SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 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 November 30, 2001 was 182,699,381 shares.
TABLE OF CONTENTS
Page
----
PART I Financial Information
Consolidated Balance Sheets
October 31, 2001 and April 30, 2001 .................................................... 1
Consolidated Statements of Operations
Three and Six Months Ended October 31, 2001 and 2000 ................................... 2
Consolidated Statements of Cash Flows
Six Months Ended October 31, 2001 and 2000 ............................................. 3
Notes to Consolidated Financial Statements ................................................ 4
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................... 16
Quantitative and Qualitative Disclosures about Market Risk................................. 46
PART II Other Information.......................................................................... 47
SIGNATURES........................................................................................... 51
H&R BLOCK, INC.
CONSOLIDATED BALANCE SHEETS
AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS
OCTOBER 31, APRIL 30,
2001 2001
---- ----
ASSETS (UNAUDITED) (AUDITED)
CURRENT ASSETS
Cash and cash equivalents $ 599,002 $ 271,813
Marketable securities - available-for-sale 1,000 8,266
Marketable securities - trading 36,591 46,158
Receivables from customers, brokers, dealers and clearing organ-
izations, less allowance for doubtful accounts of $1,724 and $1,692 925,219 1,310,804
Receivables, less allowance for doubtful accounts of $48,875
and $47,125 323,251 373,223
Prepaid expenses and other current assets 415,414 260,942
----------- -----------
TOTAL CURRENT ASSETS 2,300,477 2,271,206
INVESTMENTS AND OTHER ASSETS
Investments in available-for-sale marketable securities 300,727 270,159
Intangible assets 393,167 402,209
Goodwill 680,567 649,617
Other 248,686 239,586
----------- -----------
1,623,147 1,561,571
PROPERTY AND EQUIPMENT, at cost less accumulated
depreciation and amortization 276,007 288,847
----------- -----------
$ 4,199,631 $ 4,121,624
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 881,697 $ --
Accounts payable to customers, brokers and dealers 857,349 1,058,000
Accounts payable, accrued expenses and deposits 299,522 361,210
Accrued salaries, wages and payroll taxes 109,977 221,830
Accrued taxes on earnings 144,561 295,599
Current portion of long-term debt 50,750 51,763
----------- -----------
TOTAL CURRENT LIABILITIES 2,343,856 1,988,402
LONG-TERM DEBT 849,283 870,974
OTHER NONCURRENT LIABILITIES 92,740 88,507
STOCKHOLDERS' EQUITY
Common stock, no par, stated value $.01 per share 2,179 2,179
Additional paid-in capital 458,019 419,957
Retained earnings 1,332,933 1,449,022
Accumulated other comprehensive income (loss) (20,890) (42,767)
----------- -----------
1,772,241 1,828,391
Less cost of 36,680,380 and 34,336,910 shares of common stock
in treasury 858,489 654,650
----------- -----------
913,752 1,173,741
----------- -----------
$ 4,199,631 $ 4,121,624
=========== ===========
See Notes to Consolidated Financial Statements
-1-
H&R BLOCK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED, AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
OCTOBER 31, OCTOBER 31,
----------- -----------
2001 2000 2001 2000
---- ---- ---- ----
REVENUES
Service revenues $ 234,990 $ 265,982 $ 443,174 $ 512,714
Product revenues 131,837 60,391 236,223 111,591
Royalties 2,886 3,877 4,443 5,193
Other 9,016 7,224 19,014 12,086
--------- --------- --------- ---------
378,729 337,474 702,854 641,584
--------- --------- --------- ---------
OPERATING EXPENSES
Employee compensation
and benefits 200,687 172,900 376,716 319,440
Occupancy and equipment 61,749 56,234 121,428 116,458
Interest 29,785 63,973 59,590 127,171
Depreciation and amortization 34,329 48,685 68,928 96,142
Marketing and advertising 17,091 14,728 24,083 24,502
Supplies, freight and postage 9,470 10,005 16,043 17,584
Bad debt 6,263 8,733 17,099 14,254
Other 67,516 51,123 120,147 107,634
--------- --------- --------- ---------
426,890 426,381 804,034 823,185
--------- --------- --------- ---------
Operating loss (48,161) (88,907) (101,180) (181,601)
OTHER INCOME
Investment income, net 1,093 2,536 2,211 5,255
Other, net (9) 15 154 (3)
--------- --------- --------- ---------
1,084 2,551 2,365 5,252
--------- --------- --------- ---------
Loss before income tax benefit (47,077) (86,356) (98,815) (176,349)
Income tax benefit (19,066) (36,701) (40,020) (74,948)
--------- --------- --------- ---------
Net loss $ (28,011) $ (49,655) $ (58,795) $(101,401)
========= ========= ========= =========
Weighted average common
shares outstanding 182,288 182,806 183,073 184,664
========= ========= ========= =========
Basic and diluted net loss per share $ (.15) $ (.27) $ (.32) $ (.55)
========= ========= ========= =========
Dividends per share $ .16 $ .15 $ .31 $ .29
========= ========= ========= =========
See Notes to Consolidated Financial Statements
-2-
H&R BLOCK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED, AMOUNTS IN THOUSANDS
SIX MONTHS ENDED
----------------
OCTOBER 31,
-----------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (58,795) $ (101,401)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 68,928 96,142
Provision for bad debt 17,099 14,254
Accretion of acquisition liabilities 6,187 5,604
Tax benefit from stock option exercises 41,805 --
Changes in:
Receivables from customers, brokers, dealers and
clearing organizations 385,413 216,723
Receivables 23,180 (7,592)
Marketable securities - trading 9,567 6,343
Prepaid expenses and other current assets (154,472) (8,792)
Accounts payable to customers, brokers and dealers (200,651) (278,237)
Accounts payable, accrued expenses and deposits (61,688) (48,599)
Accrued salaries, wages and payroll taxes (111,853) (97,072)
Accrued taxes on earnings (151,038) (175,786)
Other, net (12,762) (1,169)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (199,080) (379,582)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities (1,045) (2,432)
Maturities of available-for-sale securities 27,498 10,090
Purchases of property and equipment (33,724) (23,821)
Payments made for business acquisitions, net of cash acquired (23,468) (10,659)
Other, net (13,028) (18,114)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (43,767) (44,936)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable (3,916,323) (8,197,821)
Proceeds from issuance of notes payable 4,798,020 8,828,716
Payments on acquisition debt (47,179) (63,993)
Dividends paid (57,294) (53,764)
Payments to acquire treasury shares (351,845) (222,816)
Proceeds from stock options exercised 144,263 1,708
Other, net 394 266
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 570,036 292,296
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 327,189 (132,222)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 271,813 379,901
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 599,002 $ 247,679
=========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Income taxes paid $ 99,328 $ 88,836
Interest paid 52,107 118,715
See Notes to Consolidated Financial Statements
-3-
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Unaudited, dollars in thousands, except share data
1. The Consolidated Balance Sheet as of October 31, 2001, the Consolidated
Statements of Operations for the three and six months ended October 31,
2001 and 2000, and the Consolidated Statements of Cash Flows for the six
months ended October 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 October 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 six-month results are not indicative of results to
be expected for the year.
2. Receivables consist of the following:
October 31, April 30,
----------- ---------
2001 2001
---- ----
(Unaudited) (Audited)
Business services accounts receivable $ 174,549 $ 188,041
Mortgage loans held for sale 95,785 80,925
Participation in refund anticipation loans 24,166 38,824
Loans to franchisees 35,527 28,716
Other 42,099 83,842
-------------- --------------
372,126 420,348
Allowance for doubtful accounts 48,875 47,125
-------------- --------------
$ 323,251 $ 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
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-
5. Basic net earnings (loss) per share is computed using the weighted average
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 19,007,400 and 24,376,100 shares for the six months ended
October 31, 2001 and 2000, respectively, and the conversion of 1,216 shares
of preferred stock to common stock, as they are antidilutive. The weighted
average shares outstanding for the six months ended October 31, 2001
decreased to 183,073,000 from 184,664,000 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 six months ended October 31, 2001 and 2000, the Company issued
7,288,701 and 119,338 shares of common stock, respectively, pursuant to
provisions for exercise of stock options under its stock option plans.
During the six months ended October 31, 2001, the Company acquired
9,688,400 shares of its common stock at an aggregate cost of $351,845.
During the six months ended October 31, 2000, the Company acquired
13,628,400 shares of its common stock at an aggregate cost of $222,816.
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.
-5-
8. The Company's comprehensive income is comprised of net earnings (loss),
foreign currency translation adjustments and the change in the net
unrealized gain (loss) on marketable securities. The components of
comprehensive income (loss) during the three and six months ended October
31, 2001 and 2000 were:
Three months ended Six months ended
------------------ ----------------
October 31, October 31,
----------- -----------
2001 2000 2001 2000
---- ---- ---- ----
Net earnings (loss) $ (28,011) $ (49,655) $ (58,795) $(101,401)
Change in net unrealized gain
(loss) on marketable securities 27,317 (5,670) 25,606 (1,613)
Change in foreign currency
translation adjustments (4,553) (5,017) (3,729) (6,175)
--------- --------- --------- ---------
Comprehensive income (loss) $ (5,247) $ (60,342) $ (36,918) $(109,189)
========= ========= ========= =========
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 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 re-evaluated the
useful lives of these separable intangible assets. The weighted average
life of the remaining intangible assets with finite lives 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 first step of
the test was completed during the quarter ended October 31, 2001 and no
indications of goodwill impairment were found; therefore, step two of the
goodwill impairment test is not applicable.
-6-
Had the provisions of SFAS 141 and 142 been applied for the three and six months
ended October 31, 2000, the Company's net loss and net loss per share would have
been as follows:
Three months ended Six months ended
------------------ ----------------
October 31, 2000 October 31, 2000
---------------- ----------------
Net loss Per Share Net loss Per share
-------- --------- -------- ---------
Net loss:
As reported $(49,655) $ (.27) $(101,401) $ (.55)
Add amortization (net of tax):
Goodwill 6,981 .04 14,141 .08
Assembled workforce 4,088 .02 7,704 .04
Management infrastructure 226 -- 451 --
Trade name 430 -- 861 --
-------- -------- --------- --------
Pro forma net loss $(37,930) $ (.21) $ (78,244) $ (.43)
======== ======== ========= ========
Intangible assets consist of the following:
October 31, 2001 April 30, 2001
---------------- --------------
Gross Gross
----- -----
Carrying Accumulated Carrying Accumulated
-------- ----------- -------- -----------
Amount Amortization Amount Amortization
------ ------------ ------ ------------
Amortized intangible assets:
Customer relationships $405,649 $(81,395) $ 397,049 $(61,036)
Noncompete agreements 20,587 (2,443) 17,269 (1,842)
Unamortized intangible assets:
Trade name 55,637 (4,868) 55,637 (4,868)
-------- -------- --------- --------
Total intangible assets $481,873 $(88,706) $ 469,955 $(67,746)
======== ======== ========= ========
Changes in the carrying amount of goodwill for the six months ended October
31, 2001, are as follows by segment:
April 30, October 31,
--------- -----------
2001 Acquisitions Other 2001
---- ------------ ----- ----
U.S. tax operations $126,829 $ 1,883 $ -- $128,712
International tax operations 5,755 -- 28 5,783
Mortgage operations 152,467 -- -- 152,467
Investment services 172,592 -- (113) 172,479
Business services 191,974 29,152 -- 221,126
-------- -------- --------- --------
Total goodwill $649,617 $ 31,035 $ (85) $680,567
======== ======== ========= ========
Amortization of intangible assets for the three and six months ended October 31,
2001 was $10,557 and $20,960, respectively. Estimated amortization of intangible
assets for fiscal years 2002, 2003, 2004, 2005 and 2006 is $42,258, $41,616,
$41,616, $41,538 and $40,115, respectively.
-7-
10. Included in Marketable securities-trading and Investments in
available-for-sale marketable securities 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
October 31, 2001 and April 30, 2001 was $284,673 and $238,600,
respectively. The Company received proceeds from net interest margin (NIM)
securitizations of $390,031, servicing fees of $75 and cash flows from
interest-only strips of $3,868 from the securitization trusts during the
six months ended October 31, 2001.
Mortgage servicing rights (MSRs) are included in other assets on the
consolidated balance sheet. The fair value of MSRs at October 31, 2001 and
April 30, 2001 was $77,803 and $61,796, respectively. Additions to and
amortization of MSRs for the six months ended October 31, 2001 were $28,786
and $12,779, respectively.
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 3.5% to 6.5%
Discount rate - residual interests 12% to 30%
Discount rate - MSRs 12.8%
At October 31, 2001, the sensitivities 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 $ 66,437 $ 218,236 $ 77,803
Weighted average life (in years) 3.4 2.6 2.3
Annual prepayments:
Adverse 10% - $ impact on fair value $ (869) $ (20,408) $ (8,485)
Adverse 20% - $ impact on fair value (1,589) (23,901) (15,078)
Annual credit losses:
Adverse 10% - $ impact on fair value $ (2,166) $ (27,751) Not applicable
Adverse 20% - $ impact on fair value (4,327) (50,282) Not applicable
Discount rate:
Adverse 10% - $ impact on fair value $ (2,280) $ (7,002) $ (1,397)
Adverse 20% - $ impact on fair value (4,446) (13,257) (2,895)
Variable interest rates:
Adverse 10% - $ impact on fair value $ (117) $ (11,279) $ 186
Adverse 20% - $ impact on fair value (329) (25,821) 402
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
-8-
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.
12. In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" (SFAS 144), effective for the Company's
fiscal year ending April 30, 2003. This statement supercedes Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," (SFAS 121)
and the accounting and reporting provisions of Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for the disposal of a
segment of a business. SFAS 144 establishes a single accounting model,
based on the framework established in SFAS 121, for long-lived assets to be
disposed of by sale. The Company has not yet determined the effect of SFAS
144 on the consolidated financial statements.
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
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 and six months ended October 31, 2001 and 2000 is as
follows:
-9-
Three months ended Six months ended
------------------ ----------------
October 31, October 31,
----------- -----------
2001 2000 2001 2000
---- ---- ---- ----
Revenues:
U.S. tax operations $ 28,015 $ 26,403 $ 47,994 $ 37,753
International tax operations 13,709 14,899 18,541 19,798
Mortgage operations 180,821 84,690 329,146 165,290
Investment services 64,827 131,573 133,752 262,240
Business services 91,779 78,267 171,761 154,364
Unallocated corporate (422) 1,642 1,660 2,139
------------ ------------ ------------- -------------
$ 378,729 $ 337,474 $ 702,854 $ 641,584
============ ============ ============= =============
Earnings (loss) from:
U.S. tax operations $ (104,225) $ (85,724) $ (185,393) $ (171,286)
International tax operations (991) (851) (6,644) (7,206)
Mortgage operations 93,191 20,433 159,970 41,963
Investment services (9,135) 11,779 (15,233) 23,462
Business services 2,554 (1,030) 383 (4,264)
Unallocated corporate (9,818) (7,359) (15,257) (11,900)
Interest exp.-acquisition debt (19,360) (24,484) (40,758) (51,772)
------------ ------------ ------------- -------------
(47,784) (87,236) (102,932) (181,003)
Investment income, net 1,094 2,536 2,212 5,255
Intercompany interest (387) (1,656) 1,905 (601)
------------ ------------ ------------- -------------
Loss before income tax benefit $ (47,077) $ (86,356) $ (98,815) $ (176,349)
============ ============ ============= =============
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.
14. 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.
-10-
Condensed Consolidating Statements of Operations
Three months ended October 31, 2001
----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
------------ -------- ------------ ----- ---------
Total revenues $ -- $ 246,405 $ 132,324 $ -- $ 378,729
--------- --------- --------- --------- ---------
Expenses:
Compensation & benefits -- 78,576 122,111 -- 200,687
Occupancy & equipment -- 16,223 45,526 -- 61,749
Interest -- 25,918 3,867 -- 29,785
Depreciation & amortization -- 16,827 17,502 -- 34,329
Marketing & advertising -- 4,642 12,550 (101) 17,091
Supplies, freight & postage -- 2,621 6,849 -- 9,470
Other -- 44,332 29,447 -- 73,779
--------- --------- --------- --------- ---------
-- 189,139 237,852 (101) 426,890
--------- --------- --------- --------- ---------
Operating earnings (loss) -- 57,266 (105,528) 101 (48,161)
Other income, net (47,077) -- 1,084 47,077 1,084
--------- --------- --------- --------- ---------
Earnings (loss) before
income taxes (benefit) (47,077) 57,266 (104,444) 47,178 (47,077)
Income taxes (benefit) (19,066) 10,862 (29,969) 19,107 (19,066)
--------- --------- --------- --------- ---------
Net earnings (loss) $ (28,011) $ 46,404 $ (74,475) $ 28,071 $ (28,011)
========= ========= ========= ========= =========
Three months ended October 31, 2000
------------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
------------- -------- ------------ ----- ---------
Total revenues $ -- $ 218,964 $ 118,643 $ (133) $ 337,474
--------- --------- --------- --------- ---------
Expenses:
Compensation & benefits -- 74,540 98,360 -- 172,900
Occupancy & equipment -- 12,926 43,308 -- 56,234
Interest -- 58,478 5,495 -- 63,973
Depreciation & amortization -- 22,062 26,623 -- 48,685
Marketing & advertising -- 5,309 9,523 (104) 14,728
Supplies, freight & postage -- 4,350 5,655 -- 10,005
Other -- 37,613 22,376 (133) 59,856
--------- --------- --------- --------- ---------
-- 215,278 211,340 (237) 426,381
--------- --------- --------- --------- ---------
Operating earnings (loss) -- 3,686 (92,697) 104 (88,907)
Other income, net (86,356) 22 2,529 86,356 2,551
--------- --------- --------- --------- ---------
Earnings (loss) before
income taxes (benefit) (86,356) 3,708 (90,168) 86,460 (86,356)
Income taxes (benefit) (36,701) 5,952 (42,697) 36,745 (36,701)
--------- --------- --------- --------- ---------
Net earnings (loss) $ (49,655) $ (2,244) $ (47,471) $ 49,715 $ (49,655)
========= ========= ========= ========= =========
-11-
Six months ended October 31, 2001
----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Total revenues $ -- $ 466,454 $ 236,453 $ (53) $ 702,854
--------- --------- --------- --------- ---------
Expenses:
Compensation & benefits -- 155,157 221,559 -- 376,716
Occupancy & equipment -- 30,900 90,528 -- 121,428
Interest -- 54,745 4,845 -- 59,590
Depreciation & amortization -- 33,649 35,279 -- 68,928
Marketing & advertising -- 7,904 16,381 (202) 24,083
Supplies, freight & postage -- 7,228 8,815 -- 16,043
Other -- 85,948 51,351 (53) 137,246
--------- --------- --------- --------- ---------
-- 375,531 428,758 (255) 804,034
--------- --------- --------- --------- ---------
Operating earnings (loss) -- 90,923 (192,305) 202 (101,180)
Other income, net (98,815) -- 2,365 98,815 2,365
--------- --------- --------- --------- ---------
Earnings (loss) before
income taxes (benefit) (98,815) 90,923 (189,940) 99,017 (98,815)
Income taxes (benefit) (40,020) 25,671 (65,773) 40,102 (40,020)
--------- --------- --------- --------- ---------
Net earnings (loss) $ (58,795) $ 65,252 $(124,167) $ 58,915 $ (58,795)
========= ========= ========= ========= =========
Six months ended October 31, 2000
-----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Total revenues $ -- $ 431,291 $ 210,405 $ (112) $ 641,584
--------- --------- --------- --------- ---------
Expenses:
Compensation & benefits -- 144,134 175,306 -- 319,440
Occupancy & equipment -- 26,170 90,288 -- 116,458
Interest -- 120,081 7,090 -- 127,171
Depreciation & amortization -- 44,068 52,074 -- 96,142
Marketing & advertising -- 11,134 13,616 (248) 24,502
Supplies, freight & postage -- 8,591 8,993 -- 17,584
Other -- 67,351 54,700 (163) 121,888
--------- --------- --------- --------- ---------
-- 421,529 402,067 (411) 823,185
--------- --------- --------- --------- ---------
Operating earnings (loss) -- 9,762 (191,662) 299 (181,601)
Other income, net (176,349) -- 5,252 176,349 5,252
--------- --------- --------- --------- ---------
Earnings (loss) before
income taxes (benefit) (176,349) 9,762 (186,410) 176,648 (176,349)
Income taxes (benefit) (74,948) 12,970 (88,045) 75,075 (74,948)
--------- --------- --------- --------- ---------
Net earnings (loss) $(101,401) $ (3,208) $ (98,365) $ 101,573 $(101,401)
========= ========= ========= ========= =========
-12-
Condensed Consolidating Balance Sheets
October 31, 2001
----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Cash & cash equivalents $ -- $ 502,561 $ 96,441 $ -- $ 599,002
Receivables from customers,
brokers and dealers -- 925,219 -- -- 925,219
Receivables 1,374 152,911 169,766 (800) 323,251
Intangible assets -- 236,842 156,325 -- 393,167
Goodwill -- 322,199 358,368 -- 680,567
Investments in subsidiaries 2,415,725 215 2,472 (2,417,299) 1,113
Other assets -- 903,664 373,419 229 1,277,312
----------- ----------- ----------- ----------- -----------
Total assets $ 2,417,099 $ 3,043,611 $ 1,156,791 $(2,417,870) $ 4,199,631
=========== =========== =========== =========== ===========
Notes payable $ -- $ 881,697 $ -- $ -- $ 881,697
Accts. payable to customers,
brokers and dealers -- 857,349 -- -- 857,349
Long-term debt -- 746,575 102,708 -- 849,283
Other liabilities 4,774 244,870 448,286 (380) 697,550
Net intercompany advances 1,498,573 (51,495) (1,445,111) (1,967) --
Stockholders' equity 913,752 364,615 2,050,908 (2,415,523) 913,752
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity $ 2,417,099 $ 3,043,611 $ 1,156,791 $(2,417,870) $ 4,199,631
=========== =========== =========== =========== ===========
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
=========== =========== =========== =========== ===========
-13-
Condensed Consolidating Statements of Cash Flows
Six months ended October 31, 2001
-----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Net cash provided by (used
in) operating activities $ 40,442 $ 152,534 $ (392,056) $ -- $ (199,080)
----------- ----------- ----------- ---------- -----------
Cash flows from investing:
Purchase of AFS securities -- -- (1,045) -- (1,045)
Maturities of AFS securities -- 7,722 19,776 -- 27,498
Purchase property & equipment -- (17,549) (16,175) -- (33,724)
Payments for business acq -- -- (23,468) -- (23,468)
Net intercompany advances 224,434 (688,982) 464,548 -- --
Other, net -- -- (13,028) -- (13,028)
----------- ----------- ----------- ---------- -----------
Net cash provided by (used
in) investing activities 224,434 (698,809) 430,608 -- (43,767)
----------- ----------- ----------- ---------- -----------
Cash flows from financing:
Repayments of notes payable -- (3,916,323) -- -- (3,916,323)
Proceeds from notes payable -- 4,798,020 -- -- 4,798,020
Payments on acquisition debt -- -- (47,179) -- (47,179)
Dividends paid (57,294) -- -- -- (57,294)
Pmts. to acquire treasury shares (351,845) -- -- -- (351,845)
Proceeds from stock
option exercises 144,263 -- -- -- 144,263
Other, net -- -- 394 -- 394
----------- ----------- ----------- ---------- -----------
Net cash provided by (used
in) financing activities (264,876) 881,697 (46,785) -- 570,036
----------- ----------- ----------- ---------- -----------
Net increase(decrease) in cash -- 335,422 (8,233) -- 327,189
Cash at beginning of the year -- 167,139 104,674 -- 271,813
----------- ----------- ----------- ---------- -----------
Cash at end of the year $ -- $ 502,561 $ 96,441 $ -- $ 599,002
=========== =========== =========== ========== ===========
-14-
Six months ended October 31, 2000
----------------------------------------------------------------------------------
H&R Block, Inc. BFC Other Consolidated
(Guarantor) (Issuer) Subsidiaries Elims H&R Block
----------- -------- ------------ ----- ---------
Net cash provided by (used
in) operating activities $ 38 $ (61,901) $ (317,719) $ -- $ (379,582)
----------- ----------- ----------- --------- -----------
Cash flows from investing:
Purchase of AFS securities -- -- (2,432) -- (2,432)
Maturities of AFS securities -- 5,429 4,661 -- 10,090
Purchase property & equipment -- (12,101) (11,720) -- (23,821)
Payments for business acq. -- -- (10,659) -- (10,659)
Net intercompany advances 274,834 (639,173) 364,339 -- --
Other, net -- -- (18,114) -- (18,114)
----------- ----------- ----------- --------- -----------
Net cash provided by (used
in) investing activities 274,834 (645,845) 326,075 -- (44,936)
----------- ----------- ----------- --------- -----------
Cash flows from financing:
Repayments of notes payable -- (8,197,821) -- -- (8,197,821)
Proceeds from notes payable -- 8,828,716 -- -- 8,828,716
Payments on acquisition debt -- -- (63,993) -- (63,993)
Dividends paid (53,764) -- -- -- (53,764)
Pmts. to acquire treasury shares (222,816) -- -- -- (222,816)
Proceeds from stock
option exercises 1,708 -- -- -- 1,708
Other, net -- -- 266 -- 266
----------- ----------- ----------- --------- -----------
Net cash provided by (used
in) financing activities (274,872) 630,895 (63,727) -- 292,296
----------- ----------- ----------- --------- -----------
Net decrease in cash -- (76,851) (55,371) -- (132,222)
Cash at beginning of the year -- 256,823 123,078 -- 379,901
----------- ----------- ----------- --------- -----------
Cash at end of the year $ -- $ 179,972 $ 67,707 $ -- $ 247,679
=========== =========== =========== ========= ===========
-15-
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.
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.
Mortgage operations: This segment is primarily engaged in the
origination, servicing, and sale of nonconforming and conforming mortgage
loans.
Investment services: This segment is primarily engaged in offering
investment advice and services.
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.
GENERAL BUSINESS
As the Company completes the second quarter of its fiscal year, management has
been focusing on preparation for the upcoming tax season. During the quarter,
U.S. tax operations held tuition tax schools, which provide many of its tax
professionals for the upcoming tax season. Enrollment in tuition tax schools was
up 14.5% over the prior year. This tax season U.S. tax operations will be
offering new products to bring additional value to H&R Block's client base. For
the first time, tax offices will be offering a new Refund Anticipation Loan
(RAL) product - an "instant RAL." With an "instant RAL," clients who qualify can
receive a check for loan proceeds upon the completion of their tax return and
will not have to return to the office a second time to pick up their check. In
addition, tax offices will be offering a new product to those clients whose tax
returns reflect a balance due the Internal Revenue Service (IRS). Through a
relationship with Household Bank, f.s.b (Household), clients who qualify can
receive a line of credit from Household that can be used to pay a balance due
the IRS. This line of credit will have "same as cash" terms for 90 days. Unlike
the traditional RAL products, the Company will not have a participation interest
in these lines of credit. The e-solutions business will also be offering new
products to its clients. This tax season, both software and online users will
have an opportunity to have an H&R Block tax professional review their return
and provide feedback to the client prior to filing. In addition, all software
and online clients will have the opportunity to receive a free financial plan
through Investment services.
-16-
During calendar 2002, the Company plans to execute a net interest margin (NIM)
transaction to securitize certain existing residual interests from previous NIM
transactions in an effort to expedite receiving cash for the residual interests
and to reduce the total value of residual interests on the balance sheet. In
addition, the Company's residual interests have been performing better than
expected with higher excess retained interest spread and lower loan losses and
prepayments to date than originally projected. As a result of these items, in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," the Company recorded a
$45.1 million pretax mark-to-market adjustment in other comprehensive income
(loss) during the second quarter. Beginning in the third quarter, the Company
will also be adjusting the amount of interest income recognized on certain
residual interests to reflect these new conditions. This adjustment will result
in higher interest income earned throughout the remaining life of those residual
interests.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
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 to
more accurately reflect each business segment's performance. Prior year results
have been restated based on this allocation methodology.
CONSOLIDATED H&R BLOCK, INC.
Consolidated H&R Block, Inc. - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Revenues $ 378,729 $ 337,474 $ 41,255 12.2%
--------- --------- ---------
Pretax loss (47,077) (86,356) 39,279 45.5%
Net loss $ (28,011) $ (49,655) $ 21,644 43.6%
========= ========= =========
- --------------------------------------------------------------------------------
Consolidated revenues for the three months ended October 31, 2001 increased
12.2% primarily due to the Mortgage operations segment, which increased revenues
by $96.1 million, or 113.5%, over the prior year. The Business services 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 $47.1 million for the second quarter of
fiscal 2002 compared to a loss of $86.4 million in the prior year. The
improvement over the prior year is primarily due to the Mortgage operations
segment that reported earnings of $93.2 million, a $72.8 million improvement
over last year. Increased losses from Investment services and U.S.
-17-
tax operations somewhat offset the increase from Mortgage operations. In
addition, the Company's increase over the prior year's second quarter benefited
$15.4 million from the adoption of SFAS 141 and 142, which is included in the
respective reportable segments.
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 $20.0 million to a positive $5.9 million compared to a negative $14.1
million in the prior year's second quarter. EBITDA is utilized by management to
evaluate the performance of its operating segments because many of the segments
reflect substantial amortization of 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
acquired intangible assets. The net loss, excluding the after-tax impact of this
expense, was $18.5 million, or $.10 per share in the second quarter, compared to
$28.6 million, or $.16 per share in last year's second quarter.
The net loss was $28.0 million, or $.15 per share compared to a loss of $49.7
million, or $.27 per share in the second quarter of fiscal 2001. The three
months ended October 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 second quarter, $11.7
million (net of taxes), or $.06 per share, relates to the adoption of SFAS 141
and 142.
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 on May 1, 2001.
Consolidated H&R Block, Inc. - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
----------- --------
2002 Quarter Better/(worse)
------------ --------------
2nd 1st $ %
--- --- - -
Revenues $ 378,729 $ 324,125 $ 54,604 16.9%
--------- --------- ---------
Pretax loss (47,077) (51,738) 4,661 9.0%
Net loss $ (28,011) $ (30,784) $ 2,773 9.0%
========= ========= =========
- --------------------------------------------------------------------------------
Consolidated revenues for the three months ended October 31, 2001 increased
16.9% over the three months ended July 31, 2001 primarily due to the Mortgage
operations and Business services segments, increasing $32.5 million and $11.8
million, respectively, over the first quarter. International and U.S. tax
operations also contributed to the increase in revenues. The
-18-
Company reported a pretax loss of $47.1 million for the second quarter of fiscal
2002 compared to a loss of $51.7 million in the first quarter. The
quarter-over-quarter improvement is primarily due to the Mortgage operations
segment, with a $26.4 million improvement over last quarter. This increase was
partially offset by increased losses from U.S. tax operations as it prepares for
the upcoming tax season. The net loss was $28.0 million, or $.15 per share
compared to a loss of $30.8 million, or $.17 per share in the first quarter.
The Company's performance as measured by EBITDA improved to a positive $5.9
million compared to $849 thousand for the three months ended July 31, 2001. The
Company's net loss, excluding the after-tax impact of the amortization of
acquired intangible assets, was $18.5 million, or $.10 per share in the second
quarter, compared to $21.4 million, or $.12 per share in the first quarter.
Consolidated H&R Block, Inc. - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
---------------- --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Revenues $ 702,854 $ 641,584 $ 61,270 9.6%
--------- --------- ---------
Pretax loss (98,815) (176,349) 77,534 44.0%
Net loss $ (58,795) $(101,401) $ 42,606 42.0%
========= ========= =========
- --------------------------------------------------------------------------------
Consolidated revenues for the six months ended October 31, 2001 increased 9.6%
primarily due to the Mortgage operations segment, which increased revenues by
$163.9 million, or 99.1%, over the prior year. This increase was largely offset
by the decline in revenues from Investment services. The Business services and
U.S. tax operations segments also contributed increased revenues during the six
month period.
The Company reported a pretax loss of $98.8 million for the six months ended
October 31, 2001 compared to a loss of $176.3 million in the prior year. The
improvement over the prior year is primarily due to the Mortgage operations
segment that reported earnings of $160.0 million, a $118.0 million improvement
over last year. Increased losses from Investment services and U.S. tax
operations somewhat offset the increase from Mortgage operations. In addition,
the Company's increase over the prior year benefited $30.2 million from the
adoption of SFAS 141 and 142, which is included in the respective reportable
segments.
The Company's performance as measured by EBITDA improved $39.8 million to a
positive $6.8 million compared to a negative $33.1 million for the six months
ended October 31, 2000. The Company's net loss, excluding the after-tax impact
of amortization of acquired intangible assets, was $39.9 million, or $.22 per
share in the current year, compared to $59.7 million, or $.32 per share last
year.
The net loss was $58.8 million, or $.32 per share compared to a loss of $101.4
million, or $.55 per share in the six months ended October 31, 2000. The six
months ended October 31, 2001
-19-
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, $23.2 million (net of taxes), or $.13 per share, relates to
the adoption of SFAS 141 and 142.
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 on May 1, 2001.
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 RAL products offered by a
third-party lending institution to tax clients. This segment includes the
Company's tax preparation software - 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.
U.S. Tax Operations - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Tax preparation and related fees $ 11,396 $ 9,368 $ 2,028 21.7%
Royalties 1,470 1,772 (302) -17.0%
RAL participation fees 14 5 9 180.0%
Software sales 722 1,055 (333) -31.6%
Other 14,413 14,203 210 1.5%
--------- --------- ---------
Total revenues 28,015 26,403 1,612 6.1%
========= ========= =========
Compensation & benefits 34,491 25,509 (8,982) -35.2%
Occupancy & equipment 33,828 32,147 (1,681) -5.2%
Depreciation & amortization 7,429 11,137 3,708 33.3%
Cost of software sales 452 287 (165) -57.5%
Bad debt expense (1,042) 325 1,367 --
Supplies, freight & postage 3,151 3,266 115 3.5%
Other 15,098 15,263 165 1.1%
Allocated corporate & shared costs 38,833 24,193 (14,640) -60.5%
--------- --------- ---------
Total expenses 132,240 112,127 (20,113) -17.9%
--------- --------- ---------
Pretax loss $(104,225) $ (85,724) $ (18,501) -21.6%
========= ========= =========
- --------------------------------------------------------------------------------
-20-
Tax preparation and related fees increased 21.7% to $11.4 million for the three
months ended October 31, 2001 compared to the prior year. This increase is
primarily attributable to a 4.1% increase in company-owned returns prepared and
a 16.9% increase in the average charge on those returns. Company-owned tax
returns prepared during the second quarter of fiscal 2002 were 65 thousand
compared to 62 thousand tax returns prepared last year. The average charge
earned this year was $181.33 compared to $155.17 earned last year. The overall
increase in tax returns prepared is partially attributed to the federal income
tax rebate program this summer where taxpayers needed to file their 2000 tax
returns with the IRS in order to be eligible for the rebate.
Total expenses of $132.2 million during the three months ended October 31, 2001
were $20.1 million, or 17.9% higher than last year. The increase in expenses is
attributable to a $14.6 million increase in allocated corporate and shared costs
principally due to earlier technology development and marketing costs, $7.2
million in payroll taxes associated with seasonal stock option exercises
compared to virtually none last year, a $1.7 million increase in office,
facility and equipment costs, and $1.0 million in higher tuition tax school
wages. The increase in technology and marketing costs is partly attributable to
earlier preparation and operational readiness for the upcoming tax season. This
early preparation should result in reduced levels of spending during the
remainder of the year. Amortization expense benefited from the early adoption of
SFAS No. 141 and 142, resulting in lower amortization of goodwill when compared
to the prior year by $2.8 million. Additionally, depreciation and amortization
expense was lower by $0.9 million this year due to certain assets becoming fully
depreciated at the end of the prior fiscal year.
The pretax loss of $104.2 million for the quarter ended October 31, 2001
increased 21.6% from a loss of $85.7 million in the same period a year ago.
EBITDA decreased $21.3 million to a negative $92.3 million in the second quarter
of fiscal year 2002.
Due to the seasonal nature of this segment's business, second quarter results
are not indicative of the expected results for the entire fiscal year.
-21-
U.S. Tax Operations - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
----------- --------
2002 Quarter Better/(worse)
------------ --------------
2nd 1st $ %
--- --- - -
Tax preparation and related fees $ 11,396 $ 11,348 $ 48 0.4%
Royalties 1,470 1,096 374 34.1%
RAL participation fees 14 282 (268) -95.0%
Software sales 722 773 (51) -6.6%
Other 14,413 6,480 7,933 122.4%
--------- --------- ---------
Total revenues 28,015 19,979 8,036 40.2%
========= ========= =========
Compensation & benefits 34,491 23,069 (11,422) -49.5%
Occupancy & equipment 33,828 33,126 (702) -2.1%
Depreciation & amortization 7,429 7,304 (125) -1.7%
Cost of software sales 452 319 (133) -41.7%
Bad debt expense (1,042) 881 1,923 --
Supplies, freight & postage 3,151 1,536 (1,615) -105.1%
Other 15,098 8,947 (6,151) -68.8%
Allocated corporate & shared costs 38,833 25,965 (12,868) -49.6%
--------- --------- ---------
Total expenses 132,240 101,147 (31,093) -30.7%
--------- --------- ---------
Pretax loss $(104,225) $ (81,168) $ (23,057) -28.4%
========= ========= =========
- --------------------------------------------------------------------------------
Tax preparation and related fees of $11.4 million during the three months ended
October 31, 2001 were slightly better than the three months ended July 31, 2001.
This increase was attributable to a 27.5% decrease in company-owned returns
prepared offset by a similar increase in the average charge on those returns.
Company-owned tax returns prepared during the second quarter of fiscal 2002 were
65 thousand compared to 90 thousand tax returns prepared during the first
quarter. The average charge earned during the second quarter was $181.33
compared to $144.49 earned the first quarter. Decreases in tax returns prepared
during the second quarter compared to the first quarter are normal, as is the
increase in average charge. More returns are normally prepared in the first
quarter due to the August due date for the filing of individual tax returns for
which an automatic extension of time to file was obtained.
Tuition tax school fees, included in other revenues, increased $6.3 million
during the three months ended October 31, 2001 compared to the three months
ended July 31, 2001. The second quarter of each fiscal year is when the majority
of tuition tax school classes commence and fees are collected.
Total expenses increased 30.7% to $132.2 million during the three months ended
October 31, 2001 compared to the three months ended July 31, 2001. This increase
is due to the following: (1) a $12.9 million increase in allocated corporate and
shared costs primarily related to investments in technology and marketing in
preparation for the upcoming tax season, (2) a $7.2 million increase in payroll
taxes associated with seasonal stock option exercises (seasonal stock options
can only be exercised September through November of each year), (3) a $4.1
million
-22-
increase in marketing and advertising costs related to tuition tax schools, (4)
a $3.6 million increase in wages associated with tuition tax schools, (5) a $1.4
million increase in supplies associated with tuition tax schools and general
usage and (6) a $1.2 million increase in travel and related costs associated
with a national sales meeting. Offsetting these increases were lower production
wages, bad debt and bank service fees.
The pretax loss for the three months ended October 31, 2001 was $104.2 million;
an increase of 28.4% compared to the pretax loss of $81.2 million for the three
months ended July 31, 2001. EBITDA decreased $23.1 million to a negative $92.3
million in the second quarter of fiscal year 2002 compared to a negative $69.2
million in the first quarter.
U.S. Tax Operations - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
---------------- --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Tax preparation and related fees $ 22,744 $ 17,348 $ 5,396 31.1%
Royalties 2,566 2,525 41 1.6%
RAL participation fees 296 200 96 48.0%
Software sales 1,495 1,115 380 34.1%
Other 20,893 16,565 4,328 26.1%
--------- --------- ---------
Total revenues 47,994 37,753 10,241 27.1%
========= ========= =========
Compensation & benefits 57,560 47,151 (10,409) -22.1%
Occupancy & equipment 66,954 63,447 (3,507) -5.5%
Depreciation & amortization 14,733 22,835 8,102 35.5%
Cost of software sales 771 633 (138) -21.8%
Bad debt expense (161) 400 561 --
Supplies, freight & postage 4,687 3,942 (745) -18.9%
Other 24,045 23,193 (852) -3.7%
Allocated corporate & shared costs 64,798 47,438 (17,360) -36.6%
--------- --------- ---------
Total expenses 233,387 209,039 (24,348) -11.7%
--------- --------- ---------
Pretax loss $(185,393) $(171,286) $ (14,107) -8.2%
========= ========= =========
- ----------------------------------------------------------------------------------------------------------------
Tax preparation and related fees increased 31.1% to $22.7 million during the six
months ended October 31, 2001 compared to the six months ended October 31, 2000.
This increase is primarily attributable to a 6.3% increase in company-owned
returns prepared combined with a 21.7% increase in the average charge on those
returns. Company-owned tax returns prepared during the six months ended October
31, 2001 were 155 thousand compared to 146 thousand tax returns prepared during
the same period last year. The average charge earned during the six months ended
October 31, 2001 was $159.98 compared to $131.46 earned last year.
Tuition tax school fees, included in other revenues, increased $800 thousand to
$7.6 million during the six months ended October 31, 2001 over the six months
ended October 31, 2000. This 11.8% increase in tuition tax school fees is due to
a 14.5% increase in enrollments this year.
-23-
Other revenues (excluding tuition tax school fees) of $13.3 million increased
$3.5 million, or 35.7% compared to the six months ended October 31, 2000. This
increase is due to an increase of $3.1 million in deferred Peace of Mind revenue
recognized due to increased unit sales.
Total expenses increased 11.7% to $233.4 million during the six months ended
October 31, 2001 compared to the six months ended October 31, 2000. This
increase is due to an increase of $17.4 million in allocated and shared costs
primarily related to earlier technology development and marketing costs, a $7.2
million increase in payroll taxes associated with seasonal stock option
exercises (there were virtually no seasonal exercises during the six months
ended October 31, 2000), a $3.1 million increase in office rent and facility
expenses, and a $1.1 million increase in wages associated with tuition tax
schools. The increase in technology and marketing costs is partly attributable
to earlier preparation and operational readiness for the upcoming tax season.
This early preparation should result in reduced levels of spending during the
remainder of the year. Offsetting these increases were lower depreciation and
amortization expenses of $8.1 million due to certain assets becoming fully
depreciated at the end of the prior fiscal year and the early adoption of SFAS
No. 141 and 142, resulting in the elimination of goodwill amortization.
The pretax loss for the six months ended October 31, 2001 was $185.4 million, an
increase of 8.2% compared to the pretax loss of $171.3 million for the six
months ended October 31, 2000. EBITDA decreased $20.4 million to a negative
$161.6 million for the six months ended October 31, 2001 compared to a negative
$141.1 million last year.
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.
-24-
International Tax Operations - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Canada $ 2,400 $ 2,539 $ (139) -5.5%
Australia 10,947 11,790 (843) -7.2%
United Kingdom 239 409 (170) -41.6%
Overseas franchises 123 161 (38) -23.6%
-------- -------- --------
Total revenues 13,709 14,899 (1,190) -8.0%
======== ======== ========
Canada (4,018) (4,638) 620 13.4%
Australia 4,160 4,933 (773) -15.7%
United Kingdom (396) (419) 23 5.5%
Overseas franchises (160) (48) (112) -233.3%
Allocated corporate & shared costs (577) (679) 102 15.0%
-------- -------- --------
Pretax loss $ (991) $ (851) $ (140) -16.5%
======== ======== ========
- --------------------------------------------------------------------------------
Revenues decreased by 8.0% to $13.7 million from $14.9 million last year. The
pretax loss increased by 16.5% to a loss of $991 thousand from $851 thousand
last year.
The improved performance in Canada is primarily attributed to better business
management and cost control.
The Australian results were negatively impacted by unfavorable exchange rates
and a reduction of .3% in returns prepared for the same quarter last year.
The United Kingdom pretax loss improved by 5.5% due to the closure of
unprofitable offices during the first quarter of fiscal year 2002.
The overseas franchise pretax profit decreased by 233.3%. This is driven by the
return to normal historical business levels after the introduction of the child
tax credit in Puerto Rico in the prior year.
International tax operations' EBITDA declined $737 thousand to a negative $229
thousand from a positive $508 thousand in the prior year second quarter.
-25-
International Tax Operations - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
----------- --------
2002 Quarter Better/(worse)
------------ --------------
2nd 1st $ %
--- --- - -
Canada $ 2,400 $ 3,257 $ (857) -26.3%
Australia 10,947 543 10,404 -
United Kingdom 239 632 (393) -62.2%
Overseas franchises 123 400 (277) -69.3%
-------- -------- --------
Total revenues 13,709 4,832 8,877 183.7%
======== ======== ========
Canada (4,018) (3,446) (572) -16.6%
Australia 4,160 (1,650) 5,810 --
United Kingdom (396) (179) (217) -121.2%
Overseas franchises (160) 181 (341) --
Allocated corporate & shared costs (577) (559) (18) -3.2%
-------- -------- --------
Pretax loss $ (991) $ (5,653) $ 4,662 82.5%
======== ======== ========
- --------------------------------------------------------------------------------
Revenues increased 183.7% to $13.7 million from $4.8 million in the first
quarter. The increase is driven by the beginning of the Australian tax season
during this quarter.
The pretax loss improved by 82.5% to a loss of $991 thousand. This is primarily
driven by the beginning of the Australian tax season during the second quarter.
The timing of certain expenses in Canadian operations and the return to normal
historical business levels in the overseas franchise group partially offset the
increase from Australia operations.
International tax operations' EBITDA improved 95.3% to a negative $229 thousand
from a negative $4.9 million in the first quarter of fiscal 2002.
-26-
International Tax Operations - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
---------------- --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Canada $ 5,657 $ 5,834 $ (177) -3.0%
Australia 11,490 12,385 (895) -7.2%
United Kingdom 871 1,047 (176) -16.8%
Overseas franchises 523 532 (9) -1.7%
-------- -------- --------
Total revenues 18,541 19,798 (1,257) -6.4%
======== ======== ========
Canada (7,464) (9,140) 1,676 18.3%
Australia 2,510 3,494 (984) -28.2%
United Kingdom (575) (591) 16 2.7%
Overseas franchises 21 142 (121) -85.2%
Allocated corporate & shared costs (1,136) (1,111) (25) -2.3%
-------- -------- --------
Pretax loss $ (6,644) $ (7,206) $ 562 7.8%
======== ======== ========
- --------------------------------------------------------------------------------
Revenues decreased by 6.4% to $18.5 million from $19.8 million last year. The
decrease was largely driven by unfavorable changes in currency exchange rates
primarily in Australia and also in Canada.
Pretax loss improved 7.8% to a loss of $6.6 million from $7.2 million last year.
The improved performance in Canada is attributed to better business management
and cost control mainly related to facilities costs.
The Australian results were negatively affected by unfavorable changes in
currency exchange rates, a poor beginning of the tax season and additional costs
attributed to the opening of thirteen new offices in July.
The United Kingdom pretax loss decreased by 2.7%. This is being driven by the
closure of unprofitable offices.
The overseas franchise pretax profit decreased by 85.2%. This is driven by the
return to normal historical business levels after the introduction of the child
tax credit program last year.
MORTGAGE OPERATIONS
Through Option One Mortgage Corporation and H&R Block Mortgage Corporation, this
segment offers a wide range of home mortgage products. 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
-27-
offered through some H&R Block Financial Advisors branch offices and H&R Block
Mortgage Corporation retail offices.
Mortgage Operations - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Interest income $ 27,995 $ 5,941 $ 22,054 371.2%
Loan servicing income 33,570 26,566 7,004 26.4%
Gain on sale of mortgage loans 118,186 50,792 67,394 132.7%
Other 1,070 1,391 (321) -23.1%
-------- -------- --------
Total revenues 180,821 84,690 96,131 113.5%
======== ======== ========
Compensation & benefits 42,695 28,608 (14,087) -49.2%
Variable servicing & processing 15,510 8,990 (6,520) -72.5%
Occupancy & equipment 7,581 5,616 (1,965) -35.0%
Interest expense 1,394 714 (680) -95.2%
Bad debt expense 5,450 5,550 100 1.8%
Amortization of acquisition intangibles -- 3,395 3,395 100.0%
Other 14,478 10,744 (3,734) -34.8%
Allocated corporate & shared costs 522 640 118 18.4%
-------- -------- --------
Total expenses 87,630 64,257 (23,373) -36.4%
-------- -------- --------
Pretax earnings $ 93,191 $ 20,433 $ 72,758 356.1%
======== ======== ========
- -------------------------------------------------------------------------------------------------------------
Revenues increased by 113.5% for the three months ended October 31, 2001
compared to the same period last year. The increase is primarily due to an
increase in production volume, higher excess retained interest spread earned, a
favorable secondary market environment and a larger servicing portfolio.
Revenues related to the sale of mortgage loans increased by $67.4 million over
the prior year period resulting from a significant increase in loan origination
volume, as well as better pricing execution on mortgage loan sales. During the
three months ended October 31, 2001, the Company originated $2.6 billion in
mortgage loans compared to $1.5 billion for the same period last year, an
increase of 76.3%. 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. For non-prime production, the percentage of loan refinancing
to total loan origination has not changed significantly as a result of the
decline in interest rates. One of the Company's key cross-sell initiatives
related to retail mortgage operations resulted in 61.9% of all retail loans, and
9.6% of all loans originated during the second 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 October 31, 2001 was 5.08% compared
to 3.53% for the same period last year. The better execution pricing is
partially attributable to the declining interest rate environment that has the
effect of widening spreads on mortgage loan sales. Interest income for the three
months ended October 31, 2001 totaled $28.0 million, an increase of $22.1
million over the comparable prior year period. This increase is primarily the
result of the declining interest rate environment since
-28-
new non-prime loan originations are far less sensitive to such declines as
compared to the interest rates charged on the related borrowings, which directly
reflect changes in market interest rates and therefore improves the excess
retained interest spread earned. The excess retained interest spread for the
three months ended October 31, 2001 was 5.21% compared to 2.41% for the same
period last year. Servicing revenues increased by 26.4% to $33.6 million for the
three months ended October 31, 2001, as compared to the same period last year.
The increase reflects a higher loan servicing portfolio balance and an increase
in servicing operations efficiencies. The average servicing portfolio for the
three-month period ended October 31, 2001 increased to $20.2 billion from $14.8
billion for the same period last year.
Pretax earnings increased by $72.8 million or 356.1%, to $93.2 million for the
three months ended October 31, 2001. The improved performance is primarily due
to the increase in revenues as discussed above. In addition, the higher loan
volumes helped drive a decline in the net cost of origination due to process
efficiencies and economies of scale, significantly improving the pretax margin.
The second quarter also benefited from the adoption of SFAS 141 and 142 by
eliminating amortization of goodwill, which totaled $3.4 million in the prior
year's second quarter. Mortgage operations operating profit margin of 3.52%
improved 193 basis points from 1.59% in the prior year. The operating profit
margin is defined as pretax earnings before goodwill amortization divided by
mortgage fundings. Mortgage operations EBITDA increased by $70.7 million to
$96.9 million in the second quarter of fiscal 2002.
Mortgage Operations - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
----------- --------
2002 Quarter Better/(worse)
------------ --------------
2nd 1st $ %
--- --- - -
Interest income $ 27,995 $ 19,194 $ 8,801 45.9%
Loan servicing income 33,570 32,473 1,097 3.4%
Gain on sale of mortgage loans 118,186 96,234 21,952 22.8%
Other 1,070 424 646 152.4%
-------- -------- --------
Total revenues 180,821 148,325 32,496 21.9%
======== ======== ========
Compensation & benefits 42,695 41,772 (923) -2.2%
Variable servicing & processing 15,510 11,520 (3,990) -34.6%
Occupancy & equipment 7,581 6,037 (1,544) -25.6%
Interest expense 1,394 1,795 401 22.3%
Bad debt expense 5,450 6,616 1,166 17.6%
Amortization of acquisition intangibles -- -- -- --
Other 14,478 13,526 (952) -7.0%
Allocated corporate & shared costs 522 280 (242) -86.4%
-------- -------- --------
Total expenses 87,630 81,546 (6,084) -7.5%
-------- -------- --------
Pretax earnings $ 93,191 $ 66,779 $ 26,412 39.6%
======== ======== ========
- --------------------------------------------------------------------------------
Revenues increased by 21.9% for the three months ended October 31, 2001 compared
to the first quarter of fiscal 2002. The increase is primarily due to a
favorable secondary market
-29-
environment. Revenues related to the sale of mortgage loans increased by $22.0
million over the first quarter period resulting from a significant increase in
pricing execution on mortgage loan sales. The total execution price representing
gain on sale of mortgage loans for the three months ending October 31, 2001 was
5.08% compared to 3.82% for the three months ending July 31, 2001. The better
execution pricing is partially attributable to the declining interest rate
environment that has the effect of widening spreads on mortgage loan sales.
Pretax earnings increased by $26.4 million or 39.6%, to $93.2 million for the
three months ended October 31, 2001. The improved performance is primarily due
to the increase in revenues as discussed above. Mortgage operations operating
profit margin of 3.52% improved 97 basis points from 2.55% in the first quarter
of fiscal 2002. Mortgage operations EBITDA increased by $27.0 million to $96.9
million in the second quarter of fiscal 2002.
Mortgage Operations - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
---------------- --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Interest income $ 47,189 $ 14,583 $ 32,606 223.6%
Loan servicing income 66,043 49,502 16,541 33.4%
Gain on sale of mortgage loans 214,420 99,639 114,781 115.2%
Other 1,494 1,566 (72) -4.6%
--------- --------- ---------
Total revenues 329,146 165,290 163,856 99.1%
========= ========= =========
Compensation & benefits 84,467 54,921 (29,546) -53.8%
Variable servicing & processing 27,030 16,898 (10,132) -60.0%
Occupancy & equipment 13,618 11,025 (2,593) -23.5%
Interest expense 3,189 4,087 898 22.0%
Bad debt expense 12,066 8,193 (3,873) -47.3%
Amortization of acquisition intangibles -- 6,789 6,789 100.0%
Other 28,004 20,477 (7,527) -36.8%
Allocated corporate & shared costs 802 937 135 14.4%
--------- --------- ---------
Total expenses 169,176 123,327 (45,849) -37.2%
--------- --------- ---------
Pretax earnings $ 159,970 $ 41,963 $ 118,007 281.2%
========= ========= =========
- --------------------------------------------------------------------------------
Revenues increased by 99.1% for the six months ended October 31, 2001 compared
to the same period last year. The increase is primarily due to an increase in
production volume, higher excess retained interest spread earned, a favorable
secondary market environment and a larger servicing portfolio. Revenues related
to the sale of mortgage loans increased by $114.8 million over the prior year
period resulting from a significant increase in loan origination volume, as well
as better pricing execution on mortgage loan sales. During the six months ended
October 31, 2001 the Company originated $5.3 billion in mortgage loans compared
to $2.9 billion for the same period last year, an increase of 82.5%. 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. For non-prime
-30-
production, the percentage of loan refinancing to total loan origination has not
changed significantly as a result of the decline in interest rates. One of the
Company's key cross-sell initiatives related to retail mortgage operations
resulted in 61.5% of all retail loans, and 10.0% of all loans originated during
the six months this year coming from H&R Block tax clients. The total execution
price representing gain on sale of mortgage loans for the six months ending
October 31, 2001 was 4.54% compared to 3.22% for the same period last year. The
better execution pricing is partially attributable to the declining interest
rate environment that has the effect of widening spreads on mortgage loan sales.
Interest income for the six months ended October 31, 2001 totaled $47.2 million,
an increase of $32.6 million over the comparable prior year period. This
increase is primarily the result of the declining interest rate environment
since new non-prime loan originations are far less sensitive to such declines as
compared to the interest rates charged on the related borrowings, which directly
reflect changes in market interest rates and therefore improves the excess
retained interest spread earned. The excess retained interest spread for the six
months ended October 31, 2001 was 5.08% compared to 2.37% for the same period
last year. Servicing revenues increased by 33.4% to $66.0 million for the six
months ended October 31, 2001, as compared to the same period last year. The
increase reflects a higher loan servicing portfolio balance and an increase in
servicing operations efficiencies. The average servicing portfolio for the
six-month period increased to $19.5 billion from $13.0 billion for the same
period last year.
Pretax earnings increased by $118.0 million or 281.2%, to $160.0 million for the
six months ended October 31, 2001. The improved performance is primarily due to
the increase in revenues as discussed above. In addition, the higher loan
volumes helped drive a decline in the net cost of origination due to process
efficiencies and economies of scale, significantly improving the pretax margin.
The six months ended October 31, 2001 also benefited from the adoption of SFAS
141 and 142 by eliminating amortization of goodwill, which totaled $6.8 million
in the prior year comparable six-month period. Mortgage operations operating
profit margin of 3.04% improved 135 basis points from 1.69% in the prior year.
Mortgage operations EBITDA increased by $113.6 million to $166.9 million in the
first six months of fiscal 2002 compared to the same period in fiscal 2001.
INVESTMENT SERVICES
This segment is primarily engaged in offering investment advice and services
through H&R Block Financial Advisors, Inc., a full-service securities broker.
Financial planning and investment advice and services are offered through H&R
Block Financial Advisors branch offices, and stocks, bonds, mutual funds and
other products and securities are offered through a nationwide network of
registered representatives at the same locations.
-31-
Investment Services - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
------------------ --------
October 31, Better/(worse)
----------- --------------
2001 2000 $ %
---- ---- - -
Commission & fee income $ 41,375 $ 65,348 $(23,973) -36.7%
Margin interest income 17,222 59,507 (42,285) -71.1%
Other 6,230 6,718 (488) -7.3%
-------- -------- --------
Total revenues 64,827 131,573 (66,746) -50.7%
======== ======== ========
Compensation & benefits 33,155 43,365 10,210 23.5%
Interest expense 4,267 33,381 29,114 87.2%
Occupancy & equipment 7,412 6,780 (632) -9.3%
Depreciation & amortization 4,803 4,536 (267) -5.9%
Commission, floor brokerage & fees 1,802 3,043 1,241 40.8%
Amortization of acquisition intangibles 7,381 11,456 4,075 35.6%
Other 13,414 16,905 3,491 20.7%
Allocated corporate & shared costs 1,728 328 (1,400) -426.8%
-------- -------- --------
Total expenses 73,962 119,794 45,832 38.3%
-------- -------- --------
Pretax earnings (loss) $ (9,135) $ 11,779 $(20,914) --
======== ======== ========
- --------------------------------------------------------------------------------
Investment services revenue for the second quarter of fiscal year 2002 compared
to the second quarter of 2001 decreased 50.7% to $64.8 million from $131.6
million. The overall decrease in revenues can be attributed primarily to bearish
market conditions. The economy began to slow down in the summer of 2000 and
continued to decline in the winter months and into calendar year 2001. The
September 11th tragedies exacerbated the decline in investor confidence. As a
result of this tragedy, the exchanges were closed for four days.
Pretax results for Investment services for the second quarter of fiscal year
2002, compared to 2001 decreased $20.9 million to a loss of $9.1 million from
pretax earnings of $11.8 million. The decrease in pretax results is primarily
attributed to the decline in customer trading and customer margin activity.
Total expenses decreased by 38.3% to $74.0 million from $119.8 million. As a
result of the adoption of SFAS 141 and 142, Investment services amortization of
acquired intangible assets declined by $4.1 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
second quarter of fiscal year 2002 were 377,094, whereas in the previous year's
second quarter the total customer trades were 626,436, a decline of 39.8%. As a
result, commission and fee income decreased 36.7% to $41.4 million from $65.3
million. The average commission per trade declined 10.4% from $70.52 to $63.17,
reflecting lower dollar volume trades as compared to the previous year's similar
time period.
Margin Lending. Due to declining securities values and investor uncertainty,
which has increased due to the September 11th tragedies, customer margin
balances have significantly declined. Balances fell from an average of $2.7
billion in the second quarter of 2001 to an
-32-
average of $1.1 billion for the same time period for 2002. The decrease in
margin interest revenue was primarily attributed to the decline in margin
balances and to a lesser extent, lower interest rates. At the end of the second
quarter of fiscal 2002, the Federal Funds Rate declined 400 basis points to 2.5%
from 6.5% at the end of the second quarter of fiscal 2001. Net interest margin,
defined as interest earned on the average margin loan balance less the cost of
funding those loans, declined from 1.77% for the three months ending October
2000 to 1.08% for the three months ending October 2001, 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 22.2% to $11.9 million. Underwriting revenues increased by
$3.5 million or 224.2% from the previous second quarter, 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 $4.8 million decline
in equity unit investment trusts (UIT) and a decline of $4.4 million in equity
trading. 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.
Interest Expenditures. The largest decrease in expenses for the second quarter
of fiscal year 2002, as compared to the second quarter of 2001, was interest
expense. Interest expense decreased 87.2% to $4.3 million from $33.4 million.
Interest expense is mainly comprised of interest paid on customer credit
balances and interest paid for securities lending, which is used to finance
customer margin balances. Interest paid on customer credit balances decreased
62.1% to $3.2 million from $8.5 million. The decrease is due to smaller customer
balances and lower interest rates. Balances fell from an average of $915.7
million in the second quarter of 2001 to an average of $755.9 million for the
same time period for 2002, a decline of 17.5%. Interest paid on securities
lending decreased 95.8% to $1.0 million from $24.9 million. In addition to a
decline in interest rates, the lower interest expense is attributable to the
decline in customer margin balances. Since stock loans are used to finance the
margin-lending portfolio, shrinkage has reduced the need for this financing.
Fixed Expenses. Investment services is in the midst of re-engineering and
consolidation efforts (with corporate departments). These efforts are focused on
building a stronger, more effective organization that will be better prepared to
respond to marketplace changes and provide clients with the value they are
demanding. As a result of these efforts, a reduction in workforce occurred in
October 2001 and the Company incurred severance charges of approximately $1.7
million.
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 second quarter of 2002, annuity revenue was $563 thousand. The Company
currently conducts annuity business in twelve states, but is licensed in
thirty-one 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
-33-
number of online trades represented 6.6% of total trades for the quarter ended
October 31, 2001. 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, were
offered for the first time in July. In the third quarter of fiscal 2002, the
Company will be launching fee-based services. The Investment services segment
has yet to experience significant revenues from the majority of these
initiatives.
Investment services EBITDA declined to $3.6 million in the second quarter of
fiscal 2002 from $28.4 million in the same period last year.
Investment Services - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
----------- --------
2002 Quarter Better/(worse)
------------ --------------
2nd 1st $ %
--- --- - -
Commission & fee income $ 41,375 $ 41,776 $ (401) -1.0%
Margin interest income 17,222 21,955 (4,733) -21.6%
Other 6,230 5,194 1,036 20.0%
-------- -------- --------
Total revenues 64,827 68,925 (4,098) -6.0%
======== ======== ========
Compensation & benefits 33,155 31,500 (1,655) -5.3%
Interest expense 4,267 6,645 2,378 35.8%
Occupancy & equipment 7,412 7,689 277 3.6%
Depreciation & amortization 4,803 4,982 179 3.6%
Commission, floor brokerage & fees 1,802 1,620 (182) -11.2%
Amortization of acquisition intangibles 7,381 7,381 -- --
Other 13,414 13,137 (277) -2.1%
Allocated corporate & shared costs 1,728 2,069 341 16.5%
-------- -------- --------
Total expenses 73,962 75,023 1,061 1.4%
-------- -------- --------
Pretax loss $ (9,135) $ (6,098) $ (3,037) -49.8%
======== ======== ========
- --------------------------------------------------------------------------------------------------------------------
Investment services revenue for the second quarter of fiscal year 2002 compared
to the first quarter of 2002 decreased 6.0% to $64.8 million from $68.9 million.
The overall decrease in revenues can be attributed primarily to bearish market
conditions. The economy began to slow down in the summer of 2000 and continued
to decline in the winter months and into calendar year 2001. The September 11th
tragedies exacerbated the decline in investor confidence. As a result of this
tragedy, the exchanges were closed for four days.
The pretax loss for Investment services for the second quarter of fiscal year
2002, compared to first quarter of 2002 increased 49.8% to a loss of $9.1
million from a loss of $6.1 million. The increase is primarily attributed to the
decline in customer trading and customer margin activity. Total expenses
decreased by 1.4% to $74.0 million from $75.0 million.
-34-
Trading Volume. Similar to the rest of the industry, Investment services has
been experiencing a decline in trading volume. Total customer trades for the
second quarter of fiscal year 2002 were 377,094, whereas in the first quarter
the total customer trades were 389,343, a decline of 3.1%. As a result,
commission and fee income decreased 1.0% to $41.4 million from $41.8 million.
The average commission per trade increased 1.4% from $62.29 to $63.17.
Commission rates charged to customers increased in September 2000, February
2001, and also in October 2001.
Margin Lending. Due to declining securities values and investor uncertainty,
which has increased due to the September 11th tragedies, customer margin
balances have declined. Balances fell from an average of $1.3 billion in the
first quarter of 2002 to an average of $1.1 billion in the second quarter. The
decrease in margin interest revenue was primarily attributed to the decline in
margin balances and to a lesser extent lower interest rates. At the end of the
second quarter, the Federal Funds Rate was 2.5%, a decrease of 125 basis points
from 3.75% at the end of the first quarter. Net interest margin, defined as
interest earned on the average margin loan balance less the cost of funding
those loans, declined from 1.57% to 1.08% from the end of the first quarter of
2002 to the end of the second quarter of 2002, 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 10.4% to $11.9 million. Underwriting revenues increased by
$1.1 million or 26.2% from the first quarter of 2002, 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 $2.4 million decline in
fixed income trading.
Interest Expenditures. The largest decrease in expenses for the second quarter
of fiscal year 2002, as compared to the first quarter of 2002, was interest
expense. Interest expense decreased 35.8% to $4.3 million from $6.6 million.
Interest expense is mainly comprised of interest paid on customer credit
balances and interest paid for securities lending, which is used to finance
customer margin balances. Interest paid on customer credit balances decreased
27.4% to $3.2 million from $4.4 million. The decrease is due to smaller customer
balances and lower interest rates. Balances fell from an average of $789.5
million in the first quarter of 2002 to an average of $755.9 million in the
second quarter, a decline of 4.3%. Interest paid on securities lending decreased
53.4% to $1.0 million from $2.3 million. Since stock loans are used to finance
the margin-lending portfolio, shrinkage has reduced the need for this financing.
Fixed Expenses. Investment services is in the midst of re-engineering and
consolidation efforts (with corporate departments). These efforts are focused on
building a stronger, more effective organization that will be better prepared to
respond to marketplace changes and provide clients with the value they are
demanding. As a result of these efforts, a reduction in workforce occurred in
October 2001 and the Company incurred severance charges of approximately $1.7
million.
-35-
Investment services EBITDA declined to $3.6 million in the second quarter of
fiscal 2002 from $6.8 million in the first quarter.
Investment Services - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
October 31, Better/(worse)
2001 2000 $ %
--------- --------- --------- ------
Commission & fee income $ 83,151 $ 130,136 $ (46,985) -36.1%
Margin interest income 39,177 118,544 (79,367) -67.0%
Other 11,424 13,560 (2,136) -15.8%
--------- --------- ---------
Total revenues 133,752 262,240 (128,488) -49.0%
========= ========= =========
Compensation & benefits 64,655 84,029 19,374 23.1%
Interest expense 10,912 66,375 55,463 83.6%
Occupancy & equipment 15,101 13,994 (1,107) -7.9%
Depreciation & amortization 9,785 8,318 (1,467) -17.6%
Commission, floor brokerage & fees 3,422 6,580 3,158 48.0%
Amortization of acquisition intangibles 14,762 23,027 8,265 35.9%
Other 26,551 29,791 3,240 10.9%
Allocated corporate & shared costs 3,797 6,664 2,867 43.0%
--------- --------- ---------
Total expenses 148,985 238,778 89,793 37.6%
--------- --------- ---------
Pretax earnings (loss) $ (15,233) $ 23,462 $ (38,695) --
========= ========= =========
- --------------------------------------------------------------------------------
Investment services revenue for the first six months of fiscal year 2002
compared to the first six months of 2001 decreased 49.0% to $133.8 million from
$262.2 million. The overall decrease in revenues can be attributed primarily to
bearish market conditions. The economy began to slow down in the summer of 2000
and continued to decline in the winter months and into calendar year 2001. The
September 11th tragedies exacerbated the decline in investor confidence. As a
result of this tragedy, the exchanges were closed for four days.
Pretax results for Investment services for the first six months of fiscal year
2002 compared to 2001 decreased $38.7 million to a loss of $15.2 million from
pretax earnings of $23.5 million. The decrease in pretax results is primarily
attributed to the decline in customer trading and customer margin activity.
Total expenses decreased by 37.6% to $149.0 million from $238.8 million. As a
result of the adoption of SFAS 141 and 142, Investment services amortization of
acquired intangible assets declined by $8.3 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 six months of 2002 were 766,437, whereas in the previous year's first six
months the total customer trades were 1,272,913, a decline of 39.8%. As a
result, commission and fee income decreased 36.1% to $83.2 million from $130.1
million. The average commission per trade declined 6.2% from $66.86 to $62.73,
reflecting lower dollar volume trades as compared to the previous year's similar
time period.
-36-
Margin Lending. Due to declining securities values and investor uncertainty,
which has increased due to the September 11th tragedies, customer margin
balances have significantly declined. Balances fell from an average of $2.7
billion in the first six months of 2001 to an average of $1.2 billion for the
same time period for 2002. The decrease in margin interest revenue was primarily
attributed to the decline in margin balances and to a lesser extent, lower
interest rates. At the beginning of the first quarter of fiscal 2001, the
Federal Funds Rate was 6.0% and by the end of the second quarter of fiscal 2002,
the Federal Funds Rate was 2.5%, which is a decrease of 350 basis points. Net
interest margin, defined as interest earned on the average margin loan balance
less the cost of funding those loans, declined from 1.69% for the six months
ended October 2000 to 1.34% for the six months ended October 2001, 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 25.9% to $25.1 million. Underwriting revenues increased by
$7.3 million or 395.8% from the previous first six months, 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 an $11.3 million
decline in equity UITs and a decline of $8.0 million in equity trading. 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.
Interest Expenditures. The largest decrease in expenses for the first six months
of fiscal year 2002, as compared to the first six months of 2001, was interest
expense. Interest expense decreased 83.6% to $10.9 million from $66.4 million.
Interest expense is mostly comprised of interest paid on customer credit
balances and interest paid for securities lending, which is used to finance
customer margin balances. Interest paid on customer credit balances decreased
55.0% to $7.7 million from $17.0 million. The decrease is due to smaller
customer balances and lower interest rates. Balances fell from an average of
$929.6 million in the first six months of fiscal 2001 to an average of $772.7
million for the same time period in fiscal 2002, a decline of 16.9%. Interest
paid on securities lending decreased 93.3% to $3.3 million from $49.4 million.
In addition to a decline in interest rates, the lower expense is attributable to
the decline in customer margin balances. Since stock loans are used to finance
the margin-lending portfolio, shrinkage has reduced the need for this financing.
Fixed Expenses. Investment services is in the midst of re-engineering and
consolidation efforts (with corporate departments). These efforts are focused on
building a stronger, more effective organization that will be better prepared to
respond to marketplace changes and provide clients with the value they are
demanding. As a result of these efforts, a reduction in workforce occurred in
October 2001 and the Company incurred severance charges of approximately $1.7
million.
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
-37-
added to the product line beginning in January 2001. For the first six months
of fiscal 2002, annuity revenue was $1.1 million. The Company currently conducts
annuity business in twelve states, but is licensed in thirty-one 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
online trades represented 6.6% of total trades during the six months ended
October 31, 2001. 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, were
offered for the first time in July. In the third quarter of fiscal 2002, the
Company will be launching fee-based services. The Investment services segment
has yet to experience significant revenues from the majority of these
initiatives.
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 be
rolled out nationally for the 2002 tax season. Another key cross-organizational
initiative was the creation and testing of the TPFA (Tax Preparer Financial
Advisor) program. In its pilot year, 430 TPFAs, through the most recent tax
season, cross-sold 3,000 investment-related accounts. In addition, tax client
referrals to Investment services resulted in approximately 15,000 additional new
accounts. Investment services plans to add another 600-800 TPFAs in fiscal 2002,
bringing the total to approximately 1,000-1,200.
Investment services EBITDA declined to $10.4 million for the first six months of
fiscal 2002 from $56.0 million last year.
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.
-38-
Business Services - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
October 31, Better/(worse)
2001 2000 $ %
-------- -------- - -
Accounting, consulting & tax $ 79,059 $ 69,265 $ 9,794 14.1%
Product sales 4,950 5,278 (328) -6.2%
Management fee income 3,150 4,639 (1,489) -32.1%
Other 4,620 (915) 5,535 --
-------- -------- --------
Total revenues 91,779 78,267 13,512 17.3%
======== ======== ========
Compensation & benefits 62,496 54,815 (7,681) -14.0%
Occupancy & equipment 4,491 5,556 1,065 19.2%
Depreciation & amortization 1,521 1,861 340 18.3%
Marketing & advertising 1,307 1,247 (60) -4.8%
Bad debt expense 1,617 2,427 810 33.4%
Amortization of acquisition intangibles 3,255 7,847 4,592 58.5%
Other 14,103 5,068 (9,035) -178.3%
Allocated corporate & shared costs 435 476 41 8.6%
-------- -------- --------
Total expenses 89,225 79,297 (9,928) -12.5%
-------- -------- --------
Pretax earnings (loss) $ 2,554 $ (1,030) $ 3,584 --
======== ======== ========
- --------------------------------------------------------------------------------
Business services revenues of $91.8 million increased 17.3% from $78.3 million
in the quarter ended October 31, 2000. This increase was due to the addition of
new firms, wealth management services and revenue from tax consulting.
During the quarter, the segment acquired two accounting firms, which expanded
its geographic coverage to the Seattle and San Francisco metropolitan areas.
Additionally, the segment completed add-on acquisitions relating to existing
offices in the New York City area and Dallas. The effect of these acquisitions
completed during the quarter plus the current quarter revenues from acquisitions
completed in fall 2000, net of the sale of assets of KSM Business Services, Inc.
effected in December 2000, was to increase revenue by $7.2 million or 9.2%.
The Wealth Management services are part of a focus to provide a fully integrated
approach to clients to further their business and personal financial objectives.
Revenue from the initiative consists both of fees relating to assets managed for
clients and also revenue from insurance carriers relating to alliances to
provide life insurance solutions to clients.
Pretax results improved from a $1.0 million pretax loss in the quarter ended
October 31, 2000 to $2.6 million pretax earnings for the quarter ended October
31, 2001. The pretax results comparison was positively affected by $5.0 million
as a result of the adoption of SFAS 141 and 142, which eliminates the
amortization of goodwill and intangible assets. Pretax earnings were reduced by
$.9 million due to the off-season losses of firms acquired.
-39-
Business services EBITDA declined to $7.3 million from $8.7 million in the
second quarter of last year.
During the third quarter of fiscal year 2002, the segment plans to acquire two
new consulting firms. One of the firms is expected to expand valuation, merger
and acquisition consulting capabilities and the other is expected to expand
payroll and benefits processing capabilities. Both of these are fundamental to
providing value-added services to capitalize on existing client relationships.
Due to the nature of this segment's business, revenues are seasonal, while
expenses are relatively fixed throughout the year. Results for the second
quarter are not indicative of the expected results for the entire fiscal year.
Business Services - Three-month comparison to preceding quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
2002 Quarter Better/(worse)
2nd 1st $ %
--- --- - -
Accounting, consulting & tax $ 79,059 $ 64,901 $ 14,158 21.8%
Product sales 4,950 5,365 (415) -7.7%
Management fee income 3,150 2,250 900 40.0%
Other 4,620 7,466 (2,846) -38.1%
-------- -------- --------
Total revenues 91,779 79,982 11,797 14.8%
======== ======== ========
Compensation & benefits 62,496 58,163 (4,333) -7.5%
Occupancy & equipment 4,491 5,419 928 17.1%
Depreciation & amortization 1,521 2,102 581 27.6%
Marketing & advertising 1,307 1,363 56 4.1%
Bad debt expense 1,617 3,011 1,394 46.3%
Amortization of acquisition intangibles 3,255 3,196 (59) -1.9%
Other 14,103 8,597 (5,506) -64.1%
Allocated corporate & shared costs 435 302 (133) -44.0%
-------- -------- --------
Total expenses 89,225 82,153 (7,072) -8.6%
-------- -------- --------
Pretax earnings (loss) $ 2,554 $ (2,171) $ 4,725 --
======== ======== ========
- --------------------------------------------------------------------------------
Business services revenues of $91.8 million increased 14.8% from $80.0 million
in the quarter ended July 31, 2001. This increase was due to a significant
increase in tax consulting revenue over the prior quarter of approximately $8.0
million.
Revenue from core services and general consulting services remained relatively
flat for the quarter compared to the previous quarter. The demand for services
has remained stable despite the slowing economy.
Pretax results improved from a $2.2 million pretax loss in the quarter ended
July 31, 2001 to pretax earnings of $2.6 million for the current quarter. This
increase is due to the seasonal
-40-
nature of the business, as revenues are greater in the second quarter while
costs remain relatively fixed.
Business services EBITDA improved to $7.3 million from $3.1 million in the first
quarter of fiscal 2002.
Business Services - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
October 31, Better/(worse)
2001 2000 $ %
---- ---- - -
Accounting, consulting & tax $ 143,960 $ 130,647 $ 13,313 10.2%
Product sales 10,315 9,967 348 3.5%
Management fee income 5,400 5,167 233 4.5%
Other 12,086 8,583 3,503 40.8%
--------- --------- ---------
Total revenues 171,761 154,364 17,397 11.3%
========= ========= =========
Compensation & benefits 120,659 95,241 (25,418) -26.7%
Occupancy & equipment 9,910 14,890 4,980 33.5%
Depreciation & amortization 3,623 4,099 476 11.6%
Marketing & advertising 2,670 2,766 96 3.5%
Bad debt expense 4,628 4,265 (363) -8.5%
Amortization of acquisition intangibles 6,451 14,822 8,371 56.5%
Other 22,700 21,847 (853) -3.9%
Allocated corporate & shared costs 737 698 (39) -5.6%
--------- --------- ---------
Total expenses 171,378 158,628 (12,750) -8.0%
--------- --------- ---------
Pretax earnings (loss) $ 383 $ (4,264) $ 4,647 --
========= ========= =========
- --------------------------------------------------------------------------------
Business services revenues of $171.8 million increased 11.3% from $154.4 million
in the prior year. This increase was due to the addition of new firms and
revenue from Wealth Management services.
During the six-month period, the segment acquired two accounting firms, which
expanded its geographic coverage to the Seattle and San Francisco metropolitan
areas. Additionally, the segment completed add-on acquisitions relating to
existing offices in the New York City area and Dallas. The effect of these
acquisitions completed in the six months ended October 31, 2001 plus the full
six months of revenues for acquisitions completed in the fall of 2000, net of
the sale of assets of KSM Business Services, Inc. effected in December 2000, was
to increase revenue for the six months by $9.0 million or 5.8%.
Growth from existing product lines was $8.4 million, or 5.5% of revenue, and was
primarily due to Wealth Management services. Wealth Management services are part
of a focus to provide a fully integrated approach to clients to further their
business and personal financial objectives. Revenue from the initiative consists
both of fees relating to assets managed for
-41-
clients and also revenue from insurance carriers relating to alliances to
provide life insurance solutions to clients.
Revenue from core tax services and general consulting services remained
relatively flat for the six months compared to the prior year. The demand for
services has remained stable despite the slowing economy and the September 11th
tragedies.
Pretax results improved from a $4.3 million loss in the prior year to pretax
earnings of $383 thousand for the current year. The pretax results comparison
was positively impacted by $9.1 million as a result of the adoption of SFAS 141
and 142 which eliminates amortization of goodwill and intangible assets.
Increases in fixed costs of $3.6 million, related to newly acquired firms, had
the effect of decreasing pretax earnings.
Business services EBITDA declined to $10.5 million from $14.7 million in the
prior year.
During the third quarter of fiscal year 2002, the segment plans to acquire two
new consulting firms. One of the firms is expected to expand valuation, merger
and acquisition consulting capabilities and the other is expected to expand
payroll and benefits processing capabilities. Both of these are fundamental to
providing value-added services to capitalize on existing client relationships.
Due to the nature of this segment's business, revenues are seasonal, while
expenses are relatively fixed throughout the year. Results for the six months
are not indicative of the expected results for the entire fiscal year.
UNALLOCATED CORPORATE
As previously discussed, the Company adopted a new methodology for allocation of
corporate services and support costs to business units. The change was made 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.
-42-
Unallocated Corporate &
Interest Expense on Acquisition Debt - Three-month comparison to prior year
- --------------------------------------------------------------------------------
Three months ended Variance
October 31, Better/(worse)
2001 2000 $ %
---- ---- - -
Total revenues $ (422) $ 1,642 $ (2,064) --
-------- -------- --------
Compensation & benefits 21,468 13,912 (7,556) -54.3%
Occupancy & equipment 5,284 2,857 (2,427) -85.0%
Depreciation & amortization 5,530 4,957 (573) -11.6%
Marketing & advertising 4,658 (274) (4,932) --
Other 18,210 20,855 2,645 12.7%
Allocated corporate & shared costs (45,754) (33,306) 12,448 37.4%
-------- -------- --------
Total expenses 9,396 9,001 (395) -4.4%
-------- -------- --------
Pretax loss $ (9,818) $ (7,359) $ (2,459) -33.4%
======== ======== ========
Interest expense on acquisition debt $ 19,360 $ 24,484 $ 5,124 20.9%
======== ======== ========
- --------------------------------------------------------------------------------
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 second
quarter of fiscal 2002.
Unallocated Corporate &
Interest Expense on Acquisition Debt - Three-month comparison to preceding
quarter
- --------------------------------------------------------------------------------
Fiscal Year Variance
2002 Quarter Better/(worse)
2nd 1st $ %
--- --- - -
Total revenues $ (422) $ 2,082 $ (2,504) --
-------- -------- --------
Compensation & benefits 21,468 17,166 (4,302) -25.1%
Occupancy & equipment 5,284 4,383 (901) -20.6%
Depreciation & amortization 5,530 5,812 282 4.9%
Marketing & advertising 4,658 1,449 (3,209) -221.5%
Other 18,210 14,644 (3,566) -24.4%
Allocated corporate & shared costs (45,754) (35,933) 9,821 27.3%
-------- -------- --------
Total expenses 9,396 7,521 (1,875) -24.9%
-------- -------- --------
Pretax loss $ (9,818) $ (5,439) $ (4,379) -80.5%
======== ======== ========
Interest expense on acquisition debt $ 19,360 $ 21,398 $ 2,038 9.5%
======== ======== ========
- --------------------------------------------------------------------------------
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 second
quarter of fiscal 2002.
-43-
Unallocated Corporate &
Interest Expense on Acquisition Debt - Six-month comparison to prior year
- --------------------------------------------------------------------------------
Six months ended Variance
October 31, Better/(worse)
2001 2000 $ %
---- ---- - -
Total revenues $ 1,660 $ 2,139 $ (479) -22.4%
-------- -------- ---------
Compensation & benefits 38,634 27,405 (11,229) -41.0%
Occupancy & equipment 9,667 6,468 (3,199) -49.5%
Depreciation & amortization 11,342 9,542 (1,800) -18.9%
Marketing & advertising 6,107 4,429 (1,678) -37.9%
Other 32,854 32,709 (145) -0.4%
Allocated corporate & shared costs (81,687) (66,514) 15,173 22.8%
-------- -------- ---------
Total expenses 16,917 14,039 (2,878) -20.5%
-------- -------- ---------
Pretax loss $(15,257) $(11,900) $ (3,357) -28.2%
======== ======== =========
Interest expense on acquisition debt $ 40,758 $ 51,772 $ 11,014 21.3%
======== ======== =========
- --------------------------------------------------------------------------------
The decrease in interest expense on acquisition debt is attributable to lower
financing costs and payment of a portion of the acquisition debt in fiscal 2002.
- --------------------------------------------------------------------------------
FINANCIAL CONDITION
- --------------------------------------------------------------------------------
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 a negative $43 thousand at October 31, 2001 from
$282.8 million at April 30, 2001. The working capital ratio at October 31, 2001
is 0.98 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 and the seasonal nature of the business. The increase in
short-term borrowings is largely related to approximately $258.0 million in
excess cash held to ensure on-hand liquidity in the wake of the September 11th
tragedies. 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. On October 26, 2001, the credit facility
was amended, restated and extended at $1.93 billion through October 2002.
-44-
In April 2000, 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 ($804.9 million at October 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 $1.5 billion at October
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 October 31, 2001, short-term borrowings increased to $881.7 million from a
zero balance at April 30, 2001. The Company's capital expenditures, dividend
payments, share repurchase program, Business services acquisition and contingent
payments, and normal operating activities during the first six months were
funded through both internally-generated funds and short-term borrowings. In
addition, the Company held excess cash balances of approximately $258.0 million
to ensure on-hand liquidity in the wake of the September 11th tragedies. The
Company's debt to total equity ratio at October 31, 2001 was 66.1%, compared to
44.0% at April 30, 2001.
During calendar 2002, the Company plans to execute a net interest margin (NIM)
transaction to securitize certain existing residual interests from previous NIM
transactions in an effort to expedite receiving cash for the residual interests
and to reduce the total value of residual interests on the balance sheet.
For the six months ended October 31, 2001 and 2000, interest expense was $59.6
million and $127.2 million, respectively. The decrease in interest expense is
due to lower customer credit balances, stock loan balances and acquisition debt,
as well as lower financing costs.
In March 2000, the Company's Board of Directors approved an authorization to
repurchase up to 12 million shares of its common stock. Repurchases under the
March 2000 authorization were completed in September 2001. On September 12,
2001, the Company's Board of Directors authorized the repurchase of an
additional 15 million shares of common stock. In the first six months of fiscal
2002, the Company repurchased 9.7 million shares (split-adjusted) pursuant to
these authorizations at an aggregate price of $351.8 million or an average price
of $36.32 per share. There are approximately 11.1 million shares remaining under
the September 2001 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.
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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, earnings per share, client and pricing growth goals and expectations
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 and mortgage servicing rights will differ from estimated future
excess cash flows from such items; the ability of the Company to complete a NIM
transaction on existing residual interests; the inability of the Company's
Business services segment to acquire additional firms; 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.
- --------------------------------------------------------------------------------
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 $9.5 million. 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, including the quarterly report on Form 10-Q for the period
ending July 31, 2001.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The registrant's Articles of Incorporation, as amended and restated, were
further amended, effective upon the filing of the Certificate of Amendment with
the Secretary of State of Missouri on October 15, 2001, to increase the number
of authorized shares of common stock, without par value, from 400,000,000 shares
to 500,000,000 shares. The aggregate number of shares of all classes of stock
which the registrant now has authority to issue is 506,000,000, with the
500,000,000 authorized shares of common stock and 6,000,000 authorized shares of
a class designated preferred stock, without par value. The amendment to the
Articles of Incorporation was approved by the shareholders of the registrant at
the annual meeting of shareholders held on September 12, 2001. The resolution
approved by the shareholders is set forth in Item 4 to Part II of this Form
10-Q. The Certificate of Amendment is filed as Exhibit 3.1 to this Form 10-Q and
the Restated Articles of Incorporation, incorporating all amendments thereto are
filed as Exhibit 3.2 to this Form 10-Q.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of shareholders of the registrant was held on September 12,
2001. At such meeting, three Class III directors were elected to serve
three-year terms. In addition, the resolutions set forth below were submitted to
a vote of shareholders. With respect to the election of directors and the
adoption of each resolution, the number of votes cast for, against or withheld,
the number of abstentions, the number of broker non-votes (if applicable), and
the number of no votes (if applicable) were as follows:
Election of Class III Directors
Nominee Votes FOR Votes WITHHELD
------- --------- --------------
Donna R. Ecton 80,481,505 613,168
Louis W. Smith 80,468,726 625,947
Rayford Wilkins, Jr. 80,334,461 760,212
Approval of an amendment to the Articles of Incorporation to increase
the number of authorized shares of Common Stock from 400,000,000 to
500,000,000
The following resolution was adopted by a vote of 78,304,397 shares in
favor of such resolution, 2,010,436 shares against such resolution,
462,842 shares abstaining, and 316,998 no votes. The resolution states:
"RESOLVED, That ARTICLE THREE of the Articles of Incorporation
of H&R Block, Inc., as heretofore amended, be further amended
by deleting the first sentence thereof in its entirety and
substituting therefore the following:
`ARTICLE THREE
The aggregate number of shares of all classes of stock which
the corporation shall have authority to issue is 506,000,000
divided into two classes as follows:
(i) 500,000,000 shares of a class designated
Common Stock, without par value; and
(ii) 6,000,000 shares of a class designated
Preferred Stock, without par value.'
Approval of amendments to the 1999 Stock Option Plan for Seasonal
Employees
The following resolution was adopted by a vote of 56,025,998 shares in
favor of such resolution, 14,363,565 shares against such resolution,
and 694,477 shares abstaining. There were 10,010,633 broker non-votes.
The resolution states:
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"RESOLVED, That the 1999 Stock Option Plan for Seasonal
Employees, as proposed to be amended, included as Appendix A
to the proxy statement relating to this meeting, is hereby
adopted and approved."
Approval of amendments to the 1989 Stock Option Plan for Outside
Directors
The following resolution was adopted by a vote of 58,022,054 shares in
favor of the resolution, 12,109,178 shares against such resolution, and
952,806 shares abstaining. There were 10,010,635 broker non-votes. The
resolution adopted was as follows:
"RESOLVED, That the 1989 Stock Option Plan for Outside
Directors, as proposed to be amended, included as Appendix B
to the proxy statement relating to this meeting, is hereby
adopted and approved."
Appointment of Independent Accountants
The following resolution was adopted by a vote of 77,792,602 shares in
favor of such resolution, 2,836,209 shares against such resolution, and
465,862 shares abstaining:
"RESOLVED, That the appointment of PricewaterhouseCoopers LLP
as the independent accountants for H&R Block, Inc., and its
subsidiaries for the year ending April 30, 2002 is hereby
ratified, approved and confirmed."
At the close of business on July 10, 2001, the record date for the annual
meeting of shareholders, there were 92,255,281 shares of common stock of the
registrant outstanding and entitled to vote at the meeting. There were
81,094,673 shares represented at the annual meeting of shareholders held on
September 12, 2001. Since the record date for the annual meeting of shareholders
was prior to the 2-for-1 split-up of the registrant's common stock effected
August 1, 2001, the number of shares reported in this report are pre-split
numbers and were not adjusted for the split.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits
3.1 Certificate of Amendment of Articles of Incorporation of the
registrant effective October 15, 2001.
3.2 Restated Articles of Incorporation of the registrant, as
amended to the date of this Form 10-Q.
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10.1 The registrant's 1993 Long-Term Executive Compensation Plan,
as amended August 1, 2001.
10.2 The registrant's 2000 Employee Stock Purchase Plan, as amended
August 1, 2001.
10.3 The H&R Block Stock Plan for Non-Employee Directors, as
amended August 1, 2001.
10.4 The registrant's 1989 Stock Option Plan for Outside Directors,
as amended September 12, 2001.
10.5 The registrant's 1999 Stock Option Plan for Seasonal
Employees, as amended September 12, 2001.
10.6 Employment Agreement dated as of October 8, 2001, between HRB
Management, Inc. and Jeffrey Brandmaier.
b) Reports on Form 8-K
The registrant did not file any reports on Form 8-K during the second quarter of
fiscal year 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 12/14/01 BY /s/ Frank J. Cotroneo
------------------ ------------------------------------
Frank J. Cotroneo
Senior Vice President and
Chief Financial Officer
DATE 12/14/01 BY /s/ Cheryl L. Givens
------------------ ------------------------------------
Cheryl L. Givens
Vice President and Corporate Controller
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