, we no longer record the revenues and expenses associated with leasing these employees.
Capital markets revenues decreased $4.9 million, primarily due to a 38.0% decrease in revenue per transaction.
Total expenses decreased $19.8 million, or 10.2%, from the prior year. Compensation and benefits decreased primarily due to the change in organizational structure with AmexTBS as discussed above. Other expenses declined $3.5 million, or 18.7%, as a result of a $1.6 million decline in reimbursed expenses.
The pretax loss for the three months ended July 31, 2008 was $0.3 million compared to a loss of $1.9 million in the prior year.


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CONSUMER FINANCIAL SERVICES
This segment is engaged in offering brokerage services, along with investment planning and related financial advice through HRBFA and retail banking through HRB Bank.
HRBFA offers traditional brokerage services, as well as annuities, insurance, fee-based accounts, online account access, equity research and focus lists, model portfolios, asset allocation strategies, and other investment tools and information. On August 12, 2008, we announced the signing of a definitive agreement to sell HRBFA to Ameriprise Financial, Inc. See additional discussion in note 13 to our condensed consolidated financial statements.
HRB Bank offers traditional banking services including checking and savings accounts, lines of credit, individual retirement accounts, certificates of deposit and prepaid debit card accounts. HRBFA utilizes HRB Bank for certain FDIC-insured deposits for its clients.
 
                 
   
Consumer Financial Services – Operating Statistics  
   
Three Months Ended July 31,   2008     2007  
   
 
Broker-dealer:
               
Traditional brokerage accounts(1)
    370,054       383,229  
New traditional brokerage accounts funded by tax clients
    3,299       3,311  
Cross-service revenue as a percent of total production revenue(2)
    19.3%       18.1%  
Average assets per traditional brokerage account
  $ 81,194     $ 84,775  
Average margin balances (millions)
  $ 401     $ 357  
Average customer payable balances (millions)
  $ 482     $ 560  
Number of advisors
    976       936  
Banking:
               
Efficiency ratio(3)
    88%       37%  
Annualized net interest margin(4)
    3.57%       2.11%  
Annualized pretax return on average assets(5)
    (5.27)%       1.34%  
Total assets (thousands)
  $ 1,039,397     $ 1,336,705  
Mortgage loans held for investment:
               
Loan loss reserve as a % of mortgage loans
    5.12%       0.37%  
Delinquency rate
    9.60%       3.43%  
 
 
 
(1) Includes only accounts with a positive balance.
(2) Defined as revenue generated from referred customers divided by total production revenue.
(3) Defined as non-interest expense divided by revenue net of interest expense. See “Reconciliation of Non-GAAP Financial Information” at the end of Part I, Item 2.
(4) Defined as annualized net interest revenue divided by average bank earning assets. See “Reconciliation of Non-GAAP Financial Information” at the end of Part I, Item 2.
(5) Defined as annualized pretax banking income divided by average bank assets. See “Reconciliation of Non-GAAP Financial Information” at the end of Part I, Item 2.
 


22


 

                 
   
Consumer Financial Services – Operating Results     (in 000s)  
   
Three Months Ended July 31,   2008     2007  
   
 
Service revenues:
               
Financial advisor production
revenue
  $ 51,381     $ 58,296  
Other
    14,118       18,067  
                 
      65,499       76,363  
                 
Net interest income:
               
Margin lending
    7,133       12,272  
Banking activities
    9,161       7,503  
                 
      16,294       19,775  
                 
Provision for loan loss reserves
    (14,991 )     (2,084 )
Other
    (742 )     40  
                 
Total revenues(1)
    66,060       94,094  
                 
Cost of services:
               
Compensation and benefits
    39,530       41,207  
Occupancy
    6,927       6,894  
Other
    11,914       4,810  
                 
      58,371       52,911  
Amortization of intangible assets
    -       9,156  
Selling, general and administrative
    25,425       25,821  
                 
Total expenses
    83,796       87,888  
                 
Pretax income (loss)
  $ (17,736 )   $ 6,206  
                 
 
 
Supplemental information
               
Revenues:(1)
               
Broker-dealer
  $ 67,472     $ 85,128  
Bank
    (1,412 )     8,966  
                 
    $ 66,060     $ 94,094  
                 
Pretax income (loss):
               
Broker-dealer
  $ (3,619 )   $ 1,364  
Bank
    (14,117 )     4,842  
                 
    $ (17,736 )   $ 6,206  
                 
 
 
 
(1) Total revenues, less loan loss reserves on mortgage loans held for investment and interest expense.
 
Three months ended July 31, 2008 compared to July 31, 2007
Consumer Financial Services’ revenues, net of interest expense and provision for loan loss reserves, for the three months ended July 31, 2008 decreased $28.0 million, or 29.8%, over the prior year.
Financial advisor production revenue, which consists primarily of fees earned on assets under administration and commissions on client trades, declined $6.9 million, or 11.9%, from the prior year due to lower closed-end fund revenues. The following table summarizes the key drivers of production revenue:
 
                     
 
Three Months Ended July 31,   2008     2007      
 
 
Client trades
    232,180       242,087      
Average revenue per trade
  $ 118.81     $ 136.53      
Ending balance of assets under administration (billions)
  $ 30.0     $ 32.5      
Annualized productivity per advisor
  $ 209,000     $ 253,000      
 
 
Net interest income on margin lending activities declined $5.1 million, or 41.9%, due to declining interest rates. The Federal Funds rate declined by a total of 325 basis points since the second quarter of last year. As this rate declines, we reduce the rates on margin and other asset balances, and therefore, net interest income is reduced.

23


 

Net interest income on banking activities increased $1.7 million from the prior year primarily due to a $10.2 million decline in interest expense on deposits, partially offset by a $9.2 million decline in interest income on mortgage loans held for investment. Interest expense and interest income are both declining due to lower interest rates and lower average balances in the corresponding liability or asset. Interest income is also declining due to an increase in non-accrual loans from $20.4 million at July 31, 2007 to $119.5 million at July 31, 2008. The following table summarizes the key drivers of net interest revenue on banking activities:
                                 
                (dollars in 000s)  
   
    Average Balance     Average Rate Earned (Paid)  
Three Months Ended July 31,   2008     2007     2008     2007  
   
 
Loans
  $ 994,301     $ 1,339,049       5.50%       6.72%  
Investments
    79,154       85,235       2.62%       5.35%  
Deposits
    802,285       1,105,125       (2.00%)       (5.11%)  
 
 
Detail of our mortgage loans held for investment and the related allowance at July 31, 2008 and April 30, 2008 is as follows:
                                                 
                            (dollars in 000s)  
   
As of   July 31, 2008     April 30, 2008  
   
    Outstanding
    Loan Loss
    % 30-Days
    Outstanding
    Loan Loss
    % 30-Days
 
    Principal Balance     Allowance     Past Due     Principal Balance     Allowance     Past Due  
   
 
Purchased from affiliates
  $ 643,360               13.05 %   $ 734,658               16.30 %
Purchased from third-parties
    265,383               1.04 %     269,982               1.90 %
                                                 
    $ 908,743     $ 46,853       9.60 %   $ 1,004,640     $ 45,401       11.71 %
                                                 
 
 
 
We recorded a provision for loan losses on our mortgage loans held for investment of $15.0 million during the current quarter, compared to $2.1 million in the prior year. Our loan loss provision increased significantly as a result of declining residential home prices, and increasing delinquencies occurring in our portfolio. Our loan loss reserve as a percent of mortgage loans was 5.12%, or $46.9 million, at July 31, 2008, compared to 4.49%, or $45.4 million, at April 30, 2008.
In estimating our loan loss allowance, we stratify the loan portfolio based on our view of risk associated with various elements of the pool and assign estimated loss rates based on those risks. Loss rates are based primarily on historical experience and our assessment of economic and market conditions. Loss rates consider both the rate at which loans will become delinquent (frequency) and the amount of loss that will ultimately be realized upon occurrence of a liquidation of collateral (severity). At July 31, 2008 and April 30, 2008 our weighted average frequency assumption was 14%. Our weighted average severity assumption was approximately 30% at July 31, 2008 and 22% at April 30, 2008, and increased due to declining collateral values during the quarter. Loss severity assumptions are based on the principal balance of the mortgage loan and, because the average loan to value ratio for our portfolio was 76.3%, imply a greater decline in actual property values.
Mortgage loans held for investment includes loans originated by affiliates and purchased by HRB Bank. Those loans have experienced higher rates of delinquency than other loans in our portfolio and expose us to a higher risk of potential credit loss. Residential real estate markets are experiencing significant declines in property values and mortgage default rates are increasing. If adverse market trends continue, including trends within our portfolio specifically, we may be required to record additional loan loss provisions, and those losses may be significant.
When mortgage loans become 180 days delinquent we account for those loans as “in-substance foreclosures” and classify the outstanding principal balance as other real estate owned rather than mortgage loans held for investment and record them at fair value. Mortgage loans with a principal balance of $65.8 million and a corresponding allowance balance of $12.3 million, were transferred to other real estate owned during the quarter ended July 31, 2008. During the quarter we recorded an additional impairment charge on these balances totaling $5.4 million reflecting declining collateral values.
Total expenses declined $4.1 million, or 4.7%, from the prior year. Other cost of services increased $7.1 million primarily due to higher expenses associated with the H&R Block Prepaid Emerald MasterCard® program.


24


 

Amortization of intangible assets decreased $9.2 million as the related intangible assets were fully amortized in November 2007.
The pretax loss for the three months ended July 31, 2008 was $17.7 million compared to prior year income of $6.2 million.
 
CORPORATE, ELIMINATIONS AND INCOME TAXES ON CONTINUING OPERATIONS
The pretax loss recorded in our corporate operations for the three months ended July 31, 2008 was $32.7 million compared to $15.6 million in the prior year. The increased loss is primarily due to $7.2 million in incremental interest expense resulting from our corporate operations absorbing current year financing costs for all long-term debt. In the prior year, financing costs were primarily related to borrowings incurred to cover losses of our mortgage business, and were therefore reported in discontinued operations. We also recorded $5.0 million in net impairments of residual interests in securitizations in the current year, and a $4.5 million decline in investment income.
Our effective tax rate for continuing operations was 39.7% and 40.2% for the three months ended July 31, 2008 and 2007, respectively. Our effective tax rate decreased primarily due to changes in our estimated state tax rate.
 
DISCONTINUED OPERATIONS
Discontinued operations includes mortgage businesses historically engaged in the origination of non-prime and prime mortgage loans, the sale and securitization of mortgage loans and residual interests, and the servicing of non-prime loans. During fiscal year 2008, we terminated all origination activities and sold the loan servicing operations. Our current year discontinued operations reflect the wind-down of our mortgage loan origination business. Also included in the prior year are the results of three smaller lines of business previously reported in our Business Services segment. We will begin reporting operating results of HRBFA as discontinued during our quarter ending October 31, 2008.
The pretax loss of our discontinued operations for the three months ended July 31, 2008 was $4.0 million compared to a loss of $335.4 million in the prior year. The loss from discontinued operations for the prior year period included impairments of residual interests of $49.6 million, losses relating to loan repurchase obligations of $157.3 million, and losses on the sale of mortgage loans totaling $57.4 million.
 
FINANCIAL CONDITION
These comments should be read in conjunction with the condensed consolidated balance sheets and condensed consolidated statements of cash flows found on pages 1 and 3, respectively.
 
CAPITAL RESOURCES & LIQUIDITY BY SEGMENT
Our sources of capital include cash from operations, issuances of common stock and debt. We use capital primarily to fund working capital, pay dividends, repurchase treasury shares and acquire businesses. Our Tax Services and Business Services segments are highly seasonal and therefore generally require the use of cash to fund operating losses during the period May through December.
Given the likely availability of a number of liquidity options, we believe, that in the absence of any unexpected developments, our existing sources of capital at July 31, 2008 are sufficient to meet our operating needs.
Cash From Operations. Cash used in operating activities for the first three months of fiscal year 2009 totaled $316.3 million, compared with $335.3 million for the same period last year. The change was due primarily to lower losses and reduced working capital requirements of our discontinued mortgage businesses.
Debt. We borrow under our unsecured committed lines of credit (CLOCs) to support working capital requirements primarily arising from off-season operating losses in our Tax Services and Business Services segments. We had no balance outstanding under our CLOCs at July 31, 2008, although we drew on the CLOCs in August 2008. See additional discussion in “Borrowings.”
Issuance of Common Stock. We issue shares of common stock, in accordance with our stock-based compensation plans, out of treasury shares. Proceeds from the issuance of common stock totaled $28.5 million and $15.3 million for the three months ended July 31, 2008 and 2007, respectively.


25


 

Dividends. Dividends paid totaled $46.8 million and $43.9 million for the three months ended July 31, 2008 and 2007, respectively.
Share Repurchases. In June 2008, our Board of Directors rescinded the previous authorizations to repurchase shares of our common stock, and approved an authorization to purchase up to $2.0 billion of our common stock over the next four years. We did not repurchase shares during the three months ended July 31, 2008, and do not expect to repurchase shares prior to our fourth quarter.
Restricted Cash. We hold certain cash balances that are restricted as to use. Cash and cash equivalents – restricted totaled $221.3 million at July 31, 2008 compared to $219.0 million at April 30, 2008. At July 31, 2008, Consumer Financial Services held $219.0 million of this total segregated in a special reserve account for the exclusive benefit of its broker-dealer clients.
Segment Cash Flows. A condensed consolidating statement of cash flows by segment for the three months ended July 31, 2008 is as follows:
 
                                         
(in 000s)  
   
                Consumer
             
    Tax
    Business
    Financial
          Consolidated
 
    Services     Services     Services     Corporate     H&R Block  
   
 
Cash provided by (used in):
                                       
Operations
  $ (257,431 )   $ 46,255     $ 77,641     $ (182,801 )   $ (316,336 )
Investing
    (9,062 )     (7,376 )     32,044       464       16,070  
Financing
    (17,782 )     3,738       (38,057 )     (18,480 )     (70,581 )
Net intercompany
    287,564       (57,430 )     (4,638 )     (225,496 )     -  
 
 
Tax Services. Tax Services has historically been our largest provider of annual operating cash flows. The seasonal nature of Tax Services generally results in a large positive operating cash flow in our fourth quarter. Tax Services used $257.4 million in its current three-month operations to cover off-season costs and working capital requirements. This segment used $9.1 million in investing activities primarily related to capital expenditures, and used $17.8 million in financing activities related to book overdrafts.
Business Services. Business Services funding requirements are largely related to receivables for completed work and “work in process.” We provide funding sufficient to cover their working capital needs. This segment provided $46.3 million in operating cash flows during the first three months of the year, primarily due to collections on receivables. Business Services used $7.4 million in investing activities primarily related to capital expenditures.
Consumer Financial Services. In the first three months of fiscal year 2009, Consumer Financial Services provided $77.6 million in cash from its operating activities primarily due to the timing of cash deposits that are restricted for the benefit of its broker-dealer clients. The segment provided $32.0 million in investing activities primarily from principal payments received on mortgage loans held for investment and used $38.1 million in financing activities due to the repayment of $25.0 million in Federal Home Loan Bank (FHLB) advances.
HRB Bank is a member of the FHLB of Des Moines, which extends credit to member banks based on eligible collateral. At July 31, 2008, HRB Bank had FHLB advance capacity of $373.5 million, and there was $104.0 million outstanding on this facility. Mortgage loans held for investment of $917.3 million were pledged as collateral on these advances.
 
BORROWINGS
The following chart provides the debt ratings for Block Financial LLC (BFC) as of July 31, 2008 and April 30, 2008:
 
                                                 
   
          July 31, 2008
                April 30, 2008
       
    Short-term     Long-term     Outlook     Short-term     Long-term     Outlook  
   
 
Fitch
    F2       BBB       Stable       F3       BBB       Negative  
Moody’s
    P2       Baa1       Negative       P2       Baa1       Negative  
S&P
    A2       BBB       Positive       A3       BBB-       Negative  
DBRS
    R-2(high )     BBB (high )     Stable       R-2(high )     BBB(high )     Negative  
 
 


26


 

At July 31, 2008, we maintained $2.0 billion in revolving credit facilities to support issuance of commercial paper and for general corporate purposes. These CLOCs, and borrowings thereunder, have a maturity date of August 2010 and an annual facility fee in a range of six to fifteen basis points per annum, based on our credit ratings. We had no balance outstanding as of July 31, 2008, although we did draw on the CLOCs in August 2008 to support working capital requirements primarily arising from off-season operating losses. The CLOCs, among other things, require we maintain at least $650.0 million of net worth on the last day of any fiscal quarter. We had net worth of $836.7 million at July 31, 2008.
Other than the changes outlined above, there have been no material changes in our borrowings from those reported at April 30, 2008 in our Annual Report on Form 10-K.
 
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
There have been no material changes in our contractual obligations and commercial commitments from those reported at April 30, 2008 in our Annual Report on Form 10-K.
 
REGULATORY ENVIRONMENT
HRBFA is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. At July 31, 2008, HRBFA’s net capital of $60.4 million, which was 14.4% of aggregate debit items, exceeded its minimum required net capital of $8.4 million by $52.0 million.
Other than the items discussed above, there have been no material changes in our regulatory environment from those reported at April 30, 2008 in our Annual Report on Form 10-K.
 
FORWARD-LOOKING INFORMATION
This report and other documents filed with the Securities and Exchange Commission (SEC) may contain forward-looking statements. In addition, our senior management may make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “will,” “would,” “should,” “could” or “may.” Forward-looking statements provide management’s current expectations or predictions of future conditions, events or results. They may include projections of revenues, income, earnings per share, capital expenditures, dividends, liquidity, capital structure or other financial items, descriptions of management’s plans or objectives for future operations, products or services, or descriptions of assumptions underlying any of the above. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date made and management does not undertake to update them to reflect changes or events occurring after that date except as required by federal securities laws.


27


 

RECONCILIATION OF NON-GAAP FINANCIAL INFORMATION
We report our financial results in accordance with generally accepted accounting principles (GAAP). However, we believe certain non-GAAP performance measures and ratios used in managing the business may provide additional meaningful comparisons between current year results and prior periods. Reconciliations to GAAP financial measures are provided below. These non-GAAP financial measures should be viewed in addition to, not as an alternative for, our reported GAAP results.
 
Banking Ratios (dollars in 000s)
             
Three Months Ended July 31,   2008   2007
 
Efficiency Ratio:
           
Total Consumer Financial Services expenses
  $ 104,415   $ 108,166
Less: Interest and non-banking expenses
    (91,594)     (104,043)
             
Non-interest banking expenses
  $ 12,821   $ 4,123
             
Total Consumer Financial Services revenues
  $ 86,679   $ 114,372
Less: Non-banking revenues and interest expense
    (72,033)     (103,323)
             
Banking revenue – net of interest expense
  $ 14,646   $ 11,049
             
      88%     37%
Net Interest Margin (annualized):
           
Net banking interest income
  $ 9,161   $ 7,503
Net banking interest income (annualized)
  $ 36,644   $ 30,012
             
Divided by average bank earning assets
  $ 1,026,809   $ 1,419,223
             
      3.57%     2.11%
Return on Average Assets (annualized):
           
Pretax banking income (loss)
  $ (14,117)   $ 4,842
Pretax banking income (loss), annualized
  $ (56,468)   $ 19,368
             
Divided by average bank assets
  $ 1,071,044   $ 1,442,299
             
      (5.27%)     1.34%


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Item 7A of our Annual Report on Form 10-K for fiscal year 2008 presents discussions of market risks that may impact our future results. The following should be read in conjunction with that discussion.
Sensitivity Analysis. The sensitivities of certain financial instruments to changes in interest rates as of July 31, 2008 are presented below. The following table represents hypothetical instantaneous and sustained parallel shifts in interest rates and should not be relied on as an indicator of future expected results.
 
                                                                 
    (in 000s)  
   
Carrying Value at
    Basis Point Change        
July 31, 2008     -300     -200     -100     +100     +200     +300        
   
 
Mortgage loans held for investment
  $ 868,603     $ 37,057     $ 27,088     $ 19,077     $ (20,764 )   $ (40,581 )   $ (58,717 )        
Residual interests in securitizations
    8,466       5,916       3,782       1,698       (1,545 )     (2,489 )     (3,207 )        
There have been no other material changes in our market risks from those reported at April 30, 2008 in our Annual Report on Form 10-K.
 
 
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on this evaluation, we have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
 
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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The information below should be read in conjunction with the information included in note 9 to our condensed consolidated financial statements.
RAL Litigation. We reported in our Annual Report on Form 10-K for the year ended April 30, 2008, certain events and information pertaining to lawsuits regarding our refund anticipation loan programs (collectively, “RAL Cases”). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things: disclosures in the RAL applications were inadequate, misleading and untimely; the RAL interest rates were usurious and unconscionable; we did not disclose that we would receive part of the finance charges paid by the customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act and unfair competition regarding debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program.
The amounts claimed in the RAL Cases have been very substantial in some instances, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”) and other settlements resulting in a combined pretax expense in fiscal year 2006 of $70.2 million.
We believe we have meritorious defenses to the remaining RAL Cases and we intend to defend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate or regarding the impact of the RAL Cases on our financial statements. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the currently pending RAL Cases. There were no significant developments regarding the RAL Cases during the three months ended July 31, 2008.
Peace of Mind Litigation. We are defendants in lawsuits regarding our Peace of Mind program (collectively, the “POM Cases”). The POM Cases are described below.
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Case No. 08-CV-591 in the U.S. District Court for the Southern District of Illinois, is a class action case originally filed in the Circuit Court of Madison County, Illinois on January 18, 2002, in which class certification was granted on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POM program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (1) statutory fraud by selling insurance without a license, (2) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (3) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (1) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (2) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (3) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama and Texas were excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated or associated with H&R Block Tax Services, Inc., and that sold or sells the POM product. On August 5, 2008, the court decertified the defendant class and reduced the geographical scope of the plaintiff classes from 48 states to 13 states. On August 19, 2008, we removed the case from state court in Madison County, Illinois to the U.S. District Court for the Southern District of Illinois. No trial date has been set.
There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is pending before the same judge that presided over the Texas RAL Settlement, involves the same plaintiffs’ attorneys that are involved in the Marshall litigation in Illinois, and contains similar allegations. No class has been certified in this case.


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We believe the claims in the POM Cases are without merit, and we intend to defend them vigorously. The amounts claimed in the POM Cases are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the POM Cases.
Electronic Filing Litigation. We are a defendant in a class action filed on August 30, 2002 and entitled Erin M. McNulty and Brian J. Erzar v. H&R Block, Inc., et al., Case No. 02-CIV-4654 in the Court of Common Pleas of Lackawanna County, Pennsylvania, in which the plaintiffs allege that the defendants deceptively portray electronic filing fees as a necessary and required component of standard tax preparation services and do not inform tax preparation clients that they may (1) file tax returns free of charge by mailing the returns, (2) electronically file tax returns from personal computers either free of charge or at significantly lower fees and (3) be eligible to electronically file tax returns free of charge via telephone. The plaintiffs seek unspecified damages and disgorgement of all electronic filing, tax preparation and related fees collected during the applicable class period. Class certification was granted in this case on September 5, 2007. In March 2008, we reached a tentative agreement to settle this case for an amount not to exceed $2.5 million and have accrued $1.5 million, representing our best estimate of ultimate loss. The settlement was preliminarily approved on June 27, 2008, with a final fairness hearing scheduled for September 2008.
Express IRA Litigation. On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York (Index No. 06/401110) entitled The People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc. et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. On July 12, 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than HRBFA and the claims of common law fraud. Both the New York Attorney General and HRBFA have appealed the adverse portions of the trial court’s ruling. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
On January 2, 2008, the Mississippi Attorney General filed a lawsuit in the Chancery Court of Hinds County, Mississippi First Judicial District (Case No. G 2008 6 S 2) entitled Jim Hood, Attorney for the State of Mississippi v. H&R Block, Inc., et al. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. The defendants have filed a motion to dismiss. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome.
In addition to the New York and Mississippi Attorney General actions, a number of civil actions were filed against us concerning the Express IRA product, the first of which was filed on March 17, 2006. Except for two cases pending in state court, all of the civil actions have been consolidated by the panel for Multi-District Litigation into a single action styled In re H&R Block, Inc. Express IRA Marketing Litigation in the United States District Court for the Western District of Missouri. We believe the claims in these cases are without merit, and we intend to defend these cases vigorously, but there are no assurances as to their outcome.
We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of the Express IRA litigation.
Securities Litigation. On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation was filed against the Company and certain of its officers in the United States District Court for the Western District of Missouri. The complaint alleged, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of the Company’s operations. The complaint sought unspecified damages and equitable relief. On October 5, 2007, the court dismissed the complaint and granted the plaintiffs leave to re-file the portion of the complaint pertaining to the Company’s financial statements. On November 19, 2007, the plaintiffs re-filed the complaint, alleging, among other things, deceptive, material and misleading financial statements and failure to prepare financial statements in accordance with generally accepted accounting principles. The court dismissed the re-filed complaint on February 19, 2008. On March 11, 2008, the plaintiffs appealed the dismissal. In addition, plaintiffs in a shareholder derivative action that was consolidated into the securities litigation filed a separate


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appeal on March 18, 2008, contending that the derivative action was improperly consolidated. The derivative action is Iron Workers Local 16 Pension Fund v. H&R Block, et al., in the United States District Court for the Western District of Missouri, Case No. 06-cv-00466-ODS (instituted on June 8, 2006) and was brought against certain of our directors and officers purportedly on behalf of the Company. The derivative action alleges breach of fiduciary duty, abuse of control, gross mismanagement, waste, and unjust enrichment pertaining to (1) our restatement of financial results in fiscal year 2006 due to errors in determining our state effective income tax rate and (2) certain of our products and business activities. We believe the claims in these cases are without merit and intend to defend this litigation vigorously. We currently do not believe that we will incur a material loss with respect to this litigation.
RSM McGladrey Litigation. RSM EquiCo, Inc., a subsidiary of RSM McGladrey, Inc. (RSM), is a party to a putative class action filed on July 11, 2006 and entitled Do Right’s Plant Growers, et al. v. RSM EquiCo, Inc., et al. Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations regarding business valuation services provided by RSM EquiCo, Inc., including fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition and seeks unspecified damages, restitution and equitable relief. We intend to defend this case vigorously. The amount claimed in this action is substantial and there can be no assurance regarding the outcome and resolution of this matter. It is reasonably possible that we could incur losses with respect to this litigation, although an estimate of such losses cannot be made in light of the early stage of the litigation.
RSM has a relationship with certain public accounting firms (collectively, “the Attest Firms”) pursuant to which (1) some RSM employees are also partners or employees of the Attest Firms, (2) many clients of the Attest Firms are also RSM clients, and (3) our RSM McGladrey brand is closely linked to the Attest Firms. The Attest Firms are parties to claims and lawsuits (collectively, “Attest Firm Claims”). Judgments or settlements arising from Attest Firm Claims, which exceed the Attest Firms’ insurance coverage, could have a direct adverse effect on Attest Firm operations, and could impair RSM’s ability to attract and retain clients and quality professionals. Accordingly, although RSM is not a direct party to significant Attest Firm Claims, such Attest Firm Claims could have a material adverse effect on RSM’s operations and impair the value of our investment in RSM. There is no assurance regarding the outcome of the Attest Firm Claims.
Litigation and Claims Pertaining to Discontinued Mortgage Operations. Although SCC terminated its mortgage loan origination activities and sold its loan servicing business during fiscal year 2008, it remains subject to investigations, claims and lawsuits pertaining to its loan origination and servicing activities that occurred prior to such termination and sale. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, municipalities, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others alleged to be similarly situated. Among other things, these investigations, claims and lawsuits allege discriminatory or unfair and deceptive loan origination and servicing practices, public nuisance, fraud, and violations of the Truth in Lending Act, Equal Credit Opportunity Act and the Fair Housing Act. In the current non-prime mortgage environment, the number of these investigations, claims and lawsuits has increased over historical experience and is likely to continue at increased levels. The amounts claimed in these investigations, claims and lawsuits are substantial in some instances, and the ultimate resulting liability is difficult to predict. In the event of unfavorable outcomes, the amounts SCC may be required to pay in the discharge of liabilities or settlements could be substantial and, because SCC’s operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
On June 3, 2008, the Massachusetts Attorney General filed a lawsuit in the Superior Court of Suffolk County, Massachusetts (Case No. 08-2474-BLS) entitled Commonwealth of Massachusetts v. H&R Block, Inc., et al., alleging unfair, deceptive and discriminatory origination and servicing of mortgage loans and seeks equitable relief, disgorgement of profits, restitution and statutory penalties. We believe the claims in this case are without merit, and we intend to defend this case vigorously, but there are no assurances as to its outcome. We are unable to determine an estimate of the possible loss or range of loss, if any, in light of the early stages of this litigation.
SCC also remains subject to potential claims for indemnification and loan repurchases pertaining to loans previously sold. In the current non-prime mortgage environment, it is likely that the frequency of repurchase and indemnification claims may increase over historical experience and give rise to additional litigation. In some instances, H&R Block, Inc. was required to guarantee SCC’s obligations. The amounts involved in these potential claims may be substantial, and the ultimate resulting liability is difficult to predict. In the event of


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unfavorable outcomes, the amounts SCC may be required to pay in the discharge or settlement of these claims could be substantial and, because SCC’s operating results are included in our consolidated financial statements, could have a material adverse impact on our consolidated results of operations.
Other Claims and Litigation. We have from time to time been party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others similarly situated. Some of these investigations, claims and lawsuits pertain to RALs, the electronic filing of customers’ income tax returns, the POM guarantee program, wage and hour claims and investment products. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously. The amounts claimed in these claims and lawsuits are substantial in some instances, however the ultimate liability with respect to such litigation and claims is difficult to predict. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could be material.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (collectively, “Other Claims”) concerning investment products, the preparation of customers’ income tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, intellectual property disputes, employment matters and contract disputes. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material adverse effect on our consolidated operating results or financial position.
 
There have been no material changes in our risk factors from those reported at April 30, 2008 in our Annual Report on Form 10-K.
 
 
 
 
A summary of our purchases of H&R Block common stock during the first quarter of fiscal year 2009 is as follows:
                         
(in 000s, except per share amounts)
 
            Total Number of Shares
  Maximum $ Value
    Total
  Average
  Purchased as Part of
  of Shares that May
    Number of Shares
  Price Paid
  Publicly Announced
  Be Purchased Under
    Purchased(1)   per Share   Plans or Programs(2)   the Plans or Programs(2)
 
 
May 1 – May 31
    6   $ 22.85     -   $ 2,000,000
June 1 – June 30
    10   $ 22.65     -   $ 2,000,000
July 1 – July 31
    174   $ 21.53     -   $ 2,000,000
 
(1) We purchased 190,301 shares in connection with the funding of employee income tax withholding obligations arising upon the exercise of stock options or the lapse of restrictions on nonvested shares.
(2) In June 2008, our Board of Directors rescinded previous authorizations to repurchase shares of our common stock, and approved an authorization to purchase up to $2.0 billion of our common stock over the next four years.
 
 
         
  3 .1   Amended and Restated Bylaws of H&R Block, Inc., as amended and restated as of June 11, 2008.
  10 .1   Employment Agreement dated July 19, 2008 between H&R Block Management LLC and Russell P. Smyth.
  31 .1   Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32 .1   Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.
  32 .2   Certification by Chief Financial Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
H&R BLOCK, INC.
 
/s/  Russell P. Smyth
Russell P. Smyth
President and Chief Executive Officer
September 3, 2008
 
/s/  Becky S. Shulman
Becky S. Shulman
Senior Vice President, Treasurer and
Chief Financial Officer
September 3, 2008
 
/s/  Jeffrey T. Brown
Jeffrey T. Brown
Vice President and
Corporate Controller
September 3, 2008


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