1
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, 2001
[ ] 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&R BLOCK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MISSOURI 44-0607856
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4400 MAIN STREET
KANSAS CITY, MISSOURI 64111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(816) 753-6900
(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 X No
----------- ---------
The number of shares outstanding of the registrant's Common Stock, without par
value, at the close of business on August 31, 2001 was 183,467,970 shares.
2
TABLE OF CONTENTS
Page
----
PART I Financial Information
Consolidated Balance Sheets
July 31, 2001 and April 30, 2001 ....................................................... 1
Consolidated Statements of Operations
Three Months Ended July 31, 2001 and 2000 .............................................. 2
Consolidated Statements of Cash Flows
Three Months Ended July 31, 2001 and 2000 .............................................. 3
Notes to Consolidated Financial Statements ................................................ 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................... 13
Quantitative and Qualitative Disclosures about Market Risk................................. 24
PART II Other Information.......................................................................... 25
SIGNATURES............................................................................................. 26
3
H&R BLOCK, INC.
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS
JULY 31, APRIL 30,
2001 2001
---- ----
ASSETS (UNAUDITED) (AUDITED)
CURRENT ASSETS
Cash and cash equivalents $ 251,850 $ 271,813
Marketable securities - available-for-sale 1,500 8,266
Marketable securities - trading 176,352 46,158
Receivables from customers, brokers, dealers and clearing organizations,
less allowance for doubtful accounts of $1,735 and $1,692 1,262,193 1,310,804
Receivables, less allowance for doubtful accounts of $42,877
and $47,125 277,977 373,223
Prepaid expenses and other current assets 244,466 260,942
----------- -----------
TOTAL CURRENT ASSETS 2,214,338 2,271,206
INVESTMENTS AND OTHER ASSETS
Investments in available-for-sale marketable securities 250,252 270,159
Intangible assets 391,806 402,209
Goodwill 651,527 649,617
Other 248,315 239,586
----------- -----------
1,541,900 1,561,571
PROPERTY AND EQUIPMENT, at cost less accumulated
depreciation and amortization 278,601 288,847
----------- -----------
$ 4,034,839 $ 4,121,624
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 373,335 $ --
Accounts payable to customers, brokers and dealers 1,007,318 1,058,000
Accounts payable, accrued expenses and deposits 248,693 361,210
Accrued salaries, wages and payroll taxes 98,872 221,830
Accrued taxes on earnings 215,929 295,599
Current portion of long-term debt 52,428 51,763
----------- -----------
TOTAL CURRENT LIABILITIES 1,996,575 1,988,402
LONG-TERM DEBT 870,549 870,974
OTHER NONCURRENT LIABILITIES 93,973 88,507
STOCKHOLDERS' EQUITY
Common stock, no par, stated value $.01 per share 2,179 2,179
Additional paid-in capital 416,622 419,957
Retained earnings 1,390,578 1,449,022
Accumulated other comprehensive income (loss) (43,654) (42,767)
----------- -----------
1,765,725 1,828,391
Less cost of 34,791,128 and 34,336,910 shares of common stock
in treasury 691,983 654,650
----------- -----------
1,073,742 1,173,741
----------- -----------
$ 4,034,839 $ 4,121,624
=========== ===========
See Notes to Consolidated Financial Statements
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H&R BLOCK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED, AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
THREE MONTHS ENDED
------------------
JULY 31,
--------
2001 2000
---- ----
REVENUES
Service revenues $ 205,568 $ 243,779
Product revenues 112,856 51,200
Royalties 1,557 1,316
Other 4,144 7,815
--------- ---------
324,125 304,110
--------- ---------
OPERATING EXPENSES
Employee compensation and benefits 176,029 146,540
Occupancy and equipment 59,679 60,224
Interest 29,805 63,198
Depreciation and amortization 34,599 47,457
Marketing and advertising 6,992 9,774
Supplies, freight and postage 6,573 7,579
Bad debt 10,836 5,521
Other 52,631 56,511
--------- ---------
377,144 396,804
--------- ---------
Operating loss (53,019) (92,694)
OTHER INCOME
Investment income, net 1,118 2,719
Other, net 163 (18)
--------- ---------
1,281 2,701
--------- ---------
Loss before income tax benefit (51,738) (89,993)
Income tax benefit (20,954) (38,247)
--------- ---------
Net loss $ (30,784) $ (51,746)
========= =========
Weighted average number of common
shares outstanding 183,859 186,522
========= =========
Basic and diluted net loss per share $ (.17) $ (.28)
========= =========
Dividends per share $ .15 $ .138
========= =========
See Notes to Consolidated Financial Statements
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H&R BLOCK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED, AMOUNTS IN THOUSANDS
THREE MONTHS ENDED
------------------
JULY 31,
--------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (30,784) $ (51,746)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 34,599 47,457
Provision for bad debt 10,836 5,521
Accretion of acquisition liabilities 3,585 3,234
Changes in:
Receivables from customers, brokers, dealers and
clearing organizations 48,535 118,843
Receivables (48,808) 32,989
Marketable securities - trading 3,635 1,044
Prepaid expenses and other current assets 16,476 (50,663)
Accounts payable to customers, brokers and dealers (50,682) (171,405)
Accounts payable, accrued expenses and deposits (112,517) (29,145)
Accrued salaries, wages and payroll taxes (122,958) (106,423)
Accrued taxes on earnings (79,670) (90,297)
Other, net (2,045) (3,043)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (329,798) (293,634)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities (607) (536)
Maturities of available-for-sale securities 23,686 5,602
Purchases of property and equipment (13,776) (11,536)
Payments made for business acquisitions, net of cash acquired (2,084) (1,036)
Other, net (731) 25,295
----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 6,488 17,789
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable (1,136,895) (4,536,830)
Proceeds from issuance of notes payable 1,510,230 4,893,109
Payments on acquisition debt (1,769) (2,628)
Dividends paid (27,660) (26,305)
Payments to acquire treasury shares (67,583) (213,107)
Proceeds from stock options exercised 26,915 231
Other, net 109 1,192
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 303,347 115,662
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (19,963) (160,183)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 271,813 379,901
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 251,850 $ 219,718
=========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Income taxes paid $ 68,776 $ 51,737
Interest paid 19,844 50,897
See Notes to Consolidated Financial Statements
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- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Unaudited, dollars in thousands, except share data
1. The Consolidated Balance Sheet as of July 31, 2001, the Consolidated
Statements of Operations for the three months ended July 31, 2001 and 2000,
and the Consolidated Statements of Cash Flows for the three months ended
July 31, 2001 and 2000 have been prepared by the Company, without audit. In
the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations and cash flows at July 31, 2001 and for all periods
presented have been made.
Reclassifications have been made to prior periods to conform with the
current period presentation.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These consolidated financial
statements should be read in conjunction with the financial statements and
notes thereto included in the Company's April 30, 2001 Annual Report to
Shareholders.
Operating revenues of U.S. tax operations and Business services are
seasonal in nature with peak revenues occurring in the months of January
through April. Thus, the three-month results are not indicative of results
to be expected for the year.
2. Receivables consist of the following:
July 31, April 30,
-------- ---------
2001 2001
---- ----
(Unaudited) (Audited)
Business services accounts receivable $ 164,797 $ 188,041
Mortgage loans held for sale 64,995 80,925
Participation in refund anticipation loans 28,006 38,824
Loans to franchisees 30,209 28,716
Other 32,847 83,842
-------------- ---------------
320,854 420,348
Allowance for doubtful accounts 42,877 47,125
-------------- ---------------
$ 277,977 $ 373,223
============== ===============
3. The Company files its Federal and state income tax returns on a calendar
year basis. The Consolidated Statements of Operations reflect the effective
tax rates expected to be applicable for the respective full fiscal years.
4. On June 20, 2001, the Company's Board of Directors declared a two-for-one
stock split of its Common Stock in the form of a 100% stock distribution
effective August 1, 2001, to shareholders of record as of the close of
business on July 10, 2001. All share and per share amounts have been
adjusted to reflect the retroactive effect of the stock split.
-4-
7
5. Basic net earnings (loss) per share is computed using the weighted average
number of shares outstanding during each period. Diluted net earnings
(loss) per share excludes the impact of shares issuable upon the exercise
of common stock options of 24,642,800 shares for the three months ended
July 31, 2001 and the conversion of 1,216 shares of preferred stock to
common stock, as they are antidilutive. The weighted average shares
outstanding for the three months ended July 31, 2001 decreased to
183,859,000 from 186,522,000 last year, due to the purchase of treasury
shares by the Company. The effect of these repurchases was partially
reduced by the issuance of treasury shares for stock option exercises.
6. During the three months ended July 31, 2001 and 2000, the Company issued
1,528,611 and 36,300 shares, respectively, pursuant to provisions for
exercise of stock options under its stock option plans. During the three
months ended July 31, 2001, the Company acquired 2,037,400 shares of its
common stock at an aggregate cost of $67,583. During the three months ended
July 31, 2000, the Company acquired 13,063,000 shares of its common stock
at an aggregate cost of $213,107.
7. CompuServe Corporation (CompuServe), certain current and former officers
and directors of CompuServe and the Company were named as defendants in six
lawsuits in state and Federal courts in Columbus, Ohio. All suits alleged
similar violations of the Securities Act of 1933 based on assertions of
omissions and misstatements of fact in connection with CompuServe's public
filings related to its initial public offering in April 1996. One state
lawsuit brought by the Florida State Board of Administration also alleged
certain oral omissions and misstatements in connection with such offering.
Relief sought in the lawsuits was unspecified, but included pleas for
rescission and damages.
In the class action pending in state court, the court issued, in November
2000, its order approving a settlement pursuant to which the defendants
agreed to pay a gross settlement amount of $9,500. Payment of plaintiffs'
attorneys' fees and expenses were to be paid out of the gross settlement
fund. The gross settlement fund was paid in its entirety by the Company's
insurance carrier. The agreement to settle and payment of the gross
settlement fund are not admissions of the validity of any claim or any fact
alleged by the plaintiffs and defendants continue to deny any wrongdoing
and any liability.
The Florida State Board of Administration opted out of the class action
settlement and that litigation continues separately from the state court
class action. The parties have reached a settlement that will dispose of
the case in its entirety with no material adverse impact on the Company's
consolidated financial position or results of operations.
8. The Company's comprehensive income is comprised of net earnings (loss),
foreign currency translation adjustments and the change in the net
unrealized gain or loss on marketable securities. The components of
comprehensive income (loss) during the three months ended July 31, 2001 and
2000 were:
-5-
8
Three months ended
------------------
July 31,
--------
2001 2000
---- ----
Net earnings (loss) $ (30,784) $ (51,746)
Change in net unrealized gain (loss) on mkt. securities (1,711) 4,057
Change in foreign currency translation adjustments 824 (1,158)
------------ -------------
Comprehensive income (loss) $ (31,671) $ (48,847)
============ =============
9. In May 2001, the Company elected early adoption of Statement of Financial
Accounting Standards No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets" (SFAS 141 and 142). SFAS 141
addresses financial accounting and reporting for business combinations and
replaces APB Opinion No. 16, "Business Combinations" (APB 16). SFAS 141 no
longer allows the pooling of interests method of accounting for
acquisitions, provides new recognition criteria for intangible assets and
carries forward without reconsideration the guidance in APB 16 related to
the application of the purchase method of accounting. SFAS 142 addresses
financial accounting and reporting for acquired goodwill and other
intangible assets and replaces APB Opinion No. 17, "Intangible Assets."
SFAS 142 addresses how intangible assets should be accounted for upon their
acquisition and after they have been initially recognized in the financial
statements. The new standards provide specific guidance on measuring
goodwill for impairment annually using a two-step process.
As of May 1, 2001, the Company has identified those intangible assets that
remain separable under the provisions of SFAS 141 and those that are to be
included in goodwill. In applying SFAS 142, the Company has re-evaluated
the useful lives of these separable intangible assets. The weighted average
life of the remaining amortized intangible assets is 10 years. In the year
of adoption, SFAS 142 requires the first step of the goodwill impairment
test to be completed within the first six months and the final step to be
completed within twelve months of adoption. The Company has not completed
the first step of the goodwill impairment test, but will perform the test
during the second quarter of fiscal year 2002.
Had the provisions of SFAS 141 and 142 been applied for the three months
ended July 31, 2000, the Company's net loss and net loss per share would
have been as follows:
Three months ended
------------------
July 31, 2000
-------------
Net loss Per share
-------- ---------
Net loss:
As reported $ (51,746) $ (.28)
Add: Goodwill amortization 7,160 .04
Assembled workforce amortization 3,616 .02
Management infrastructure amortization 225 --
Trade name amortization 431 --
------------ -------------
Pro forma net loss $ (40,314) $ (.22)
============ =============
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Intangible assets consist of the following:
July 31, 2001 April 30, 2001
------------- --------------
Gross Gross
----- -----
Carrying Accumulated Carrying Accumulated
-------- ----------- -------- -----------
Amount Amortization Amount Amortization
------ ------------ ------ ------------
Amortized intangible assets:
Customer relationships $ 397,049 $ (71,148) $ 397,049 $ (61,036)
Noncompete agreements 17,269 (2,133) 17,269 (1,842)
Unamortized intangible assets:
Trade names 55,637 (4,868) 55,637 (4,868)
--------- ----------- ---------- -----------
Total intangible assets $ 469,955 $ (78,149) $ 469,955 $ (67,746)
========= =========== ========== ===========
Changes in the carrying amount of goodwill for the three months ended July
31, 2001, are as follows by segment:
April 30, July 31,
--------- --------
2001 Acquisitions Other 2001
---- ------------ ----- ----
U.S. tax operations $ 126,829 $ 1,015 $ -- $ 127,844
International tax operations 5,755 -- 192 5,947
Mortgage operations 152,467 -- -- 152,467
Investment services 172,592 -- (56) 172,536
Business services 191,974 759 -- 192,733
--------- ----------- ---------- -----------
$ 649,617 $ 1,774 $ 136 $ 651,527
========= =========== ========== ===========
Adjustments made to International tax operations are due to changes in
foreign currency translation rates.
Amortization of intangible assets for the three months ended July 31, 2001
was $10,403. Estimated amortization of intangible assets for fiscal years
2002, 2003, 2004, 2005 and 2006 is $40,552, $39,911, $39,911, $39,832 and
$38,409, respectively.
10. Included in Investments in available-for-sale marketable securities and
Marketable securities-trading on the consolidated balance sheet are
residual interests in securitizations (residuals) of real estate mortgage
investment conduits (REMICs). The fair value of the residuals at July 31,
2001 and April 30, 2001 were $367,812 and $238,600, respectively. The
Company received servicing fees of $39 and cash flows from interest-only
strips of $546 from the securitization trusts during the three months ended
July 31, 2001.
Mortgage servicing rights (MSRs) are included in other assets on the
consolidated balance sheet. The fair value of MSRs at July 31, 2001 and
April 30, 2001 were $68,863 and $61,796, respectively. Additions to and
amortization of MSRs for the three months ended July 31, 2001 were $13,125
and $6,058, respectively.
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10
The key assumptions the Company utilizes to estimate the cash flows of the
residual interests and MSRs are as follows:
Estimated annual prepayments 23% to 90%
Estimated annual credit losses .75% to 3.5%
Discount rate - residual interests 12% to 20%
Discount rate - MSRs 12.8%
At July 31, 2001, the sensitivity of the current fair value of the
residuals and MSRs to 10% and 20% adverse changes in the above key
assumptions are as follows:
Residential Mortgage Loans
--------------------------
Cross- Servicing
Collateralized NIMs Asset
-------------- ---- -----
Carrying amount/fair value of residuals $ 203,481 $ 164,331 $ 68,863
Weighted average life (in years) 2.8 3.2 2.5
Annual prepayments:
Adverse 10% - $ impact on fair value $ (7,434) $ (21,776) $ (7,695)
Adverse 20% - $ impact on fair value (7,492) (34,269) (16,882)
Annual credit losses:
Adverse 10% - $ impact on fair value $ (4,633) $ (20,028) Not applicable
Adverse 20% - $ impact on fair value (9,852) (40,182) Not applicable
Discount rate:
Adverse 10% - $ impact on fair value $ (4,951) $ (6,377) $ (1,574)
Adverse 20% - $ impact on fair value (9,668) (13,196) (3,072)
Variable interest rates:
Adverse 10% - $ impact on fair value $ (1,481) $ (46,430) $ (.1)
Adverse 20% - $ impact on fair value (2,772) (91,681) (.3)
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of
the change in assumption to the change in fair value may not be linear.
Also in this table, the effect of a variation of a particular assumption on
the fair value of the retained interest is calculated without changing any
other assumptions; in reality, changes in one factor may result in changes
in another, which might magnify or counteract the sensitivities.
11. In May 2001, the Company adopted Emerging Issues Task Force (EITF) Issue
99-20, "Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets" (EITF
99-20). EITF 99-20 addresses how the holder of beneficial interests should
recognize cash flows on the date of the transaction, how interest income is
recognized over the life of the interests and when securities must be
written down to fair value due to other than temporary impairments. The
adoption of EITF 99-20 did not have a material impact on the consolidated
financial statements.
-8-
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12. Block Financial Corporation (BFC) is an indirect, wholly owned subsidiary
of the Company. BFC is the Issuer and the Company is the Guarantor of the
Senior Notes issued on October 21, 1997 and April 13, 2000. 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 stockholder's equity and
other intercompany balances and transactions.
Condensed Consolidating Statements of Operations
Three months ended July 31, 2001
------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Total revenues $ -- $ 220,049 $ 104,129 $ (53) $ 324,125
--------- --------- ---------- --------- ----------
Expenses:
Compensation & benefits -- 76,581 99,448 -- 176,029
Occupancy & equipment -- 14,677 45,002 -- 59,679
Interest -- 28,827 978 -- 29,805
Depreciation & amortization -- 16,822 17,777 -- 34,599
Marketing & advertising -- 3,262 3,831 (101) 6,992
Supplies, freight & postage -- 4,607 1,966 -- 6,573
Other -- 41,616 21,904 (53) 63,467
--------- --------- ---------- --------- ----------
-- 186,392 190,906 (154) 377,144
Operating earnings (loss) -- 33,657 (86,777) 101 (53,019)
Other income, net (51,738) -- 1,281 51,738 1,281
--------- --------- ---------- --------- ----------
Earnings (loss) before
income taxes (benefit) (51,738) 33,657 (85,496) 51,839 (51,738)
Income taxes (benefit) (20,954) 14,809 (35,804) 20,995 (20,954)
--------- --------- ---------- --------- ----------
Net earnings (loss) $ (30,784) $ 18,848 $ (49,692) $ 30,844 $ (30,784)
========= ========= ========== ========= ==========
Three months ended July 31, 2000
-------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Total revenues $ -- $ 212,327 $ 91,762 $ 21 $ 304,110
--------- --------- ---------- --------- ----------
Expenses:
Compensation & benefits -- 69,594 76,946 -- 146,540
Occupancy & equipment -- 13,244 46,980 -- 60,224
Interest -- 61,603 1,595 -- 63,198
Depreciation & amortization -- 22,006 25,451 -- 47,457
Marketing & advertising -- 5,825 4,093 (144) 9,774
Supplies, freight & postage -- 4,241 3,338 -- 7,579
Other -- 29,738 32,324 (30) 62,032
--------- --------- ---------- --------- ----------
-- 206,251 190,727 (174) 396,804
Operating earnings (loss) -- 6,076 (98,965) 195 (92,694)
Other income, net (89,993) (22) 2,723 89,993 2,701
--------- --------- ---------- --------- ----------
Earnings (loss) before
income taxes (benefit) (89,993) 6,054 (96,242) 90,188 (89,993)
Income taxes (benefit) (38,247) 7,018 (45,348) 38,330 (38,247)
--------- --------- ---------- --------- ----------
Net earnings (loss) $ (51,746) $ (964) $ (50,894) $ 51,858 $ (51,746)
========= ========= ========== ========= ==========
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12
Condensed Consolidating Balance Sheets
July 31, 2001
------------------------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Cash & cash equivalents $ -- $ 168,239 $ 83,611 $ -- $ 251,850
Receivables from customers,
brokers and dealers -- 1,262,193 -- -- 1,262,193
Receivables -- 122,353 155,624 -- 277,977
Intangible assets -- 244,167 147,639 -- 391,806
Goodwill -- 322,199 329,328 -- 651,527
Investments in subsidiaries 2,420,972 215 798 (2,420,972) 1,013
Other assets -- 829,450 369,904 (881) 1,198,473
----------- ----------- ----------- ----------- -----------
Total assets $ 2,420,972 $ 2,948,816 $ 1,086,904 $(2,421,853) $ 4,034,839
=========== =========== =========== =========== ===========
Notes payable $ -- $ 373,335 $ -- $ -- $ 373,335
Accts. payable to customers,
brokers and dealers -- 1,007,318 -- -- 1,007,318
Long-term debt -- 746,413 124,136 -- 870,549
Other liabilities 4,763 153,101 542,438 9,593 709,895
Net intercompany advances 1,342,467 377,715 (1,709,607) (10,575) --
Stockholders' equity 1,073,742 290,934 2,129,937 (2,420,871) 1,073,742
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity $ 2,420,972 $ 2,948,816 $ 1,086,904 $(2,421,853) $ 4,034,839
=========== =========== =========== =========== ===========
April 30, 2001
------------------------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Cash & cash equivalents $ -- $ 167,139 $ 104,674 $ -- $ 271,813
Receivables from customers,
brokers and dealers -- 1,310,804 -- -- 1,310,804
Receivables -- 172,409 200,814 -- 373,223
Intangible assets -- 251,492 150,717 -- 402,209
Goodwill -- 322,199 327,418 -- 649,617
Investments in subsidiaries 2,452,643 215 262 (2,452,643) 477
Other assets -- 720,004 394,431 (954) 1,113,481
----------- ----------- ----------- ----------- -----------
Total assets $ 2,452,643 $ 2,944,262 $ 1,178,316 $(2,453,597) $ 4,121,624
=========== =========== =========== =========== ===========
Notes payable $ -- $ -- $ -- $ -- $ --
Accts. payable to customers,
brokers and dealers -- 1,058,000 -- -- 1,058,000
Long-term debt -- 746,250 124,724 -- 870,974
Other liabilities 4,763 228,847 782,058 3,241 1,018,909
Net intercompany advances 1,274,139 637,487 (1,907,206) (4,420) --
Stockholders' equity 1,173,741 273,678 2,178,740 (2,452,418) 1,173,741
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity $ 2,452,643 $ 2,944,262 $ 1,178,316 $(2,453,597) $ 4,121,624
=========== =========== =========== =========== ===========
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Condensed Consolidating Statements of Cash Flows
Three months ended July 31, 2001
--------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Net cash used in
operating activities $ 7,670 $ (106,534) $ (230,934) $ -- $ (329,798)
----------- ----------- ----------- ----------- -----------
Cash flows from investing:
Purchase of AFS securities -- -- (607) -- (607)
Maturities of AFS securities -- 3,185 20,501 -- 23,686
Purchase property & equipment -- (9,114) (4,662) -- (13,776)
Payments for business acq -- -- (2,084) -- (2,084)
Net intercompany advances 60,658 (259,772) 199,114 -- --
Other, net -- -- (731) -- (731)
----------- ----------- ----------- ----------- -----------
Net cash provided by
investing activities 60,658 (265,701) 211,531 -- 6,488
----------- ----------- ----------- ----------- -----------
Cash flows from financing:
Repayments of notes payable -- (1,136,895) -- -- (1,136,895)
Proceeds from notes payable -- 1,510,230 -- -- 1,510,230
Payments on acquisition debt -- -- (1,769) -- (1,769)
Dividends paid (27,660) -- -- -- (27,660)
Pmts. to acquire treasury shares (67,583) -- -- -- (67,583)
Proceeds from stock
option exercises 26,915 -- -- -- 26,915
Other, net -- -- 109 -- 109
----------- ----------- ----------- ----------- -----------
Net cash provided by
financing activities (68,328) 373,335 (1,660) -- 303,347
----------- ----------- ----------- ----------- -----------
Net decrease in cash -- 1,100 (21,063) -- (19,963)
Cash at beginning of the year -- 167,139 104,674 -- 271,813
----------- ----------- ----------- ----------- -----------
Cash at end of the year $ -- $ 168,239 $ 83,611 $ -- $ 251,850
=========== =========== =========== =========== ===========
-11-
14
Three months ended July 31, 2000
-------------------------------------------------------------------------------
H&R Block, Inc BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Net cash used in
operating activities $ 38 $ (74,454) $ (219,218) $ -- $ (293,634)
----------- ----------- ----------- ------------ -----------
Cash flows from investing:
Purchase of AFS securities -- -- (536) -- (536)
Maturities of AFS securities -- 2,718 2,884 -- 5,602
Purchase property & equip -- (5,127) (6,409) -- (11,536)
Pmts. for business acq -- -- (1,036) -- (1,036)
Net intercompany advances 239,143 (417,672) 178,529 -- --
Other, net -- -- 25,295 -- 25,295
----------- ----------- ----------- ------------ -----------
Net cash provided by
investing activities 239,143 (420,081) 198,727 -- 17,789
----------- ----------- ----------- ------------ -----------
Cash flows from financing:
Repayments of notes payable -- (4,536,830) -- -- (4,536,830)
Proceeds from notes payable -- 4,893,109 -- -- 4,893,109
Pmts. on acquisition debt -- -- (2,628) -- (2,628)
Dividends paid (26,305) -- -- -- (26,305)
Pmts. to acquire treasury shares (213,107) -- -- -- (213,107)
Proceeds from stock
option exercises 231 -- -- -- 231
Other, net -- -- 1,192 -- 1,192
----------- ----------- ----------- ------------ -----------
Net cash provided by
financing activities (239,181) 356,279 (1,436) -- 115,662
----------- ----------- ----------- ------------ -----------
Net decrease in cash -- (138,256) (21,927) -- (160,183)
Cash at beginning of the year -- 256,823 123,078 -- 379,901
----------- ----------- ----------- ------------ -----------
Cash at end of the year $ -- $ 118,567 $ 101,151 $ -- $ 219,718
=========== =========== =========== ============ ===========
13. On May 1, 2001, the Company adopted a new methodology for allocation of
corporate services and support costs to business units. The change was made
in an effort to more accurately reflect each business segment's
performance. Prior year results have been restated based on this allocation
methodology. Information concerning the Company's operations by reportable
operating segments for the three months ended July 31, 2001 and 2000 is as
follows:
-12-
15
Three months ended
------------------
July 31,
--------
2001 2000
---- ----
Revenues:
U.S. tax operations $ 19,979 $ 11,350
International tax operations 4,832 4,899
Mortgage operations 148,325 80,600
Investment services 68,925 130,667
Business services 79,982 76,097
Unallocated corporate 2,082 497
--------- ---------
$ 324,125 $ 304,110
========= =========
Earnings (loss) from:
U.S. tax operations $ (81,168) $ (85,562)
International tax operations (5,653) (6,355)
Mortgage operations 66,779 21,530
Investment services (6,098) 11,683
Business services (2,171) (3,234)
Unallocated corporate (5,439) (4,541)
Interest expense-acquisition debt (21,398) (27,288)
--------- ---------
(55,148) (93,767)
Investment income, net 1,118 2,719
Intercompany interest 2,292 1,055
--------- ---------
Loss before income tax benefit $ (51,738) $ (89,993)
========= =========
Intercompany interest represents net interest expense charged to financial
related businesses for corporate cash that was borrowed to fund their operating
activities and net unallocated interest expense attributable to commitment fees
on the unused portion of the Company's credit facility.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------------
GENERAL
- --------------------------------------------------------------------------------
OVERVIEW OF REPORTABLE OPERATING SEGMENTS
The principal business activity of the Company's operating subsidiaries is
providing tax and financial services to the general public. The Company operates
in the following reportable segments:
U.S. tax operations: This segment primarily consists of the Company's
traditional tax business - which served 16.9 million taxpayers in fiscal
year 2001, more than any other company. This segment is primarily engaged
in providing tax return preparation, filing, and related services in the
United States. Tax-related service revenues include fees from
company-owned tax offices and royalties from franchised offices. This
segment also participates in the refund anticipation loan (RALs) products
offered by a third-party lending institution to tax clients. This segment
includes the Company's tax preparation software -
-13-
16
Kiplinger TaxCut(R) from H&R Block, other personal productivity software,
online tax preparation through a tax preparer (whereby the client fills
out an online tax organizer and sends it to a tax preparer for
preparation), online do-it-yourself tax preparation, online professional
tax review and online tax advice through the hrblock.com website.
Revenues from this segment are seasonal.
International tax operations: This segment is primarily engaged in
providing local tax return preparation, filing and related services in
Canada, Australia and the United Kingdom. In addition, there are
franchise offices in 9 countries that prepare U.S. tax returns for U.S.
citizens living abroad. This segment served 2.3 million taxpayers in
fiscal 2001. Tax-related service revenues include fees from company-owned
tax offices and royalties from franchised offices. Revenues from this
segment are seasonal.
Mortgage operations: This segment is primarily engaged in the
origination, servicing, and sale of nonconforming and conforming mortgage
loans. This segment mainly offers, through a network of mortgage brokers,
a flexible product line to borrowers who are creditworthy but do not meet
traditional underwriting criteria. Conforming mortgage loan products, as
well as the same flexible product line available through brokers, are
offered through some H&R Block Financial Advisors branch offices and H&R
Block Mortgage Corporation retail offices.
Investment services: This segment is primarily engaged in offering
investment advice through H&R Block Financial Advisors, Inc., a
full-service securities broker. Financial planning and investment advice
are offered through H&R Block Financial Advisors branch offices and tax
offices, and stocks, bonds, mutual funds and other products and
securities are offered through a nationwide network of registered
representatives, at the same locations.
Business services: This segment is primarily engaged in providing
accounting, tax and consulting services to business clients and tax,
estate planning, financial planning, wealth management and insurance
services to individuals. Revenues from this segment are seasonal.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
THREE MONTHS ENDED JULY 31, 2001 COMPARED TO
THREE MONTHS ENDED JULY 31, 2000
The analysis that follows should be read in conjunction with the tables below
and the Consolidated Statements of Operations found on page 2. All amounts in
the following tables are in thousands.
On May 1, 2001, the Company adopted a new methodology for allocation of
corporate services and support costs to business units. The change was made in
an effort to more accurately reflect each business segment's performance. Prior
year results have been restated based on this allocation methodology.
-14-
17
Consolidated H&R Block, Inc.
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Revenues $ 324,125 $ 304,110 $ 20,015 6.6%
------------- --------- ---------
Pretax loss (51,738) (89,993) 38,255 42.5%
Net loss $ (30,784) $ (51,746) $ 20,962 40.5%
============= ========= =========
- --------------------------------------------------------------------------------
Consolidated revenues for the three months ended July 31, 2001 increased 6.6%
primarily due to the Mortgage operations segment, which increased revenues by
$67.7 million, or 84.0%, over the prior year. The U.S. tax operations segment
also contributed to the increase in revenues. These increases were partially
offset by the decline in revenues from Investment services.
The Company reported a pretax loss of $51.7 million for the first quarter of
fiscal 2002 compared to a loss of $90.0 million in the prior year. The
improvement over the prior year is primarily due to the Mortgage operations
segment that reported earnings of $66.8 million, a $45.2 million improvement
over last year.
The Company's performance as measured by earnings before interest (including
interest expense on acquisition debt, investment income and interest allocated
to operating business units), taxes, depreciation and amortization (EBITDA)
improved 104.5% to a positive $0.8 million compared to a negative $19.0 million
in the prior year's first quarter. EBITDA is utilized by management to evaluate
the performance of its operating segments because many of the segments reflect
substantial amortization of certain acquired intangible assets and goodwill
resulting from recent acquisitions. Management believes EBITDA is a good
measure of cash flow generation because the Company's operations have not
historically been capital intensive, and it also removes the effects of purchase
accounting. The calculation of EBITDA may not be comparable to the calculation
of EBITDA by other companies.
In addition, the Company continues to measure its performance based on the
calculation of earnings excluding the after-tax impact of amortization of
certain acquired intangible assets. The net loss, excluding the after-tax impact
of this expense, was $21.4 million, or $.12 per share in the first quarter,
compared to $31.1 million, or $.17 per share in last year's first quarter.
The net loss was $30.8 million, or $.17 per share compared to a loss of $51.7
million, or $.28 per share in the first quarter of fiscal 2001. The three months
ended July 31, 2001 reflect the adoption of SFAS 141 and 142 effective May 1,
2001 related to business combinations, goodwill and other intangible assets,
which eliminates goodwill and certain other intangible asset amortization. Of
the improvement over the prior year's first quarter, $11.4 million, or $.06 per
share, relates to the adoption of SFAS 141 and 142.
-15-
18
The effective income tax rate decreased from 42.5% last year to 40.5% this year.
The decrease in the effective tax rate is primarily due to the reduction in
non-deductible goodwill and other intangible asset amortization related to the
adoption of SFAS 141 and 142 in the first quarter of fiscal year 2002.
An analysis of operations by reportable operating segments follows.
U.S. Tax Operations
- ----------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Tax preparation and related fees $ 11,348 $ 7,980 $ 3,368 42.2%
Royalties 1,096 753 343 45.6%
RAL participation fees 282 195 87 44.6%
Software sales 773 60 713 --
Other 6,480 2,362 4,118 174.3%
--------- --------- ---------
Total revenues 19,979 11,350 8,629 76.0%
========= ========= =========
Compensation & benefits 23,069 21,642 (1,427) -6.6%
Occupancy & equipment 33,126 31,300 (1,826) -5.8%
Depreciation & amortization 7,304 11,698 4,394 37.6%
Cost of software sales 319 346 27 7.8%
Bad debt expense 881 75 (806) --
Supplies, freight & postage 1,536 676 (860) -127.2%
Other 8,947 7,930 (1,017) -12.8%
Allocated corporate & shared costs 25,965 23,245 (2,720) -11.7%
--------- --------- ---------
Total expenses 101,147 96,912 (4,235) -4.4%
--------- --------- ---------
Pretax loss $ (81,168) $ (85,562) $ 4,394 5.1%
========= ========= =========
- ----------------------------------------------------------------------------------
Revenues increased 76.0% to $20.0 million for the three months ended July 31,
2001 compared to the same period last year. Tax preparation and related fees
increased 42.2% to $11.3 million for the three months ended July 31, 2001
compared to the prior year. This increase is primarily attributable to an 8%
increase in company-owned returns prepared and a 27% increase in the average
fee on those returns. Company-owned tax returns prepared through July of
89,600 compares to 83,000 last year. The average fee per client served earned
this year of $144.49 compares to $113.62 earned last year. Franchise offices
experienced a similar increase in tax preparation and related fees, leading to a
45.6% increase in royalties during the three months ended July 31, 2001. The
overall increase in tax returns prepared is partially attributed to the federal
income tax rebate program this summer where taxpayers are required to file their
2000 tax returns with the IRS in order to be eligible for the rebate. The
increase in the average fee per client served is partially attributed to an
increase in the number of more complex income tax returns prepared this year.
-16-
19
Other revenue of $6.5 million through July 31, 2001 was $4.1 million better than
last year primarily due to higher revenues from the Company's Peace of Mind
program.
Total expenses of $101.1 million through July increased $4.2 million or 4.4%
compared to last year. This increase in expenses is attributable to higher tax
preparation wages to support the related increase in revenues, a normal
inflationary impact on occupancy and equipment expenses and higher allocated
corporate services and shared costs primarily due to investments in technology.
Depreciation and amortization expense benefited from the early adoption of SFAS
141 and 142, resulting in lower amortization of goodwill when compared to the
prior year by $2.8 million. Additionally, depreciation expense decreased by $1.5
million this year due to certain assets becoming fully depreciated at the end of
the prior fiscal year.
The pretax loss of $81.2 million was $4.4 million or 5.1% better than the same
period a year ago. EBITDA increased $0.9 million to a negative $69.2 million in
the first quarter of fiscal year 2002.
Due to the nature of this segment's business, first quarter results are not
indicative of the expected results for the entire fiscal year.
International Tax Operations
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Canada $ 3,257 $ 3,295 $ (38) -1.2%
Australia 543 595 (52) -8.7%
United Kingdom 632 638 (6) -0.9%
Overseas franchises 400 371 29 7.8%
------- ------- -------
Total revenues 4,832 4,899 (67) -1.4%
======= ======= =======
Canada (3,446) (4,502) 1,056 23.5%
Australia (1,650) (1,439) (211) -14.7%
United Kingdom (179) (172) (7) -4.1%
Overseas franchises 181 190 (9) -4.7%
Allocated corporate & shared costs (559) (432) (127) -29.4%
------- ------- -------
Pretax loss $(5,653) $(6,355) $ 702 11.1%
======= ======= =======
- --------------------------------------------------------------------------------
International revenues decreased by 1.4% to $4.8 million from $4.9 million last
year. The decrease was driven by unfavorable changes in currency exchange rates
in Canada and Australia.
The pretax loss improved 11.1% to $5.7 million from a loss of $6.4 million last
year.
The improved performance in Canada is primarily attributed to better business
management and cost control mainly related to bad debts and facilities costs.
-17-
20
The Australian results were negatively affected by unfavorable changes in
currency exchange and additional expenses due to the opening of thirteen new
offices in anticipation of the Australian tax season that began in July.
The United Kingdom pretax loss increased by 4.1% primarily driven by unfavorable
changes in currency exchange and severance costs incurred as unprofitable
offices are being closed.
The overseas franchise pretax profit decreased by 4.7% primarily driven by
additional labor and training costs due to increases in return volume.
International tax operations' EBITDA improved 5.8% to a negative $4.9 million.
Mortgage Operations
- ------------------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Interest income $ 19,194 $ 8,642 $ 10,552 122.1%
Loan servicing income 32,473 22,936 9,537 41.6%
Gain on sale of mortgage loans 96,234 48,847 47,387 97.0%
Other 424 175 249 142.3%
-------- -------- --------
Total revenues 148,325 80,600 67,725 84.0%
======== ======== ========
Compensation & benefits 41,772 26,313 (15,459) -58.8%
Variable servicing & processing 11,520 7,908 (3,612) -45.7%
Occupancy & equipment 6,037 5,409 (628) -11.6%
Interest expense 1,795 3,373 1,578 46.8%
Bad debt expense 6,616 2,643 (3,973) -150.3%
Amortization of acquisition intangibles -- 3,394 3,394 100.0%
Other 13,526 9,733 (3,793) -39.0%
Allocated corporate & shared costs 280 297 17 5.7%
-------- -------- --------
Total expenses 81,546 59,070 (22,476) -38.1%
-------- -------- --------
Pretax earnings $ 66,779 $ 21,530 $ 45,249 210.2%
======== ======== ========
- ----------------------------------------------------------------------------------------
Revenues increased 84.0% in the first quarter of fiscal 2002 over the prior
year. The increase is primarily due to an increase in production volume, a
favorable secondary market environment and a larger servicing portfolio.
Revenues related to the sale of mortgage loans increased $47.4 million over the
prior year resulting from a significant increase in loan origination volume, as
well as secondary market pricing and, to a lesser extent, better pricing
execution on mortgage loan sales. During the three months ended July 31, 2001,
the Company originated $2.6 billion in mortgage loans compared to $1.4 billion
for the same period last year, an increase of 89.3%. The increase in loan
production is a result of an increase in the average loan size, an increase in
the size of the sales force, an improvement in the closing ratio and to a lesser
extent, the declining interest rate environment. One of the Company's key
cross-sell initiatives related to retail mortgage operations resulted in 61.2%
of all retail loans, and 10.4% of all loans originated
-18-
21
during the first quarter this year coming from H&R Block tax clients. The total
execution price representing gain on sale of mortgage loans for the three months
ending July 31, 2001 was 3.82% compared to 2.58% for the same three months
ending July 31, 2000. The better execution pricing is attributable to the
declining interest rate environment that has the effect of widening spreads on
mortgage loan sales and improved overall execution through improved structuring
of the underlying sales. Servicing revenues increased 41.6% over the prior year.
The increase is principally attributable to a higher loan servicing portfolio
balance and an increase in servicing operations efficiencies. The average
servicing portfolio for the three-month period increased to $18.6 billion
compared to $13.0 billion for the same period last year. In addition, interest
income increased $10.6 million over the prior year primarily related to residual
interests being held as trading securities during the three months ended July
31, 2001.
Pretax earnings increased $45.2 million or 210.2% to $66.8 million for the three
months ended July 31, 2001. The improved performance is primarily due to the
increased revenues. In addition, the higher loan volumes helped drive a decline
in the net cost of origination. The first quarter also benefited from the
adoption of SFAS 141 and 142 by eliminating amortization of goodwill, which was
$3.4 million in the prior year's first quarter. Mortgage operations operating
profit margin of 2.55% improved 75 basis points from 1.80% in the prior year.
The results of the wholesale and retail mortgage operations were slightly
reduced by costs associated with the winding down of certain mortgage
activities. Mortgage operations EBITDA increased $42.9 million to $69.9 million
in the first quarter of fiscal 2002.
Investment Services
- --------------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Commission & fee income $ 41,776 $ 64,788 $(23,012) -35.5%
Margin interest income 21,955 59,037 (37,082) -62.8%
Other 5,194 6,842 (1,648) -24.1%
-------- --------- --------
Total revenues 68,925 130,667 (61,742) -47.3%
======== ========= ========
Compensation & benefits 31,500 40,664 9,164 22.5%
Interest expense 6,645 32,994 26,349 79.9%
Occupancy & equipment 7,689 7,214 (475) -6.6%
Depreciation & amortization 4,982 3,782 (1,200) -31.7%
Commission, floor brokerage & fees 1,620 3,537 1,917 54.2%
Amortization of acquisition intangibles 7,381 11,571 4,190 36.2%
Other 13,137 12,886 (251) -2.0%
Allocated corporate & shared costs 2,069 6,336 4,267 67.4%
-------- --------- --------
Total expenses 75,023 118,984 43,961 37.0%
-------- --------- --------
Pretax earnings (loss) $ (6,098) $ 11,683 $(17,781) -152.2%
======== ========= ========
- ---------------------------------------------------------------------------------------
Investment services revenues for the first quarter of fiscal year 2002 decreased
47.3% to $68.9 million from $130.7 million in the first quarter of 2001. The
overall decrease in revenues can be
-19-
22
attributed primarily to bearish market conditions. Revenue is very closely
linked with the overall performance of market indices.
Investment services reported a pretax loss of $6.1 million for the first quarter
of fiscal year 2002 compared to pretax earnings of $11.7 million in the prior
year. The decrease in pretax earnings is primarily attributed to the decline in
customer trading and customer margin activity. Total expenses decreased by 37.0%
to $75.0 million from $119.0 million. As a result of the adoption of SFAS 141
and 142, Investment services amortization of intangible assets has declined by
$4.2 million.
Trading Volume. Similar to the rest of the industry, Investment services has
been experiencing a decline in trading volume. Total customer trades for the
first quarter of 2002 were 389,000, whereas in the previous year's first quarter
the total customer trades were 646,000 (a decline of 39.8%). As a result,
commission and fee income decreased 35.5% to $41.8 million from $64.8 million.
The average commission per trade declined 1.6% from $63.31 to $62.29, reflecting
lower dollar volume trades.
Margin Lending. Due to declining securities values and market volatility,
customer margin balances have significantly declined from an average of $2.74
billion in the first quarter of 2001, to an average of $1.27 billion in the
first quarter of 2002. The decline in margin interest revenue was primarily
attributed to declines in interest rates and also margin balances. Net interest
margin, interest earned on the average margin loan balance less the cost of
funding those loans, declined from 1.80% to 1.57% as interest rates have fallen
and compressed spreads.
Principal Trading. Decimalization replaced fractional trading for listed
equities on January 29, 2001 and for NASDAQ equities on April 9, 2001. The
impact of decimalization has reduced the dealer spread between the bid and ask
prices, reducing revenue opportunities. Overall principal trading revenue,
including equities, fixed income trading, underwriting, and unit investment
trusts, decreased 36.5% to $13.2 million. Underwriting revenues increased by
$3.8 million primarily due to increased demand for Trust Preferred Debt
Securities. More clients have shown a greater interest in fixed rate capital
securities due to the current equity market conditions. More than offsetting
this increase was a $6.5 million decline in equity unit investment trusts
(UIT). Client demand for equity UITs fell as many equity UITs have taken sharp
down turns from initial offering prices in late fiscal 2000 and early fiscal
2001.
Products. Continuing efforts to become an advisory-based relationship provider,
a number of key initiatives occurred despite the difficult financial and market
environment. Annuities were added to the product line beginning in January 2001.
For the first quarter of 2002, annuity revenue was $0.5 million. The Company
currently conducts annuity business in eight states and will continue to add
additional states to distribute the product. In the fall of 2000, the Company
began offering online accounts to its customers. The number of on-line trades
currently represents 7.5% of total trades. Accounts with cash management
features like the VISA Gold ATM/Check card, which offers customers the choice of
a 1% cash rebate on every VISA Gold purchase or airline miles that can be
redeemed on any airline, began being offered in July. Currently under
development are fee-based services. The Investment services segment has yet to
experience significant revenues from these initiatives.
-20-
23
During the tax season, the Express IRA product was launched in six tax services
regions, introducing new technology, sales activities, service functions and
training across the tax services and HRBFA organizations. This product will
expand into more regions for the 2002 tax season. Another key
cross-organizational initiative was the creation and testing of the TPFA (Tax
Preparer Financial Advisor) program during the 2001 tax season. Investment
services plans to add another 800 TPFAs in fiscal 2002 bringing the total to
approximately 1,200.
Investment services EBITDA declined to $6.8 million in the first quarter of
fiscal 2002 from $27.5 million in the same period last year.
Business Services
- --------------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Accounting, consulting & tax $ 64,901 $ 61,382 $ 3,519 5.7%
Product sales 5,365 4,689 676 14.4%
Management fee income 2,250 528 1,722 326.1%
Other 7,466 9,498 (2,032) -21.4%
-------- -------- --------
Total revenues 79,982 76,097 3,885 5.1%
======== ======== ========
Compensation & benefits 58,163 40,426 (17,737) -43.9%
Occupancy & equipment 5,419 9,334 3,915 41.9%
Depreciation & amortization 2,102 2,238 136 6.1%
Marketing & advertising 1,363 1,519 156 10.3%
Bad debt expense 3,011 1,838 (1,173) -63.8%
Amortization of acquisition intangibles 3,196 6,975 3,779 54.2%
Other 8,597 16,779 8,182 48.8%
Allocated corporate & shared costs 302 222 (80) -36.0%
-------- -------- --------
Total expenses 82,153 79,331 (2,822) -3.6%
-------- -------- --------
Pretax loss $ (2,171) $ (3,234) $ 1,063 32.9%
======== ======== ========
- --------------------------------------------------------------------------------------
Business services revenues of $80.0 million increased 5.1% from $76.1 million in
the prior year. This increase was primarily a result of revenue from the
insurance alliance, which is part of the Wealth Management initiative to provide
asset management and life insurance services to clients. The initiative is part
of a focus to provide a fully integrated approach to clients to further their
business and personal financial objectives. Revenue from core services increased
by 6% for the quarter, which was offset by a decrease in tax consulting revenues
for the quarter. Revenue from financial, technology and other consulting
services was relatively flat for the quarter. While the market for core services
has remained stable, the slowing economy has caused a decrease in the demand for
specialized consulting services.
Pretax loss decreased from $3.2 million in the prior year to $2.2 million for
the current year. As a result of the adoption of SFAS 141 and 142, amortization
of goodwill and certain intangible assets decreased by $3.8 million. The pretax
loss increased by $2.1 million as a result of
-21-
24
increased fixed expenses. In addition, the pretax loss was increased by $.7
million due to the off-season losses of three firms acquired during fiscal 2001
and the sale of one firm in December 2000. Business services EBITDA declined to
$3.1 million from $6.0 million in the first quarter of last year.
Subsequent to the end of the first quarter, Business services acquired two
regional accounting firms which expanded its geographic regions to encompass two
major metropolitan areas outside of the segment's existing geographic locations.
Management expects that one of these firms will add significant strength in the
financial institution consulting area, which will be used to capitalize on both
their existing client base and future potential clients.
Due to the nature of this segment's business, revenues are seasonal, while
expenses are relatively fixed throughout the year. Results for the first quarter
are not indicative of the expected results for the entire fiscal year.
Unallocated Corporate &
Interest Expense on Acquisition Debt
- --------------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
July 31, Better/(worse) than
-------- -------------------
2001 2000 $ %
---- ---- - -
Total revenues $ 2,082 $ 497 $ 1,585 318.9%
-------- -------- --------
Compensation & benefits 17,166 13,493 (3,673) -27.2%
Occupancy & equipment 4,383 3,611 (772) -21.4%
Depreciation & amortization 5,812 4,585 (1,227) -26.8%
Marketing & advertising 1,449 4,703 3,254 69.2%
Other 14,644 11,854 (2,790) -23.5%
Allocated corporate & shared costs (35,933) (33,208) 2,725 8.2%
-------- -------- --------
Total expenses 7,521 5,038 (2,483) -49.3%
-------- -------- --------
Pretax loss $ (5,439) $ (4,541) $ (898) -19.8%
======== ======== ========
Interest expense on acquisition debt $ 21,398 $ 27,288 $ 5,890 21.6%
======== ======== ========
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As discussed above, the Company adopted a new methodology for allocation of
corporate services and support costs to business units. The change was made in
an effort to more accurately reflect each business segment's performance. Total
corporate services and support costs are included in the Unallocated corporate
segment. These costs are then allocated to the Company's businesses. Prior year
results have been restated based on this allocation methodology.
The decrease in interest expense on acquisition debt is attributable to lower
financing costs and payment of a portion of the acquisition debt in the first
quarter of fiscal 2002.
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FINANCIAL CONDITION
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These comments should be read in conjunction with the Consolidated Balance
Sheets and Consolidated Statements of Cash Flows found on pages 1 and 3,
respectively.
LIQUIDITY
Working capital decreased to $217.8 million at July 31, 2001 from $282.8 million
at April 30, 2001. The working capital ratio at July 31, 2001 is 1.11 to 1,
compared to 1.14 to 1 at April 30, 2001. The decrease in working capital and the
working capital ratio is attributable to the increase in short-term borrowings
which was partially offset by the increase in Marketable securities-trading due
to the timing of the net interest margin transaction. Historically, a large
portion of tax return preparation occurs in the fourth quarter and has the
effect of increasing certain assets and liabilities during the fourth quarter,
including cash and cash equivalents, receivables, accrued salaries, wages and
payroll taxes and accrued taxes on earnings.
The Company incurs short-term borrowings throughout the year primarily to fund
receivables associated with its Business services, mortgage loans held for sale
and participation in RALs, and to fund seasonal working capital needs. These
short-term borrowings in the U.S. are supported by a $1.86 billion back-up
credit facility through October 2001, subject to annual renewal.
In April 2001, the Company first entered into third party off-balance sheet
arrangements and whole-loan sale arrangements for Option One Mortgage
Corporation (Option One). These arrangements, modified in April 2001, allow the
Company to originate mortgage loans and then sell the loans to a third-party
trust without having to use short-term borrowings to fund the loans. The
arrangements, which are not guaranteed by the Company, freed up excess cash and
short-term borrowing capacity ($836.8 million at July 31, 2001), improved
liquidity and flexibility, and reduced balance sheet risk, while providing
stability and access to liquidity in the secondary market for mortgage loans.
The Company has commitments to fund mortgage loans of $1.6 billion at July 31,
2001, as long as there is no violation of any conditions established in the
contracts. External market forces impact the probability of commitments being
exercised, and therefore, total commitments outstanding do not necessarily
represent future cash requirements. If the commitments are exercised, they will
be funded using the Company's off-balance sheet arrangements.
At July 31, 2001, short-term borrowings increased to $373.3 million from a zero
balance at April 30, 2001. The Company's capital expenditures, dividend
payments, share repurchase program, Business services acquisition payments and
normal operating activities, including participation in RALs, during the first
three months were funded through both internally-generated funds and short-term
borrowings. The Company's debt to total equity ratio at July 31, 2001 was 54.7%,
compared to 44.0% at April 30, 2001.
For the three months ended July 31, 2001 and 2000, interest expense was $29.8
million and $63.2 million, respectively. The decrease in interest expense is due
to lower stock loan balances, short-term borrowings and acquisition debt, as
well as lower financing costs.
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In March 2000, the Company's Board of Directors approved a plan to repurchase up
to 12 million shares of its common stock. In the first quarter of fiscal 2002,
the Company repurchased 2.0 million shares (split-adjusted). There are
approximately 3.7 million shares remaining under this authorization. The Company
plans to continue to purchase its shares on the open market in accordance with
this authorization, subject to various factors including the price of the stock,
the ability to maintain progress toward a financial and capital structure that
will support a mid single A rating (Moody's - A2; Standard & Poors - A; and
Fitch - A), the availability of excess cash, the ability to maintain liquidity
and financial flexibility, securities laws restrictions and other investment
opportunities available.
FORWARD-LOOKING INFORMATION
The information contained in this Form 10-Q and the exhibits hereto may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements are based upon current information, expectations, estimates and
projections regarding the Company, the industries and markets in which the
Company operates, and management's assumptions and beliefs relating thereto.
Words such as "will," "plan," "expect," "remain," "intend," "estimate,"
"approximate," and variations thereof and similar expressions are intended to
identify such forward-looking statements. These statements speak only as of the
date on which they are made, are not guarantees of future performance, and
involve certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual outcomes and results could materially differ from
what is expressed, implied or forecast in such forward-looking statements. Such
differences could be caused by a number of factors including, but not limited
to, the uncertainty of laws, legislation, regulations, supervision and licensing
by Federal, state and local authorities and their impact on any lines of
business in which the Company's subsidiaries are involved; unforeseen compliance
costs; the uncertainty that the Company will achieve or exceed its revenue,
earnings, client and pricing growth goals for fiscal year 2002; changes in
economic, political or regulatory environments; changes in competition and the
effects of such changes; the inability to implement the Company's strategies;
changes in management and management strategies; the Company's inability to
successfully design, create, modify and operate its computer systems and
networks; the uncertainty that actual future excess cash flows from residual
interests in securitizations of REMIC certificates will differ from estimated
future excess cash flows from such items; litigation involving the Company; the
uncertainty of the impact of share repurchases on earnings per share; and risks
described from time to time in reports and registration statements filed by the
Company and its subsidiaries with the Securities and Exchange Commission.
Readers should take these factors into account in evaluating any such
forward-looking statements. The Company undertakes no obligation to update
publicly or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
There have been no material changes in market risk from those reported at April
30, 2001.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
CompuServe Corporation (CompuServe), certain current and former officers and
directors of CompuServe and the Company were named as defendants in six lawsuits
in state and Federal courts in Columbus, Ohio. All suits alleged similar
violations of the Securities Act of 1933 based on assertions of omissions and
misstatements of fact in connection with CompuServe's public filings related to
its initial public offering in April 1996. One state lawsuit brought by the
Florida State Board of Administration also alleged certain oral omissions and
misstatements in connection with such offering. Relief sought in the lawsuits
was unspecified, but included pleas for rescission and damages.
In the class action pending in state court, the court issued, in November 2000,
its order approving a settlement pursuant to which the defendants agreed to pay
a gross settlement amount of $9,500. Payment of plaintiffs' attorneys' fees and
expenses were to be paid out of the gross settlement fund. The gross settlement
fund was paid in its entirety by the Company's insurance carrier. The agreement
to settle and payment of the gross settlement fund are not admissions of the
validity of any claim or any fact alleged by the plaintiffs and defendants
continue to deny any wrongdoing and any liability.
The Florida State Board of Administration opted out of the class action
settlement and that litigation continues separately from the state court class
action. The parties have reached a settlement that will dispose of the case in
its entirety with no material adverse impact on the Company's consolidated
financial position or results of operations.
The lawsuits discussed herein were previously reported in Forms 10-K and 10-Q
filed by the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
b) Reports on Form 8-K
The registrant did not file any reports on Form 8-K during the first quarter of
fiscal 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.
----------------------------------------
(Registrant)
DATE 09/14/01 BY /s/ Frank J. Cotroneo
---------------------- -----------------------------------------
Frank J. Cotroneo
Senior Vice President and
Chief Financial Officer
DATE 09/14/01 BY /s/ Cheryl L. Givens
---------------------- -----------------------------------------
Cheryl L. Givens
Vice President and Corporate Controller
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