(Mark One)
| [X] | ||
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the fiscal year ended: April 30, | ||
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the transition period fromto | ||
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 Identification Number) | |
| incorporation or organization) |
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)
Securities registered pursuant to Section 12(b) of the Act:Act:
| Title of | Name of | |
| Common Stock, without par value | New York Stock Exchange | |
| Pacific Exchange |
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of Class)
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. YesNoü
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. YesNoü
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 þü Noo.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o[ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one) Large accelerated filerüAccelerated filerNon-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesNo þü No o
The aggregate market value of the registrant’s Common Stock (all voting stock) held by non-affiliates of the registrant, computed by reference to the price at which the stock was sold on October 31, 2004,2005, was $7,683,275,768.$8,049,475,793.
Number of shares of registrant’s Common Stock, without par value, outstanding on June 30, 2005: 165,970,297.May 31, 2006: 321,925,770.
Documents incorporated by reference
The definitive proxy statement relating to the registrant’s Annual Meeting of Shareholders, to be held September 7, 2005,2006, is incorporated by reference in Part III to the extent described therein.
TABLE OF CONTENTS
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INTRODUCTION AND FORWARD LOOKING STATEMENTS
Specified portions of our proxy statement, which will be filed in August 2005,July 2006, are listed as “incorporated by reference” in response to certain items. Our proxy statement will be printed within our Annual Report and mailed to shareholders in August 2005July 2006 and will also be available on our website atwww.hrblock.com.www.hrblock.com.
In this report, and from time to time throughout the year, we share our expectations for the Company’s future performance. These forward-looking statements are based upon current information, expectations, estimates and projections regarding the Company, the industries and markets in which we operate, and our assumptions and beliefs at that time. 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, which are difficult to predict. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in these forward-looking statements. Words such as “believe,” “will,” “plan,” “expect,” “intend,” “estimate,” “approximate,” and similar expressions may identify such forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS ... –
H&R Block is a diversified company with subsidiaries deliveringproviding tax, investment, mortgage and business services and products. For 50 years, we have been developing relationships with millions of tax clients and our strategy is to expand on these relationships. Our Tax Services segment provides income tax return preparation and other services and products related to tax return preparation to the general public in the United States, and in Canada, Australia and the United Kingdom. We also offer investment services and securities products through H&R Block Financial Advisors, Inc. (“HRBFA”)(HRBFA). Our Mortgage Services segment offers a full range of home mortgage services through Option One Mortgage Corporation (“Option One”)(Option One) and H&R Block Mortgage Corporation (“HRBMC”)(HRBMC). RSM McGladrey Business Services, Inc. (“RSM”)(RSM) is a national accounting, tax and business consulting firm primarily serving mid-sized businesses.
H&R BLOCK’S MISSION .... –
“To help our clients achieve their financial objectives
objectives by serving as their tax
and financial partner.”
H&R Block, Inc. was organized as a corporation in 1955 under the laws of the State of Missouri, and is a holding company with operating subsidiaries providing financial services and products to the general public. “H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.
RECENT DEVELOPMENTS ... – In March 2006, the Office of Thrift Supervision (OTS) approved the charter of the H&R Block Bank. The bank will commence operations on May 1, 2006. In fiscal year 2007, we will realign certain segments of our business to reflect a new management reporting structure.
On February 22, 2006, the Company’s management and the Audit Committee of the Board of Directors concluded to restate previously issued consolidated financial statements for the fiscal quarters ended October 26, 2004, we issued $400.0 million of 5.125% Senior Notes under our shelf registration statements. The Senior Notes are due on October 30, 2014. The proceeds from31, 2005 and July 31, 2005, and the notes were used to repay our $250.0 million in 63/4% Senior Notes, which were due on November 1, 2004. The remaining proceeds were used for working capital, capital expenditures, repayment of other debt and other general corporate purposes. As offiscal years ended April 30, 2005 we had $850.0 million available under our shelf registration statements.and 2004 and the related fiscal quarters. The Company arrived at this conclusion during the course of its closing process for the quarter ended January 31, 2006. The restatement pertained primarily to errors in determining the Company’s state effective income tax rate, including errors in identifying changes in state apportionment, expiring state net operating losses and related factors, for the fiscal years ended April 30, 2005 and 2004, and the related fiscal quarters.
On June 8, 2005, our Board of Directors declared a two-for-one stock split of the Company’s Common Stock in the form of a 100% stock distribution, effective August 22, 2005, to shareholders of record as of the close of business on August 1, 2005.
the stock split.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
–
See discussion below and in Item 8, note2019 to our consolidated financial statements.
See discussion below and in Item 8, note
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DESCRIPTION OF BUSINESS –
TAX SERVICES
GENERAL ... – Our Tax Services segment is primarily engaged in providing tax return preparation and related services and products in the United States and its territories, Canada, Australia and the United Kingdom. Revenues include fees earned for services performed at company-owned retail tax offices, royalties from franchise retail tax offices, sales of Peace of Mind (“POM”)(POM) guarantees, sales of tax preparation and other software, fees from online tax preparation, and participation in refund anticipation loans (“RALs”)(RALs). Segment revenues constituted 53.4%50.3% of our consolidated revenues for fiscal year 2006, 53.4% for 2005, and 51.6% for 2004, and 52.2% for 2003.2004.
Retail income tax return preparation and related services are provided by tax professionals via a system of retail offices operated directly by us or by franchisees. In addition toWe also offer our retailservices though seasonal offices welocated inside major retailers.
We offer a number of digital tax preparation alternatives.
Clients also have many online options: multiple versions of do-it-yourself tax preparation, professional tax review, tax advice and tax preparation through a tax professional, whereby the client completes a tax organizer and sends it to a tax professional for preparation and/or signature.
By offering professional and do-it-yourself tax preparation options through multiple channels, we can serve our clients in the manner in which they choose to be served.
We also offer clients a number of options for receiving their income tax refund, including a check directly from the Internal Revenue Service (“IRS”)(IRS), an electronic deposit directly to their bank account, a refund anticipation check or a RAL.
The following are some of the services we offer with our tax preparation service:
PEACE OF MIND GUARANTEE ... – The POM guarantee is offered to U.S. clients, whereby we (1) represent our clients if audited by the IRS, and (2) assume the cost, subject to certain limits, of additional taxes owed by a client resulting from errors attributable to one of our tax professionals.professionals’ work. The POM program has a per client cumulative limit of $5,000 in additional taxes assessed with respect to the federal, state and local tax returns we prepared for the taxable year covered by the program.
RALs ... – RALs are offered to our U.S. clients by a designated bank through a contractual relationship with HSBC Holdings plc (“HSBC”)(HSBC). An eligible, electronic filing client may apply for a RAL at one of our offices. After meeting certain eligibility criteria, clients are offered the opportunity to apply for a loan from HSBC in amounts up to $9,999 based upon their anticipated federal income tax refund. We simultaneously transmit the income tax return information to the IRS and the lending bank. Within a few days or less after the filing date, the client receives a check or direct deposit in the amount of the loan, less the bank’s transaction fee, our tax return preparation fee and other fees for client-selected services. Additionally, qualifying electronic filing clients are eligible to receive their RAL proceeds, less applicable fees, in approximately one hour after electronic filing using the Instant Money service. For a RAL to be repaid, the IRS directly deposits the participating client’s federal income tax refund into a designated account at the lending bank. See related discussion of RAL participations below.
RACs ... – Refund Anticipation Checks (“RACs”)(RACs) are offered to U.S. clients who may not wish to obtain a RAL or do not qualify for the RAL program, but who would like to either (1) receive their refund faster and do not have a bank account for the IRS to direct deposit their refund or (2) have their tax preparation fees paid directly out of their refund. A RAC is not a loan and is provided through a contractual relationship with HSBC.
EXPRESS IRAs ... – Individual retirement accounts (“Express IRAs”)(Express IRAs), invested in FDIC-insured money market accounts, are offered to U.S. clients as a tax-advantaged retirement savings tool. HRBFA acts as custodian on the accounts, with the funds being invested at insured depository institutions paying competitive money market interest rates.
TAX RETURN PREPARATION COURSES ... – We offer income tax return preparation courses to the public, which teach taxpayersstudents how to prepare income tax returns and provide us with a source of trained tax professionals.
SOFTWARE PRODUCTS ... – We develop and market TaxCut income tax preparation software, H&R Block DeductionProtm,
Kiplinger’s Home and Business Attorney and Kiplinger’s WILLPowerSM software products.
TaxCut offers a simple step-by-step tax preparation interview, data imports from money management software and tax preparation software, calculations, completion of the appropriate tax forms, checking for errors and, for an additional charge, electronic filing.
ONLINE TAX PREPARATION ... – We offer a comprehensive range of tax services and products, from tax advice to complete professional and do-it-yourself tax return preparation and electronic filing, through our website atwww.hrblock.comandwww.taxcut.com.www.taxcut.com. These websites allow clients to prepare their federal and state income tax returns using the TaxCut Online
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Tax Program, (“OTP”), access tax tips, advice and tax-related news and use calculators for tax planning.
Beginning with the fiscal year 2003 tax season, we participated in the Free File Alliance (“FFA”)(FFA). This alliance was created by the tax return preparation industry and the IRS, and allows qualified filers to prepare and file their federal return online at no charge. We feel that this program provides a valuable public service and increases our visibility with new clients, while also providing an opportunity to offer our state return preparation services to these new clients at our regular prices.
CASHBACK PROGRAM ... – We offer a refund discount (“CashBack”)(CashBack) program to our customers in Canada. Canadian law specifies the procedures we must follow in conducting the program. In accordance with current Canadian regulations, if a customer’s tax return indicates the customer is entitled to a tax refund, we issue a check to the client. The client assigns to us the full amount of the tax refund to be issued by the Canada Revenue CanadaAgency (CRA) and the refund check is then sent by Revenue Canadathe CRA directly to us. In accordance with the law, the discount is deemed to include both the tax return preparation fee and the fee for tax refund discounting. This program is financed by short-term borrowings. The number of returns discounted under the CashBack program in fiscal year 20052006 was approximately 581,000,653,000, compared to 581,000 in 2005 and 552,000 in 2004 and 531,000 in 2003.2004. See discussion of the Canadian tax season extension under “Seasonality of Business.”
CLIENTS SERVED ... – We, together with our franchisees, served approximately 21.421.9 million clients worldwide during fiscal year 2005,2006, compared to 21.4 million in 2005 and 21.6 million in 2004 and 21.7 in 2003.2004. See discussion of the Canadian tax season extension under “Seasonality of Business.” We served 19.119.5 million clients in the U.S. during fiscal year 2005,2006, compared to 19.1 million in 2005 and 19.3 million in 2004 and 19.5 million in 2003.2004. “Clients served” includes taxpayers for whom we prepared income tax returns in offices, federal software units sold, online completed and paid federal returns, and paid online state returns when no federal return was purchased, as well asand taxpayers for whom we provided only paid electronic filing services. Returns for ourOur U.S. clients served constituted 15.5%15.7% of an IRS estimate of total individual income tax returns filed as of April 29, 2005,30, 2006, compared to 15.6% in 2005 and 15.7% in 2004 and 16.0% in 2003.2004.
OWNED AND FRANCHISED OFFICES ... – A summary of our company-owned and franchise offices is as follows:
| April 30, | 2005 | 2004 | 2003 | |||||||||||
U.S. OFFICES ... | ||||||||||||||
| Company-owned offices | 5,811 | 5,172 | 4,688 | |||||||||||
Company-owned shared locations (1) | 1,296 | 996 | 607 | |||||||||||
| Total company-owned offices | 7,107 | 6,168 | 5,295 | |||||||||||
| Franchise offices | 3,528 | 3,418 | 3,967 | |||||||||||
Franchise shared locations (1) | 526 | 323 | 95 | |||||||||||
| Total franchise offices | 4,054 | 3,741 | 4,062 | |||||||||||
| 11,161 | 9,909 | 9,357 | ||||||||||||
INTERNATIONAL OFFICES ... | ||||||||||||||
| Canada | 912 | 891 | 910 | |||||||||||
| Australia | 378 | 378 | 362 | |||||||||||
| Other | 10 | 7 | 6 | |||||||||||
| 1,300 | 1,276 | 1,278 | ||||||||||||
| April 30, | 2006 | 2005 | 2004 | |||||||||
U.S. OFFICES— | ||||||||||||
| Company-owned offices | 6,387 | 5,811 | 5,172 | |||||||||
Company-owned shared locations(1) | 1,473 | 1,296 | 996 | |||||||||
| Total company-owned offices | 7,860 | 7,107 | 6,168 | |||||||||
| Franchise offices | 3,703 | 3,528 | 3,418 | |||||||||
Franchise shared locations(1) | 602 | 526 | 323 | |||||||||
| Total franchise offices | 4,305 | 4,054 | 3,741 | |||||||||
| 12,165 | 11,161 | 9,909 | ||||||||||
INTERNATIONAL OFFICES— | ||||||||||||
| Canada | 1,011 | 912 | 891 | |||||||||
| Australia | 362 | 378 | 378 | |||||||||
| Other | 10 | 10 | 7 | |||||||||
| 1,383 | 1,300 | 1,276 | ||||||||||
| (1) | Shared locations include offices located within Wal-Mart, Sears or other third-party businesses. |
Offices in shared locations include 9471,138 offices operated in Wal-Mart stores and 757793 offices in Sears stores operated as “H&R Block at Sears.” The Wal-Mart agreement is in the process of being extended, with the new agreement expected to expireexpires in May 2007, and the Sears license agreement expires in July 2007, both subject to termination rights.
We offer franchises as a way to expand our presence in the market. Our franchise arrangements provide us with certain rights which are designed to protect our brand. Most of our franchisees receive signs, designated equipment, specialized forms, local advertising, initial training, and supervisory services, and pay us a percentage of gross tax return preparation and related service revenues as a franchise royalty.
From time to time, we have acquired the territories of existing franchisees and other tax return preparation businesses, and will continue to do so if future conditions warrant and satisfactory terms can be negotiated. During fiscal year 2004, we made payments ofpaid $243.2 million related to acquire the acquisition of primarily assets and stock in the franchise territoriesoperations of ten of our former major franchisees. One franchisee is continuing litigation
RAL PARTICIPATIONS AND 2003 TAX SEASON WAIVER ...– Since July 1996, we have been a party to agreements with HSBC and its predecessors to participate in RALs provided by a lending bank to H&R Block tax clients. The 1996 agreement was amended and restated in January 2003 and again in June 2003. In the June 2003 agreement, we obtained the right to purchase a 49.9% participation interest in RALs obtained through company-owned and regular franchise offices and a 25% interest in RALs obtained through major franchise offices. The current agreement continues through June 2006. During fiscal year 2006, we signed a new agreement with HSBC in which we obtained the right to
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purchase a 49.9% participation interest in all RALs obtained through our retail offices. We received a signing bonus from HSBC during the current year in connection with this agreement, which was primarily recorded as deferred revenue at April 30, 2006. The new agreement will be in effect from July 2006 through June 2011. Our purchases of the participation interests are financed through short-term borrowings, and we bear all of the credit risk associated with our interests in the RALs. Revenue from our participation is calculated as the rate of participation multiplied by the fee paid by the borrower to the lending bank. Our RAL participation revenue was $177.9 million, $182.8 million and $168.4 million in fiscal years 2006, 2005 and 2004, respectively.
SEASONALITY OF BUSINESS – ... Because most of our clients file their tax returns during the period from January through April of each year, substantially all of our revenues from income tax return preparation and related services and products are received during this period. As a result, our tax segment generally operates at a loss through the first eight months of the fiscal year. Historically, these losses primarily reflect wages of year-round personnel, training of tax professionals, rental and furnishing of retail tax offices, and other costs and expenses relating to preparation for the upcoming tax season. Additionally, the tax business is affected by economic conditions and unemployment rates. Peak revenues occur during the applicable tax season, as follows:
| United States and Canada | January – April | |||||
| Australia | July – October | |||||
In the current fiscal year, Revenue Canadathe CRA extended the Canadian tax season to May 1, 2006. Clients served in our Canadian operations in fiscal year 2006 includes approximately 41,400 returns in both company-owned and franchise offices which were accepted by the client on May 1, 2006. The revenues related to these returns will be recognized in fiscal year 2007. Last year, the Canadian tax season was extended to May 2, 2005. Clients served in our Canadian operations in fiscal year 2005 includes approximately 47,500 returns in both company-owned and franchise offices which were accepted by the client on May 1 and 2, 2005. The revenues related to these returns will bewere recognized in fiscal year 2006.
COMPETITIVE CONDITIONS – ... The retail tax services business is highly competitive. There are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services. Many tax return preparation firms and many firms not otherwise in the tax return preparation business are involved in providing electronic filing and RAL services to the public. Commercial tax return preparers and electronic filers are highly competitive with regard to price, service and reputation for quality. In terms of the number of offices and personal tax returns prepared and electronically filed in offices, online and via our software, we are the largest company providing direct tax return preparation and electronic filing services in the U.S. We also believe we operate the largest tax return preparation businesses in Canada and Australia.
GOVERNMENT REGULATION – ... Primary efforts toward the regulation of U.S. commercial tax return preparers have historically been made at the federal level. Federal legislation requires income tax return preparers to, among other things, set forth their signatures and identification numbers on all tax returns prepared by them, and retain all tax returns prepared for three years. Federal laws also subject income tax return preparers to accuracy-related penalties in connection with the preparation of income tax returns. Preparers may be prohibited from further acting as income tax return preparers if they continuously and repeatedly engage in specified misconduct. With certain exceptions, the Internal Revenue Code also prohibits the use or disclosure by income tax return preparers of certain income tax return information without the prior written consent of the taxpayer. In addition, the Gramm-Leach-Bliley Act and
Federal Trade Commission regulations adopted thereunder require income tax preparers to adopt and disclose consumer privacy policies, and provide consumers a reasonable opportunity to “opt-out” of having personal information disclosed to unaffiliated third parties for marketing purposes. Some states have adopted or proposed strict “opt-in” requirements in connection with use or disclosure of consumer information.
We believe the federal legislation regulating commercial tax return preparers and consumer privacy has not had and will not have a material adverse effect on the operations of H&R Block. In addition, no present state statutes of this nature have had a material adverse effect on our business. We cannot, however, predict what the effect may be of the enactment of new statutes or adoption of new regulations.
The federal government regulates the electronic filing of income tax returns in part by requiring individuals and businesses to be accepted into the electronic filing program. Once accepted, electronic filers must comply with all publications and notices of the IRS applicable to electronic filing, provide certain
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information to the taxpayer, comply with advertising standards for electronic filers, and be subjected to possible monitoring by the IRS, penalties for disclosure or use of income tax return preparation and other preparer penalties, and suspension from the electronic filing program. States that have adopted electronic filing programs for state income tax returns have also enacted laws regulating electronic filers and the advertising and offering of electronic filing services.
Federal statutes and regulations also regulate an electronic filer’s involvement in RALs. Electronic filers must clearly explain the RAL is a loan and not a substitute for or a quicker way of receiving an income tax refund. Federal laws place restrictions on the fees an electronic filer may charge in connection with RALs. In addition, some states and localities have enacted laws and adopted regulations for RAL facilitators and/or the advertising of RALs. There are also many states that have statutes regulating, through licensing and other requirements, the activities of brokering loans, providing credit services and offering “credit repair” services to consumers for a fee (“Loan(Loan Activity Statutes”)Statutes). We believe the procedures under which we facilitate RALs are structured so our activities are not included within the scope of the activities regulated by these Loan Activity Statutes. There can be no assurances, however, that states with these Loan Activity Statutes will not contend successfully that these statutes apply to the RAL business and that we will need to become licensed under the Loan Activity Statutes, otherwise comply with statutory requirements, or modify procedures so that the Loan Activity Statutes are inapplicable.
Many states have statutes requiring the licensing of persons offering contracts of insurance. We have received from certain state insurance regulators inquiries about our POM guarantee program and the applicability of the state insurance statutes. In states where the inquiries are closed, the regulators affirmed our position that the POM guarantee is not a contract of insurance and is therefore not subject to state insurance licensing laws. In the few states where inquiries are pending, we believe there are no insurance laws under which the POM guarantee constitutes a contract of insurance. There can be no assurances, however, that the product, or other similar products we may offer in the future, will not be scrutinized as potential insurance products and held to be subject to various insurance laws and regulations.
Many of our income tax courses are regulated and licensed in select states. Failure to obtain a tax school license could limit our ability to develop interest in tax preparation as a career or obtain qualified tax professionals.
We believe the federal, state and local laws and legislation regulating electronic filing, RALs and the facilitation of RALs, loan brokers, credit services, credit repair services, insurance products, and proprietary schools have not, and will not in the future, have a material adverse effect on our operations. We cannot predict, however, what the effect may be of the enactment of new statutes or the adoption of new regulations pertaining to these matters.
As noted above under “Owned and Franchised Offices,” many of the income tax return preparation offices operating in the U.S. under the name “H&R Block” are operated by franchisees. Certain aspects of the franchisor/franchisee relationship have been the subject of regulation by the Federal Trade Commission and by various states. The extent of regulation varies, but relates primarily to disclosures to be made in connection with the grant of franchises and limitations on termination by the franchisor under the franchise agreement. To date, no such regulation has materially affected our business. We cannot predict, however, the effect of applicable statutes or regulations that may be enacted or adopted in the future.
We also seek to determine the applicability of all government and self-regulatory organization statutes, ordinances, rules and regulations in the international countries in which we operate (collectively, “Foreign Laws”)Foreign Laws) and to comply with these Foreign Laws. We cannot predict what effect the enactment of future Foreign Laws, changes in interpretations of existing Foreign Laws, or the results of future regulator inquiries regarding the applicability of Foreign Laws may have on our segments, any particular subsidiary, or our consolidated financial statements.
Statutes and regulations relating to income tax return preparers, electronic filing, franchising and other areas affecting
the income tax business also exist in other countries in which we operate. In addition, the Canadian government regulates the refund-discounting program in Canada. These laws have not materially affected our international operations.
See discussion in “Risk Factors” for additional information.
MORTGAGE SERVICES
GENERAL – ... Our Mortgage Services segment originates mortgage loans, services non-prime mortgage loans and sells and securitizes mortgage loans and residual interests in the U.S. Revenues primarily consist of gains from sales and securitizations of mortgage assets, accretion on residual interests and servicing fee income. Segment revenues constituted 28.2%25.6% of our consolidated revenues for fiscal year 2006 and 28.2% for 2005 and 31.2% for 2004 and 30.8% for 2003.2004.
We originate both non-prime and prime mortgage loans. Non-prime mortgages are those that may not be offered through
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government-sponsored loan agencies and typically involve borrowers with limited income documentation, high levels of consumer debt or past credit problems. Even though these borrowers have credit problems, they also tend to have equity in thetheir property that will be used to secure the loan. Prime mortgages are those that may be offered through government sponsored loan agencies. We conduct business through four channels:
| • | ||
| Option One’s wholesale origination channel works with independent brokers throughout the U.S. to fund non-prime mortgage loans through a national branch network. Wholesale originations represent the majority of Option One’s total loan production. | ||
| • | HRBMC originates residential mortgage loans directly to retail | |
| • | Option One’s national accounts channel forms partnerships with financial institutions, including national and regional banks, to allow them to offer non-prime loans. | |
| • | Option One’s bulk acquisitions channel specializes in the purchase of performing non-prime mortgage loan pools. |
Option One is headquartered in Irvine, California and operates in 48 states by serving 42,00049,000 mortgage broker locations and through its network of 3635 wholesale loan production branches and six national accounts branches.eight retail production offices.
HRBMC, a wholly-owned subsidiary of Option One, is a retail mortgage lender for prime, non-prime and government loans and is licensed to conduct business in all 50 states. HRBMC is an approved seller/servicer for Fannie Mae and Freddie Mac and is HUD authorized to originate and underwrite FHA and VA mortgage loans.
In the current year, we terminated approximately 1,200 employees and closed some of our branch offices through a restructuring. This resulted in a pretax charge of $12.6 million. See additional discussion of our restructuring charge in Item 8, note 16 to the consolidated financial statements.
LOAN ORIGINATION ... – The following table details our originations by channel forWe originated $40.8 billion, $31.0 billion and $23.3 billion in mortgage loans during fiscal years 2006, 2005 and 2004, and 2003:
| (in 000s) | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||
| Wholesale | $ | 21,841,783 | $ | 16,828,138 | $ | 11,434,138 | ||||||||
| Retail | 4,023,914 | 3,105,021 | 2,918,378 | |||||||||||
| National accounts | 3,974,224 | 2,642,944 | 1,814,092 | |||||||||||
| Bulk acquisitions | 1,161,803 | 679,910 | 411,013 | |||||||||||
| $ | 31,001,724 | $ | 23,256,013 | $ | 16,577,621 | |||||||||
respectively. Information regarding our non-prime loan originations is as follows:
| (dollars in 000s) | |||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Loan type: | |||||||||||||||
| 2-year ARM | 61.6% | 63.4% | 70.3% | ||||||||||||
| 3-year ARM | 4.0% | 5.2% | 5.1% | ||||||||||||
| Fixed 1st | 17.7% | 28.7% | 23.9% | ||||||||||||
| Fixed 2nd | 3.8% | 1.6% | 0.7% | ||||||||||||
| Interest only 1st | 12.6% | 0.7% | – % | ||||||||||||
| Other | 0.3% | 0.4% | – % | ||||||||||||
| Loan purpose: | |||||||||||||||
| Cash-out refinance | 63.5% | 67.1% | 64.9% | ||||||||||||
| Purchase | 30.8% | 26.0% | 26.9% | ||||||||||||
| Rate or term refinance | 5.7% | 6.9% | 8.2% | ||||||||||||
| Loan characteristics: | |||||||||||||||
| Average loan size | $ | 160 | $ | 151 | $ | 144 | |||||||||
| Weighted-average loan-to-value | 78.9% | 78.1% | 78.7% | ||||||||||||
| Weighted-average FICO score | 614 | 608 | 604 | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Loan type: | ||||||||||||
| 2-year ARM | 43.9% | 61.6 | % | 63.4 | % | |||||||
| 3-year ARM | 1.9% | 4.0 | % | 5.2 | % | |||||||
Fixed 1st | 12.7% | 17.7 | % | 28.7 | % | |||||||
Fixed 2nd | 4.9% | 3.8 | % | 1.6 | % | |||||||
Interest only 1st | 21.1% | 12.6 | % | 0.7 | % | |||||||
| 40-Year | 13.4% | 0.0 | % | 0.0 | % | |||||||
| Other | 2.2% | 0.3 | % | 0.4 | % | |||||||
| Percentage of fixed-rate mortgages | 20.0% | 22.1 | % | 30.4 | % | |||||||
| Percentage of adjustable-rate mortgages | 80.0% | 77.9 | % | 69.6 | % | |||||||
| Percentage of first mortgage loans owner-occupied | 91.7% | 92.6 | % | 92.9 | % | |||||||
| Loan purpose: | ||||||||||||
| Cash-out refinance | 60.2% | 63.5 | % | 67.1 | % | |||||||
| Purchase | 35.0% | 30.8 | % | 26.0 | % | |||||||
| Rate or term refinance | 4.8% | 5.7 | % | 6.9 | % | |||||||
WHOLESALE. Wholesale loan originations involve an independent broker who assists the borrower in completing the loan application, which includes securing information regarding their assets, liabilities, income, credit history, employment history and personal information. We require a credit report on each applicant from an industry-recognized credit reporting company. In evaluating an applicant’s credit history, we use credit bureau risk scores, generally known as a FICO score, which is a statistical ranking of likely future credit performance developed by Fair, Isaac & Company and provided by the three national credit data repositories. Qualified independent appraisers are required to appraise mortgaged properties used to secure mortgage loans. The broker then identifies a lender who offers a loan product best suited to the borrower’s financial
needs. No one broker currently originates more than 0.6%0.7% of our total non-prime production.
Upon receipt of an application from a broker, a credit report and an appraisal report, one of our branch offices processes and underwrites the loan. Our underwriting guidelines require mortgage loans be underwritten in a standardized procedure that complies with federal and state laws and regulations. The guidelines are primarily intended to assess the value of the mortgaged property, evaluate the adequacy of the property as collateral for the mortgage loan, and assess the creditworthiness
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of the related borrower. The underwriting process may include an automated underwriting decision system as a tool to assist in the assessment of the creditworthiness of the borrower. Based upon this assessment, we advise the broker whether the loan application meets our underwriting guidelines and product description by issuing a loan approval or denial. In some cases, we issue a “conditional approval,” which requires the submission of additional information or clarification. The mortgage loans are underwritten with a view toward resale in the secondary market.
RETAIL. HRBMC originates our retail mortgage loans. In fiscal year 2005, 75%2006, 69% of our retail originations were non-prime and 25%31% were prime, compared to 59%75% and 41%25%, respectively, in 2004. These loans are processed by loan officers in HRBMC offices. Approximately one-third of these offices are co-located with our retail tax offices. The co-located offices are key to working towards our mission of becoming our clients’ tax and financial partner.2005. During fiscal year 2005,2006, approximately 35%20% of HRBMC’s loans were made to existing H&R Block clients compared to 49%35% in 2004.2005.
The application and approval process in our retail locations is similar to those described above under “Wholesale.” Retail mortgage loans are originated with the intent to sell.
SALE AND SECURITIZATION OF LOANS ... – Substantially all non-prime mortgage loans are sold daily to qualifying special purpose entities (“Trusts”)(Trusts). See discussion of our loan sale and securitization process in Item 7, under “Off-Balance Sheet Financing Arrangements.” At April 30, 2006, Option One held $407.5 million in loans for transfer to the H&R Block Bank when it commences operations in May 2006. These loans have been classified as held for investment on our consolidated balance sheet.
Substantially all of our retail prime mortgage loans are sold to Countrywide Home Loans, Inc. (“Countrywide”)(Countrywide). The majority of mortgage loans sold to Countrywide are underwritten through an automated system under which Countrywide assumes our representations and warranties, which comply with Countrywide’s underwriting guidelines. This agreement allows us to achieve improved execution due to price, efficiencies in delivery, and elimination of redundancies in operations. We do not retain servicing rights related to the prime mortgage loans. HRBMC non-prime mortgage loans are sold to Option One. See discussion of our prime warehouse line in Item 7, under “Capital Resources and Liquidity by Segment.”
SERVICING ... – Loan servicing involves collecting and remitting mortgage loan payments, making required advances, accounting for principal and interest, holding escrow for payment of taxes and insurance and contacting delinquent borrowers. We receive loan-servicing fees monthly over the life of the mortgage loans. We only service non-prime mortgage loans. At the end of fiscal year 2005,2006, we serviced 441,981 loans totaling $73.4 billion, compared to 435,290 loans totaling $68.0 billion compared toat April 30, 2005 and 324,364 loans totaling $45.3 billion at April 30, 2004 and 246,463 loans totaling $31.3 billion at April 30, 2003.2004.
The following table summarizes our servicing portfolio by origin and includes related mortgage servicing rights (“MSRs”)(MSRs) as of April 30, 20052006 and the rate we earned on each type of servicing during fiscal year 2005:2006:
| (dollars in 000s) | ||||||||||||||
| Type of Servicing | Principal Balance | MSR Balance | Rate Earned | |||||||||||
| Originated | $ | 47,376,295 | $ | 166,614 | 0.41% | |||||||||
| Sub-servicing | 20,450,482 | – | 0.22% | |||||||||||
| Purchased | 167,687 | – | 0.51% | |||||||||||
| Total | $ | 67,994,464 | $ | 166,614 | 0.36% | |||||||||
| (dollars in 000s) | ||||||||||||
| Type of Servicing | Principal Balance | MSR Balance | Rate Earned | |||||||||
| Originated | $ | 62,813,849 | $ | 272,472 | 0. 38 | % | ||||||
| Sub-servicing | 10,471,509 | - | 0. 18 | % | ||||||||
| Purchased | 96,719 | - | 0. 50 | % | ||||||||
| Total | $ | 73,382,077 | $ | 272,472 | 0. 38 | % | ||||||
When non-prime loans are sold or securitized, we generally retain the right to service the loans, which results in MSR assets and liabilities being recorded on our balance sheet. Assumptions used in estimating the value of MSRs are discussed in Item 8, note 1 to our consolidated financial statements. In addition to servicing loans we originate, we also service non-prime loans originated by other lenders, designated in the above table as sub-servicing. MSRs are recorded only in conjunction with our originated or purchased loan-servicing portfolio.
GEOGRAPHIC DISTRIBUTION ... – The following table details the percent of non-prime loan origination volume and our loan origination branches by state, excluding our Retail channel, for fiscal years 20052006 and 2004:2005:
| 2005 | 2004 | |||||||||||||||||
| Percent of | Number of | Percent of | Number of | |||||||||||||||
| State | Volume | Branches | Volume | Branches | ||||||||||||||
| California | 21.8% | 8 | 18.8% | 5 | ||||||||||||||
| New York | 11.5% | 2 | 14.4% | 2 | ||||||||||||||
| Massachusetts | 8.4% | 2 | 10.2% | 1 | ||||||||||||||
| Florida | 7.2% | 4 | 6.4% | 4 | ||||||||||||||
| New Jersey | 5.3% | 3 | 5.1% | 3 | ||||||||||||||
| Other | 45.8% | 23 | 45.1% | 25 | ||||||||||||||
| 2006 | 2005 | |||||||||||||||
| Percent of | Number of | Percent of | Number of | |||||||||||||
| State | Volume | Branches | Volume | Branches | ||||||||||||
| California | 24.5 | % | 6 | 21.8 | % | 8 | ||||||||||
| Florida | 10.7 | % | 3 | 7.2 | % | 4 | ||||||||||
| New York | 9.1 | % | 2 | 11.5 | % | 2 | ||||||||||
| Massachusetts | 6.7 | % | 2 | 8.4 | % | 2 | ||||||||||
| New Jersey | 5.1 | % | 1 | 5.3 | % | 3 | ||||||||||
| Other | 43.9 | % | 20 | 45.8 | % | 23 | ||||||||||
COMPETITIVE CONDITIONS ... – Both the non-prime and prime sectors of the residential mortgage loan market are highly competitive. The principal methods of competition are price, service and product differentiation. There are a substantial number of companies competing in the residential loan market, including mortgage banking companies, commercial banks,
savings associations, credit unions and other financial institutions. There are also numerous companies competing in the business of servicing non-prime loans. No one firm is a dominant supplier of non-prime and prime mortgage loans or a
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dominant servicer of non-prime loans.Inside B&C Lending ranked Option One as the number seven originator, based on market share as of DecemberMarch 31, 2004,2006, and the number fourthree servicer, based on servicing volume as of DecemberMarch 31, 2004,2006, of non-prime loans in the industry.
SEASONALITY OF BUSINESS ... – Residential mortgage volume is not subject to significant seasonal fluctuations. The mortgage business is cyclical, however, and directly affected by national economic conditions, trends in business and finance and is impacted by changes in interest rates.
GOVERNMENT REGULATION ... – Mortgage loans purchased, originated and/or serviced are subject to federal laws and regulations, including:
| • | ||
| The federal Truth-in-Lending Act, as amended, and Regulation Z promulgated thereunder; | ||
| • | The Equal Credit Opportunity Act, as amended, and Regulation B promulgated thereunder; | |
| • | The Fair Credit Reporting Act, as amended; | |
| • | The Fair Debt Collection Practices Act; | |
| • | The federal Real Estate Settlement Procedures Act, as amended, and Regulation X promulgated thereunder; | |
| • | The Home Ownership Equity Protection Act | |
| • | The Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended; | |
| • | The Home Mortgage Disclosure Act | |
| • | The federal Fair Housing Act; | |
| • | The Telephone Consumer Protection Act; | |
| • | The Gramm-Leach-Bliley Act and regulations adopted thereunder; | |
| • | The Fair and Accurate Credit Transactions Act; | |
| • | Regulation AB; and | |
| • | Certain other laws and regulations. |
Under environmental legislation and case law applicable in certain states, it is possible that liability for environmental hazards in respect of real property may be imposed on a holder of a deed to the property, which may impair the underlying collateral.
Applicable state laws generally regulate interest rates and other charges pertaining to non-prime loans. These states also require certain disclosures and require originators of certain mortgage loans to be licensed unless an exemption is available. In addition, most states have other laws, public policies and general principles of equity relating to consumer protection, unfair and deceptive practices, and practices that may apply to the origination, servicing and collection of mortgage loans.
In recent years, there has been a noticeable increase in state, county and municipal statutes, ordinances and regulations that prohibit or regulate so-called “predatory lending” practices. Predatory lending statutes such as HOEPA, regulate “high-cost loans,” which are defined separately by each state, county or municipal statute, regulation or ordinance, but generally include mortgage loans with interest rates exceeding a (1) specified margin over the Treasury Index for a comparable maturity, or (2) designated percentage of points and fees.fees charged to borrowers. Statutes, ordinances and regulations that regulate high-cost loans generally prohibit mortgage lenders from engaging in certain defined practices, or require mortgage lenders to implement certain practices, in connection with any mortgage loans that fit within the definition of a high-cost loan. We do not originate loans which meet the definition of high-cost loans under any law.
Certain state laws restrict or prohibit prepayment penalties on mortgage loans, and we relied on the federal Alternative Mortgage Transactions Parity Act (“Parity Act”)(Parity Act) and related rules issued in the past by the Office of Thrift Supervision (“OTS”)OTS to preempt state limitations on prepayment penalties. In September 2003, the OTS released a new rule that reduced the scope of the Parity Act preemption effective July 1, 2004 and, as a result, we can no longer rely on the Parity Act to preempt state restrictions on prepayment penalties. The elimination of this federal preemption requires compliance with state restrictions on prepayment penalties. These restrictions prohibit us from charging any prepayment penalty in six states and restrict the amount or duration of prepayment penalties that we may impose in an additional eleven states. This places us at a competitive disadvantage relative to financial institutions that continue to enjoy federal preemption of such state restrictions. Such institutions can charge prepayment penalties without regard to state restrictions and, as a result, may be able to offer loans with interest rate and loan fee structures that are more attractive than the interest rate and loan fee structures that we are able to offer.
See discussion in “Risk Factors” for additional information.
BUSINESS SERVICES
GENERAL
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This segment consists primarily of RSM McGladrey, Inc., which provides accounting, tax, accounting, and business consulting services in
Services are also provided bythrough the following wholly-owned subsidiaries:businesses:
| RSM McGladrey Retirement Resources administers retirement plans, helps clients design the best plan for their needs, and provides retirement plan investment advice, year-end compliance, tax reporting and consulting. | |||
| RSM EquiCo, Inc. is an investment banking firm specializing in business valuations, acquisitions and divestitures for private middle-market businesses. | |||
| RSM McGladrey Employer Services, Inc. | |||
| RSM McGladrey Financial Process Outsourcing, Inc. is a provider of accounting, reporting, payroll and bill paying services to distributors/franchisors and their population of retailers/franchisees. | |||
| PDI Global, Inc. provides marketing, communications and visibility programs, tax and financial planning guides, and marketing and management consulting services to accountants, consultants, lawyers, banks, insurers, and other financial service providers. |
From time to time, we have acquired businesses, and will continue to do so if future conditions warrant and satisfactory terms can be negotiated. During fiscal year 2006, we paid $190.7 million to acquire all the outstanding common stock of American Express Tax and Business Services, Inc., which has been merged into RSM McGladrey, Inc.
RELATIONSHIP WITH MCGLADREY & PULLEN, LLPATTEST FIRMS ... – By regulation, we cannot provide audit and attest services. McGladrey & Pullen, LLP (“M&P”), a&P, and other public accounting firm, providesfirms, including those public accounting firms previously associated with American Express Tax and Business Services, with whom we do business (collectively, “the Attest Firms”) provide audit and review services and other services in which M&P issuesthe Attest Firms issue written reports on client financial statements. Through an administrative services agreementa number of agreements, including agreements with M&P,these Attest Firms, we lease accounting personnel and provide accounting, payroll, human resources and other administrative services to M&Pthe Attest Firms and receive a management fee for these services. We also have a cost-sharing arrangement with M&P,the Attest Firms, whereby they reimburse us for the costs of certain items, mainly supplies and for the use of RSM owned or leased real estate, property and equipment. M&P is aThe Attest Firms are limited liability partnershippartnerships with itstheir own governing bodymanagement committees, legal and accordingly, is abusiness advisors, professional liability insurance and risk management policies. Accordingly, the Attest Firms are separate legal entityentities and is not an affiliate.affiliates. Some partners and employees of M&Pthe Attest Firms are also our employees.employees of RSM McGladrey.
SEASONALITY OF BUSINESS ... – Revenues for this segment are largely seasonal in nature, with peak revenues occurring during January through April.
COMPETITIVE CONDITIONS ... – The accounting, tax and consulting business is highly competitive. The principal methods of competition are price, service and reputation for quality. There are a substantial number of accounting firms offering similar services at the international, national, regional and local levels. As our focus is on middle-market businesses, our principal competition is with national and regional accounting firms. We believe we have a competitive advantage in the geographic areas in which we are currently located based on the breadth of services we can offer to these clients above and beyond what a traditional accounting firm can offer.
GOVERNMENT REGULATION ... – Many of the same federal and state regulations relating to tax preparers and the information concerning tax reform discussed above in the “Government Regulation” section of “Tax Services” apply to the Business Services segment as well. However, accountants are not subject to the same prohibition on the use or disclosure of certain income tax return information as tax professionals. Accounting firms are also subject to state and federal regulations governing accountants, auditors and financial planners. Various legislative and regulatory proposals have been made relating to auditor independence and accounting oversight, among others. Some of these proposals, if adopted, could have an impact on RSM’sour operations. We believe current state and federal regulations and known legislative and regulatory proposals do not and will not have a material adverse effect on our operations, but we cannot predict what the effect of future legislation, regulations and proposals may be.
We and M&Pthe Attest Firms have jointly developed and implemented policies, procedures and controls designed to safeguard M&P’sensure
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the Attest Firms’ independence and integrity as an audit firm in compliance with applicable SEC regulations and professional responsibilities. These policies, procedures and controls are designed to monitor and prevent violations of applicable independence rules and include, among others,other things, (1) informing our officers, directors and other members of senior management concerning auditor independence matters, (2) procedures for monitoring securities ownership, (3) communicating with SEC audit clients regarding the SEC’s interpretation and application of relevant independence rules and guidelines, and (4) requiring RSM employees to comply with M&P’sthe Attest Firms’ independence and relationship policies (including M&P’sthe Attest Firms’ independence compliance questionnaire procedures). We believe these policies, procedures and controls are adequate, although there can be no assurances they will ensureresult in compliance with applicable independence rules and requirements. Any
noncompliance could cause M&Pthe Attest Firms to lose the ability to perform audits of financial statements filed withfor firms subject to regulation by the SEC.
See discussion in “Risk Factors” for additional information.
INVESTMENT SERVICES
GENERAL
HRBFA is a registered broker-dealer with the SEC and is a member of the New York Stock Exchange (“NYSE”)(NYSE), other national securities exchanges, Securities Investor Protection Corporation (“SIPC”)(SIPC), and the National Association of Securities Dealers, Inc. (“NASD”)(NASD). HRBFA is also a registered investment advisor.
The integration of investment advice with our tax client base allows us to leverage an already established relationship. In the past twothree years, new service offerings have allowed us to shift our focus from a transaction-based client relationship to a more advice-based focus.
FINANCIAL SERVICES OFFERINGS ... – We offer a full range of financial services, including financialinvestment planning, college savings products, flexible brokerage accounts with cash management features, professionally managed accounts and a comprehensive line of insurance annuity products. Clients may also open professionally managed accounts.
As previously discussed in “Tax Services,” we offer our tax clients the opportunity to open an Express IRA through HRBFA as a part of the tax return preparation process. Clients opened approximately 106,50067,000 Express IRAs during tax season 2006, approximately 106,500 in 2005 and approximately 145,400 in 2004 and approximately 105,400 in 2003.2004.
We act as a dealer in fixed income marketssecurities including corporate and municipal bonds, various U.S. Government and U.S. Government Agency securities and certificates of deposit.
CUSTOMER ACTIVITY – Customer trades in fiscal year 2006 totaled approximately 1.0 million, compared to approximately 0.9 million in 2005 and approximately 1.0 million in 2004. Average revenue per trade was $119.11 in fiscal year 2006, compared to $123.33 in 2005 and $119.36 in 2004. We had 418,162 traditional brokerage accounts at April 30, 2006, compared to 431,749 at 2005 and 463,736 at 2004. Assets under administration totaled $31.8 billion, $27.8 billion and $26.7 billion at April 30, 2006, 2005 and 2004, respectively.
FINANCIAL ADVISORS ... – Key to our future success is retentionare retaining and recruiting productive financial advisors. One of our key initiatives in fiscal year 20052006 was to build revenues through the addition of financialby attracting and retaining productive advisors.
During fiscal years 2006, 2005 and 2004, we added 193, 258 and 255 advisors, respectively. These additions were offset by attrition of 257, 233 and 230 advisors, respectively. Our overall retention rate for fiscal year 20052006 was approximately 77%75%, essentially flat with the prior year. The retention rate for our higher-producing advisors was approximately 92%87%, down slightly from 93%92% in 2004.2005. Advisor productivity by recruitment class is as follows:
| (in 000s) | |||||||||||
| Revenue | Total Production | ||||||||||
| Per Advisor | Revenues | ||||||||||
Fiscal year 2005 ... | |||||||||||
| Pre-2003 class | $ | 230 | $ | 121,342 | |||||||
| 2003 recruits | 114 | 16,416 | |||||||||
| 2004 recruits | 98 | 19,941 | |||||||||
| 2005 recruits | 65 | 8,203 | |||||||||
Fiscal year 2004 ... | |||||||||||
| Pre-2003 class | $ | 216 | $ | 135,128 | |||||||
| 2003 recruits | 84 | 17,717 | |||||||||
| 2004 recruits | 61 | 7,664 | |||||||||
(in 000s)
| Revenue | Total Production | |||||||
| Per Advisor | Revenues | |||||||
FISCAL YEAR 2006— | ||||||||
| Pre-2004 class | $ | 250 | $ | 137,212 | ||||
| 2004 recruits | 157 | 19,579 | ||||||
| 2005 recruits | 109 | 19,942 | ||||||
| 2006 recruits | 111 | 13,741 | ||||||
FISCAL YEAR 2005— | ||||||||
| Pre-2003 class | $ | 230 | $ | 121,342 | ||||
| 2003 recruits | 114 | 16,416 | ||||||
| 2004 recruits | 98 | 19,941 | ||||||
| 2005 recruits | 65 | 8,203 | ||||||
FISCAL YEAR 2004— | ||||||||
| Pre-2003 class | $ | 216 | $ | 135,128 | ||||
| 2003 recruits | 84 | 17,717 | ||||||
| 2004 recruits | 61 | 7,664 | ||||||
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Financial advisors generally reach full productivity levels equal to those achieved at their prior firm approximately 24 to 36 months after they join our company.
PARTNERING WITH TAX PROFESSIONALS ... – The H&R Block Preferred Partner ProgramsmSM facilitates strategic, referral-based partnerships between tax professionals and financial advisors. The program includes the Licensed Referral Tax Professional (“LRTP”)(LRTP) program and new for fiscal year 2005, a non-licensed option, which allows non-licensed tax professionals to gain additional rewards and recognition when making qualified client referrals to financial advisor partners. The LRTP program helps tax professionals become licensed to sellobtain a securities license, teaming them with a financial advisor and providing a commission to the LRTP for business referred to Investment Services.
As of April 30, 2005,2006, our Preferred Partner Program had 9,552 active tax partners, of which 705 were licensed. We had 6,442 active tax partners, of which 686 were licensed. We had 461 licensed tax partners at the end of fiscal year 2004.2005. As a result of this initiative, we added 18,164more than 17,000 new customer accounts and assets totaling $573.0$764.3 million during the current fiscal year.year 2006. We willexpect to continue to increase the number of tax partners in the coming year.
INTEGRATED ONLINE SERVICES ... – We have an online investment center on our website atwww.hrblock.com.www.hrblock.com. Online users have the opportunity to open accounts, obtain research, create investment plans, buy and sell securities, and view the status of their accounts.
OFFICE LOCATIONS ... – HRBFA is authorized to do business as a broker-dealer in all 50 states, the District of Columbia and Puerto Rico. At the end of fiscal year 2005,2006, we operated 257219 branch offices, compared to approximately 358257 offices in 20042005 and 600358 in 2003.2004. The reduced number of branch offices is primarily due to the evolution of our tax-partnering program, in which now locates financial advisors are located in retail tax offices.offices, and the consolidation of smaller branches. At April 30, 2005,2006, we had 9473 offices co-located with retail tax and mortgage offices. We believe the existence of these locations contributes to our growth and client satisfaction.
COMPETITIVE CONDITIONS ... – HRBFA competes directly with a broad range of companies seeking to attract consumer financial assets, including full-service brokerage firms, discount and online brokerage firms, mutual fund companies, investment banking firms, commercial and savings banks, insurance companies and others. The financial services industry has become considerably more concentrated as numerous securities firms have been acquired by or merged into other firms. Some of these competitors have greater financial resources than HRBFA and offer additional financial services. In addition, we expect competition from domestic and international commercial banks and larger securities firms to continue to increase as a result of legislative and regulatory initiatives in the U.S., including the passage of the Gramm-Leach-Bliley Act in November 1999 and the implementation of the U.S.A. Patriot Act in April 2002. These initiatives strive to remove or relieve certain restrictions on mergers between commercial banks and other types of financial services providers and extend privacy provisions and anti-money laundering procedures across the financial services industry.
Discount brokerage firms and online-only financial services providers compete vigorously with HRBFA with respect to commission charges. Some full-commission brokerage firms also offer greater product breadth, discounted commissions and more robust online services to selected retail brokerage customers. Additionally, some competitors in both the full-commission and discount brokerage industries have substantially increased their spending on advertising and direct solicitation of customers.
Competition in the online trading business has become similarly intense as recent expansion and customer acceptance of conducting financial transactions online has attracted new brokerage firms to the market.
We compete based on expertise and integration with our tax services relationships, quality of service, breadth of services offered, prices, accessibility through delivery channels and technological innovation and expertise and integration with our tax services relationships.innovation.
SEASONALITY OF BUSINESS ... – The Investment Services segment does not, as a whole, experience significant seasonal fluctuations. The securities business is cyclical, however, and directly affected by national and global economic and political conditions, trends in business and finance and changes in the conditions of the securities markets in which our clients invest.invest, as well as fluctuating interest rates.
GOVERNMENT REGULATION ... – The securities industry is subject to extensive regulation, covering all aspects of the securities business, including registration of our offices and personnel, sales methods, the acceptance and execution of customer orders, the handling of customer funds and securities, trading practices, capital structure, record keeping policies and practices, margin lending, execution and settlement of transactions, the conduct of directors, officers and employees, and the supervision of employees. The various governmental authorities and industry self-regulatory organizations that have supervisory and regulatory jurisdiction over us generally have broad enforcement powers to censure, fine, issue cease-and-desist orders or suspend or expel a broker-dealer or any of its officers or employees who violate applicable laws or regulations.
The SEC is the federal agency responsible for the administration of the federal securities laws. The SEC has delegated much of the regulation of broker-dealers to self-regulatory organizations, principally the NASD, Inc., Municipal
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Securities Rulemaking Board and the NYSE, which has been designated as HRBFA’s primary regulator. These self-regulatory organizations adopt rules, subject to SEC approval, governing the industry and conduct periodic examinations of HRBFA’s brokerage operations and clearing activities. Securities firms are also subject to regulation by state securities administrators in states in which they conduct business.
As a registered broker-dealer, HRBFA is subject to the Net Capital Rule (Rule 15c3-1) promulgated by the SEC and adopted through incorporation by reference in NYSE Rule 325. The Rule, which specifies minimum net capital requirements for registered brokers and dealers, is designed to measure the financial soundness and liquidity of a broker-dealer and requires at least a minimum portion of its assets be kept in liquid form. Additional discussion of this requirement and HRBFA’s calculation of net capital is located in Item 7, under “Capital Resources and Liquidity by Segment.”
See discussion in “Risk Factors” for additional information.
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SERVICE MARKS, TRADEMARKS AND PATENTS ...
–
We have made a practice of selling our services and products under service marks and trademarks and of obtaining protection for these by all available means. Our service marks and trademarks are protected by registration in the U.S. and other countries where our services and products are marketed. We consider these service marks and trademarks, in the aggregate, to be of material importance to our business, particularly our business segments providing services and products under the “H&R Block” brand.
We have made a practice of selling our services and products under service marks and trademarks and of obtaining protection for these by all available means. Our service marks and trademarks are protected by registration in the U.S. and other countries where our services and products are marketed. We consider these service marks and trademarks, in the aggregate, to be of material importance to our business, particularly our business segments providing services and products under the “H&R Block” brand.
We have no registered patents that are material to our business.
EMPLOYEES ...
–
We have approximately13,40016,000 regular full-time employees. The highest number of persons we employed during the fiscal year ended April 30, 2005,2006, including seasonal employees, was approximately 133,800.134,500.
We have approximately
AVAILABILITY OF REPORTS AND OTHER INFORMATION ...
–
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website atwww.hrblock.comas soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website atwww.hrblock.comas soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC.
Copies of the following corporate governance documents are posted on our website: (1) The Amended and Restated Articles of Incorporation of H&R Block, Inc., (2) The Amended and Restated Bylaws of H&R Block, Inc., (3) The H&R Block, Inc. Corporate Governance Guidelines, (4) the H&R Block, Inc. Code of Business Ethics and Conduct, (5) the H&R Block, Inc. Audit Committee Charter, (6) the H&R Block, Inc. Governance and Nominating Committee Charter, and (7) the H&R Block, Inc. Compensation Committee Charter. If you would like a printed copy of any of these corporate governance documents, please send your request to the Office of the Secretary, H&R Block, Inc., 4400 Main Street, Kansas City, Missouri 64111.
Information contained on our website does not constitute any part of this report.
In this report, and from time to time throughout the year, we share our expectations for the Company’s future performance. The following explains the critical risk factors impacting our business and reasons actual results may differ from our expectations. This discussion does not intend to be a comprehensive list and there may be other risks and factors that may have an effect on our business.
LIQUIDITY AND CAPITAL – We use capital primarily to fund working capital requirements, pay dividends, repurchase shares of our common stock and acquire businesses. We are dependent on the use of our off-balance sheet arrangements to fund our daily non-prime originations and the secondary market to securitize and sell mortgage loans and residual interests. See Item 7, under “Off-Balance Sheet Financing Arrangements.” We are also dependent on commercial paper issuances and/or bank lines to fund RAL participations and seasonal working capital needs. A disruption in such markets could adversely affect our access to these funds. To meet our future financing needs, we may issue additional debt or equity securities.
LITIGATION – We are involved in lawsuits in the normal course of our business related to RALs, our Peace of Mind guarantee program, electronic filing of tax returns, Express IRAs, losses incurred by customers in their investment accounts, mortgage lending activities and other matters. Adverse outcomes related to litigation could result in substantial damages and could adversely affect our results of operations. Negative public opinion can also result from our actual or alleged conduct in such claims, possibly damaging our reputation and adversely affecting the market price of our stock. See Item 3, “Legal Proceedings” for additional information.
PRIVACY OF CLIENT INFORMATION – We manage highly sensitive client information in all of our operating segments, which is regulated by law. Problems with the safeguarding and proper use of this information could result in regulatory actions and negative publicity, which could adversely affect our reputation and results of operations.
INTERNAL CONTROL CERTIFICATION – We have documented and tested our internal control procedures in accordance with various SEC rules governing Section 404 of the Sarbanes-Oxley Act (SOX 404). SOX 404 requires us to assess the effectiveness of our internal controls over financial reporting annually, and obtain an opinion on the effectiveness of this internal control from our Independent Registered Public Accounting Firm. We may
14
encounter problems or delays in completing the review and evaluation, the implementation of improvements and the receipt of an attestation from our independent auditors. Additionally, management’s assessment of our internal controls over financial reporting may identify deficiencies that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Should we, or our independent auditors, determine in future periods that we have a material weaknesses in our internal controls over financial reporting, our results of operations or financial condition may be adversely affected and the price of our common stock may decline.
OPERATIONAL RISK – There is a risk of loss resulting from inadequate or failed processes or systems, theft or fraud. These can occur in many forms including, among others, errors, business interruptions, inappropriate behavior of or misconduct by our employees or those contracted to perform services for us, and vendors that do not perform in accordance with their contractual agreements. These events can potentially result in financial losses or other damages. We rely on internal and external information and technological systems to manage our operations and are exposed to risk of loss resulting from breaches in the security, or other failures of these systems. Replacement of our major operational systems could have a significant impact on our ability to conduct our core business operations and increase our risk of loss resulting from disruptions of normal operating processes and procedures that may occur during the implementation of new information and transaction systems.
TAX SERVICES
COMPETITIVE POSITION – Increased competition for tax preparation clients in our retail offices, online and software channels could adversely affect our current market share and limit our ability to grow our client base. See clients served statistics included in Item 7, under “Tax Services.”
COMPETITIVE POSITION – Increased competition for tax preparation clients in our retail offices, online and software channels could adversely affect our current market share and limit our ability to grow our client base. See clients served statistics included in Item 7, under “Tax Services.”
REFUND ANTICIPATION LOANS – Changes in government regulation related to RALs could adversely affect our ability to offer RALs or our ability to purchase participation interests. Changes in IRS practices could adversely affect our ability to use the IRS debt indicator to limit our bad debt exposure. Changes in any of these, as well as possible litigation related to RALs, may adversely affect our results of operations. See discussion of RAL litigation in Item 3, “Legal Proceedings.”
MORTGAGE SERVICES
COMPETITIVE POSITION – The majority of our mortgage loan applications are submitted through a network of brokers who have relationships with many other mortgage lenders. Unfavorable changes in our pricing, service or other factors could result in a decline in our mortgage origination volume. A decline in our servicer ratings could adversely affect our pricing and origination volume. Increased competition among mortgage lenders can also result in a decline in coupon rates offered to our borrowers, which in turn lowers margins and could adversely affect our gains on sales of mortgage loans.
COMPETITIVE POSITION – The majority of our mortgage loan applications are submitted through a network of brokers who have relationships with many other mortgage lenders. Unfavorable changes in our pricing, service or other factors could result in a decline in our mortgage origination volume. A decline in our servicer ratings could adversely affect our pricing and origination volume. Increased competition among mortgage lenders can also result in a decline in coupon rates offered to our borrowers, which in turn lowers margins and could adversely affect our gains on sales of mortgage loans.
MARKET RISKS – Our day-to-day operating activities of originating and selling mortgage loans have many aspects of interest rate risk. Additionally, the valuation of our retained residual interests and mortgage servicing rights includes many estimates and assumptions made by management surrounding interest rates, prepayment speeds and credit losses. Variation in interest rates or the factors underlying our assumptions could affect our results of operations. See Item 7A, under “Mortgage Services,” for discussion of interest rate risk, and Item 7, under “Critical Accounting Policies,” for discussion of our valuation methodology.
LEGISLATION AND REGULATION – Several states and cities are considering or have passed laws, regulations or ordinances aimed at curbing predatory lending and servicing practices. The federal government is also considering legislative and regulatory proposals in this regard. In general, these proposals involve lowering the existing federal HOEPA thresholds for defining a “high-cost” loan and establishing enhanced protections and remedies for borrowers who receive such loans. If unfavorable laws and regulations are passed, it could restrict our ability to originate loans. If rating agencies refuse to rate our loans, loan buyers may not want to purchase loans labeled as “high-cost,” and it could restrict our ability to sell our loans in the secondary market. Accordingly, all of these items could adversely affect our results of operations.
In 2002, the Federal Reserve Board adopted changes to Regulation C promulgated under the HMDA. Among other things, the new regulations require lenders to report pricing data on loans with annual percentage rates that exceed the yield on treasury bills with comparable maturities by 3%. The expanded reporting was effective in 2004 for reports filed in 2005. We anticipate that a majority of our loans would be subject to the expanded reporting requirements. The expanded reporting does not provide for additional loan information such as credit risk, debt-to-income ratio, loan-to-value ratio, documentation level or other salient loan features. However, reported information may lead to increased litigation as the information could be misinterpreted by third parties and could adversely affect our results of operations.
COUNTERPARTY CREDIT RISK – Derivative instruments involve counterparty credit risk, which is the risk that a counterparty may fail to perform on its contractual obligations. We manage this risk through the use of a policy that includes
15
credit standard guidelines, counterparty diversification, monitoring of counterparty financial condition, use of master netting agreements with counterparties, and exposure limits based on counterparty credit, exposure amount and management risk tolerance. The policy is reviewed on an annual basis and as conditions warrant. See Item 7A, under “Mortgage Services,” and Item 8, note 8 to our consolidated financial statements for discussion of our derivative instruments.
REAL ESTATE MARKET – Our residual interests and beneficial interest in Trusts are secured by mortgage loans, which are in turn secured by residential real estate. Any material decline in real estate values would likely result in higher delinquencies, defaults and foreclosures. Additionally, a significant portion of the mortgage loans we originate or service is secured by properties in California. A decline in the economy or the residential real estate market values, or the occurrence of a natural disaster not covered by standard homeowners’ insurance policies, such as an earthquake, hurricane or wildfire, could decrease the value of mortgaged properties in California. Any sustained period of increased delinquencies, foreclosures or losses could harm our ability to originate and sell loans, the prices we receive on our loans, or the values of our mortgage servicing rights and residual interests in securitizations, which could adversely affect our financial condition and results of operations.
BUSINESS SERVICES
ALTERNATIVE PRACTICE STRUCTURE WITH ATTEST FIRMS – Our relationship with the Attest Firms requires us to comply with applicable regulations regarding the practice of public accounting and auditor independence rules and requirements. In addition, our relationship with the Attest Firms closely links our RSM McGladrey brand with the Attest Firms. If the Attest Firms were to encounter regulatory or independence issues resulting from their relationship with us or if significant litigation arose involving the Attest Firms or their services which implicated RSM McGladrey, our brand reputation and our ability to realize the mutual benefits of our relationship, such as the ability to attract and retain quality professionals, could be impaired.
ALTERNATIVE PRACTICE STRUCTURE WITH ATTEST FIRMS – Our relationship with the Attest Firms requires us to comply with applicable regulations regarding the practice of public accounting and auditor independence rules and requirements. In addition, our relationship with the Attest Firms closely links our RSM McGladrey brand with the Attest Firms. If the Attest Firms were to encounter regulatory or independence issues resulting from their relationship with us or if significant litigation arose involving the Attest Firms or their services which implicated RSM McGladrey, our brand reputation and our ability to realize the mutual benefits of our relationship, such as the ability to attract and retain quality professionals, could be impaired.
INTEGRATION OF AMERICAN EXPRESS TAX AND BUSINESS SERVICES – The integration of American Express Tax and Business Services is proceeding according to plan. While we expect a successful integration, there is the potential that it could be delayed or otherwise impacted, which could adversely affect our financial condition and results of operations.
INVESTMENT SERVICES
REGULATORY ENVIRONMENT – The broker-dealer industry continues to come under increased scrutiny by federal and state regulators and self-regulatory organizations and, as a result, more focus has been placed on compliance issues. If we do not comply with these regulations, it could result in regulatory actions and negative publicity, which could adversely affect our results of operations and our ability to recruit and retain qualified advisors. Negative public opinion about our industry could damage our reputation even if we are in compliance with such regulations.
REGULATORY ENVIRONMENT – The broker-dealer industry continues to come under increased scrutiny by federal and state regulators and self-regulatory organizations and, as a result, more focus has been placed on compliance issues. If we do not comply with these regulations, it could result in regulatory actions and negative publicity, which could adversely affect our results of operations and our ability to recruit and retain qualified advisors. Negative public opinion about our industry could damage our reputation even if we are in compliance with such regulations.
INTEGRATION INTO THE H&R BLOCK BRAND – We are working to foster an advice-based relationship with our tax clients through our retail tax office network. This advice-based relationship is key to the integration of Investment Services into the H&R Block brand and deepening our current client relationships. If we are unable to successfully integrate, it may significantly impact our ability to differentiate our business from other investment service providers and grow our client base.
RECRUITING AND RETENTION OF FINANCIAL ADVISORS – Attracting and retaining experienced financial advisors is extremely competitive in the investment industry. Additionally, in this industry, clients tend to follow their advisors, regardless of their affiliated investment firm. The inability to recruit and retain qualified and productive advisors, may adversely affect our results of operations.
RECURRING OPERATING LOSSES – Continuing operating losses in our Investment Services segment may impact the valuation of goodwill and intangible assets. Such losses could also necessitate additional capital contributions to comply with regulatory requirements. The inability to operate this segment in a profitable manner may adversely affect our results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We own our corporate headquarters, which
Most of our tax offices, except those in shared locations, are operated under leases throughout the U.S. Our Canadian executive offices are located in a leased office in Calgary, Alberta. Our Canadian tax offices are operated under leases throughout Canada.
Option One’s executive offices are located in leased offices in Irvine, California. Option One also leases offices for its loan origination and servicing centers and branch office operations
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throughout the U.S. HRBMC is headquartered in leased offices in Lake Forest,Irvine, California. Option One and HRBMC also leaseleases offices for theirits loan origination and servicing centers and branch office operations throughout the U.S.
The executive offices of HRBFA are located in leased offices in Detroit, Michigan. Branch offices are operated throughout the U.S., in a combination of leased and owned facilities.
RSM’s executive offices are located in leased offices in Bloomington, Minnesota. Its administrative offices are located in leased offices in Davenport, Iowa. RSM also leases office space throughout the U.S.
We began construction of new corporate headquarters during fiscal year 2005, which will allow us to consolidate the majority of our Kansas City-based personnel into one facility. The new building will be located in downtown Kansas City, Missouri and we expect it to be completed in fiscal year 2007.
All current leased and owned facilities are in good repair and adequate to meet our needs.
ITEM 3. LEGAL PROCEEDINGS
The information below should be read in conjunction with the information included in Item 8, note
RAL LITIGATION ... – We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). Plaintiffs in theThe RAL Cases have alleged,involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things, that disclosures in the RAL applications were inadequate, misleading and untimely; that the RAL interest rates were usurious and unconscionable; that we did not disclose that we would receive part of the finance charges paid by the customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract;contract, unjust enrichment;enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act;Act and unfair competition with respect to debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program. In many of the RAL Cases, the plaintiffs seek to proceed on behalf of a class of similarly situated RAL customers, and in certain instances the courts have allowed the cases to proceed as class actions. In other cases, courts have held that plaintiffs must pursue their claims on an individual basis, and may not proceed as a class action.
The amounts claimed in the RAL Cases have been very substantial in some instances.
We have successfully defended against numerous RAL Cases, although severalsome of the RAL Cases are still pending. Of the RAL Cases that are no longer pending, somewhich were dismissed on our motions for dismissal or summary judgment, and others were dismissed voluntarily by the plaintiffs after denial of class certification. Other cases werehave been settled, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”) and other settlements resulting in a combined pretax expense in fiscal year 2006 of $70.2 million (the “2006 Settlements”). The 2006 Settlements are described below.
On December 21, 2005, we entered into a settlement agreement regarding four RAL Cases entitledDeadra D. Cummins, et al.v. H&R Block,Inc. et al.;Mitchell v. H&R Block, Inc. et al.;Green v. H&R Block, Inc. et al.; andBecker v. H&R Block, Inc.(the “Cummins Settlement Agreement”). Pursuant to the Cummins Settlement Agreement, we will contribute a total of up to $62.5 million in cash for purposes of making payments to the settlement class, paying all attorneys’ fees and costs to class counsel and covering service awards to the representative plaintiffs. In addition, we paid costs for providing notice of the settlement to settlement class members. We recorded an additional reserve of $50.7 million related to this settlement in fiscal year 2006 to fully reserve for the settlement amount.
On April 19, 2006, we entered into a settlement agreement, subject to final court approval, regarding litigation entitledLynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et al.(the “Carnegie Settlement Agreement”). Pursuant to the Carnegie Settlement Agreement, we will contribute a total of $19.5 million in cash for purposes of making payments to the settlement class, paying all attorneys’ fees and costs to class counsel, incentive payment awards to plaintiff and all notice and administration costs. We recorded a reserve of $19.5 million related to this settlement in fiscal year 2006.
We believe we have meritorious defenses to the remaining RAL Cases and we intend to defend the remaining RAL Casesthem vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Likewise, there can be no assurances regarding the impact of the RAL Cases on our financial statements. We have accrued our best estimate of the probable loss related to the RAL Cases. The following is updated information regarding the pending RAL Cases that are attorney general actions or class actions or putative class actions:
Lynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et al.al., (formerly Joel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., Block Financial Corporation, et al.) Case No. 98 C 2178, United States District Court for the Northern District of Illinois, Eastern Division, instituted on April 18, 1998. In March 2004, the court either dismissed or decertified all of the plaintiffs’ claims other thanThis case is stayed and will be resolved as part of one count alleging violations of the racketeering and conspiracy provisions of the Racketeer Influenced and Corrupt Organizations Act. On May 9, 2005, the parties agreed to a settlement, subject to court approval. The settlement agreement provided for (i) the defendants to pay $110 million in cash and $250 million face value in freely transferable rebate coupons and (ii) all persons who applied for and obtained a RAL through an H&R Block office or certain lenders from January 1, 1987 through April 29, 2005 (the “Carnegie Settlement Class”) to release all claims against us regarding RALs or certain services provided in
17 2005. We intend to continue defending the case vigorously, but there are no assurances as to its outcome.
Joyce Green, et al. v. H&R Block, Inc., Block Financial Corporation, et al., Case No. 97195023, in the Circuit Court for Baltimore City, Maryland, instituted on July 14, 1997. This1997;Levon and Geral Mitchell, et al. v. H&R Block, Inc. and Ruth Wren,Case No. CV-95-2067, in the Circuit Court of Mobile County, Alabama, instituted on June 13, 1995; andLynn Becker v. H&R Block, Inc.,Case No. CV-2004-03-1680 in the Court of Common Pleas, Summit County, Ohio, Instituted on April 15, 2004. These cases are stayed and will be resolved as part of the Cummins Settlement Agreement.
Sandra J. Basile, et al v. H&R Block, Inc., et al,April Term 1992 Civil Action No. 3246 in the Court of Common Pleas, First Judicial District Court of Pennsylvania, Philadelphia County, instituted on April 23, 1993. The court decertified the class on December 31, 2003. The Pennsylvania appellate court subsequently reversed the trial court’s decertification decision. We are seeking review of the appellate court’s decision by the Pennsylvania Supreme Court.
The People of California v. H&R Block, Inc., H&R Block Services, Inc., H&R Block Enterprises, Inc., H&R Block Tax Services, Inc., Block Financial Corporation, HRB Royalty, Inc. and Does 1 through 50, Case No. C 06 2058 SC, in the United States District Court for the Northern District of California, instituted on February 15, 2006 (alleging, among other things, untrue, misleading or deceptive statements in marketing RALs and unfair competition with respect to debt collection activities; seeks equitable relief, civil penalties and restitution). The case was removed to federal court on March 17, 2006, and a motion was filed to add HSBC as a necessary party to the case. The California attorney general is awaiting trial. No trial date has been set.seeking to remand the case to state court.
PEACE OF MIND LITIGATION ... –Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al.al., Civil Action 2003L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2003,2002, that was granted class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POMPeace of Mind (POM) program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (i) statutory fraud by selling insurance without a license, (ii) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (iii) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (i) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (ii) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (iii) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama are excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated or associated with H&R Block Tax Services, Inc., and that sold or sells the POM product. The trial court subsequently denied the defendants’ motion to certify class certification issues for interlocutory appeal. Discovery is proceeding. No trial date has been set.
There is one other putative class action pending against us in Texas that involves the Peace of MindPOM guarantee. This case is being tried before the same judge that presided over the Texas RAL Settlement, and involves the same plaintiffsplaintiffs’ attorneys that are involved in the Marshall litigation in Illinois, and substantiallycontains similar allegations. No class has been certified in this case.
We believe the claims in the POM action are without merit, and we intend to defend them vigorously. The amounts claimed in the POM actions are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate. Likewise, there can be no assurances regarding the impact of these actions on our consolidated financial statements.
EXPRESS IRA LITIGATION – On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York entitledThe People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc.The complaint alleges fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product. The complaint seeks equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. A number of civil actions were subsequently filed against us concerning the matter. We intend to defend these cases vigorously, but there are no assurances as to their outcome.
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SECURITIES AND SHAREHOLDER DERIVATIVE LITIGATION – Over a period of several weeks beginning on March 16, 2006, eight shareholder derivative actions were initiated against certain of the Company’s current and former directors and officers (two of which were subsequently dismissed voluntarily by the plaintiffs). These cases were purportedly brought on behalf of the Company, which is named as a “nominal defendant.” These cases generally involve allegations of breach of fiduciary duty, abuse of control, gross mismanagement, waste and unjust enrichment pertaining to (i) the Company’s restatement of financial results due to errors in determining the Company’s state effective income tax rate and (ii) certain of the Company’s products and other business activities. We intend to defend these cases vigorously, but there are no assurances as to their outcome. The shareholder derivative cases that currently have not been dismissed areHibbard v. H&R Block, Inc., et al.,in the United States District Court for the Western District of Missouri, Case No. 5:06-cv-06059-RED (instituted on May 16, 2006);Gottlieb v. H&R Block, et al.,in the Circuit Court of Jackson County, Missouri, Case No. 0616-CV-14109 (instituted on June 5, 2006);Lebowitz v. H&R Block, et al.,,in the Circuit Court of Jackson County, Missouri, Case No. 0616-CV-14124 (instituted on June 5, 2006);Staehr v. H&R Block, Inc., et al.,in the United States District Court for the Western District of Missouri, Case No. 4:06-cv-00284-GAF (instituted on April 5, 2006);Momentum Partners v. H&R Block, et al.,in the United States District Court for the Western District of Missouri, Case No. 06-cv-00465-SWH (instituted on June 8, 2006); andIron Workers Local 16 Pension Fund v. H&R Block, et al.,in the United States District Court for the Western District of Missouri, Case No. 06-cv-00466-ODS (instituted on June 8, 2006).
In addition to the shareholder derivative actions, five putative class actions alleging violations of certain securities laws were filed beginning in March 2006 (two of which were subsequently dismissed by the plaintiffs). These actions allege, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of the Company’s operations. The actions seek unspecified damages and equitable relief. We intend to defend these cases vigorously, but there are no assurances as to their outcome. The cases that have not been dismissed areNettie v. H&R Block, Inc. and Mark A. Ernstin the United States District Court in the Western District of Missouri, Case No. 06-0235-CV-W-ODS (instituted on March 17, 2006);Winters v. H&R Block, Inc., et al.,in the United States District Court in the Western District of Missouri, Case No. 04:06-CV-00243-NKL (instituted on March 20, 2006);New Jersey Carpenters Pension Fund v. H&R Block, Inc., et al.,in the United States District Court in the Southern District of New York, Case No. 06-CV-2204-KMK (instituted on March 21, 2006); andKadagian v. H&R Block, Inc., et al.,in the United States District Court in the Southern District of New York, Case No. 06-CV-2306-KMK (instituted on March 24, 2006).
OTHER CLAIMS AND LITIGATION ... – As reported in a current report on Form 8-K dated November 8, 2004,previously, the NASD brought charges against HRBFA regarding the sale by HRBFA of
Enron debentures in 2001. A hearing for this matter is scheduled forcommenced in May 2006. Two private civil actions subsequently were filed against HRBFA concerning2006 and was recessed until the matter raised in the NASD’s charges. Bothfall of these private actions subsequently were dismissed without prejudice, although one of the actions has since been refiled.2006. We intend to defend the NASD charges vigorously, although there can be no assurances regarding the outcome and resolution of the matter.
As part of an industry-wide review, the IRS is investigating tax-planning strategies that certain RSM clients utilized during fiscal years 2000 through 2003. Specifically, the IRS is examining these strategies to determine whether RSM complied with tax shelter registrationreporting and listing regulations and whether such strategies were appropriate.abusive as defined by the IRS. If the IRS were to determine that theseRSM did not comply with the tax shelter reporting and listing regulations, it might assess fines or penalties against RSM. Moreover, if the IRS were to determine that the tax planning strategies were inappropriate, clients that utilized the strategies could face penalties and interest for underpayment of taxes. Some of these clients are seeking or may attempt to seek recovery from RSM. While thereThere can be no assurance regarding the outcome of this matter, we do not believe its resolution will have a material adverse effect on our operations or consolidated financial statements.
We have from time to time been party to claims and lawsuits not discussed herein arising out of our business operations. These claims and lawsuits include actions by state attorneys general, individual plaintiffs, as well asand cases in which plaintiffs seek to represent a class of similarly situated customers. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. Some of these claims and lawsuits pertain to RALs, the electronic filing of customers’ income tax returns, and the POM guarantee program and our Express IRA program. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously, although there is no assurance as to their outcome.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (“Other Claims”)(Other Claims) concerning investment products, the preparation of customers’ income tax returns, the fees
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charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage foreclosures, other aspects of the mortgage business, intellectual property disputes, employment matters and contract disputes. We believe we have meritorious defenses to each of the Other Claims, and we are defending or intend to defend, them vigorously. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material adverse effect on our consolidated financial statements.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2005. Information regarding executive officers is contained in Item 10 of this report.
2006.
PART II
| ITEM 5. | MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
H&R Block’s common stock is traded principally on the NYSE and is also traded on the Pacific Exchange. The information called for by this item with respect to H&R Block’s common stock appears in Item 8, note 2120 to our consolidated financial statements. The remaining information called for by this item relating to “Securities Authorized for Issuance under Equity Compensation Plans” is reported in Item 8, note 1312 to our consolidated financial statements. On July 5, 2005,June 15, 2006, there were 30,90924,935 shareholders of record and the closing stock price on the NYSE was $58.73$23.50 per share.
A summary of our purchases of H&R Block common stock during the fourth quarter of fiscal year 20052006 is as follows:
| (shares in 000s) | ||||||||||||||||||
| Total Number of | Maximum Number | |||||||||||||||||
| Total | Average | Shares Purchased as | of Shares that May Be | |||||||||||||||
| Number of Shares | Price Paid | Part of Publicly Announced | Purchased Under the | |||||||||||||||
| Purchased(2) | per Share | Plans or Programs(1) | Plans or Programs(1) | |||||||||||||||
| February 1 – February 28 | 1 | $ | 50.82 | – | 15,104 | |||||||||||||
| March 1 – March 31 | 2 | $ | 51.87 | – | 15,104 | |||||||||||||
| April 1 – April 30 | 1 | $ | 50.70 | – | 15,104 | |||||||||||||
(shares in 000s)
| Average | Total Number of Shares | Maximum Number of | ||||||||||||||
| Total Number of | Price Paid | Purchased as Part of Publicly | Shares that May Be Purchased | |||||||||||||
| Shares Purchased (2) | per Share | Announced Plans or Programs(1) | Under the Plans or Programs(1) | |||||||||||||
| February 1 – February 28 | 6 | $ | 24.09 | - | 10,494 | |||||||||||
| March 1 – March 31 | 1 | $ | 25.17 | - | 10,494 | |||||||||||
| April 1 – April 30 | 3 | $ | 22.05 | - | 10,494 | |||||||||||
| (1) | On June 9, 2004, our Board of Directors approved the | |
| (2) | All shares |
ITEM 6. SELECTED FINANCIAL DATA
We derived the selected
| (in 000s, except per share amounts) | |||||||||||||||||||||||
| Restated | Restated | Restated | Restated | ||||||||||||||||||||
| April 30, | 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||||
| Revenues | $ | 4,420,019 | $ | 4,247,880 | $ | 3,731,126 | $ | 3,311,943 | $ | 2,982,157 | |||||||||||||
| Net income before change in accounting principle | 635,857 | 715,608 | 477,615 | 441,287 | 278,211 | ||||||||||||||||||
| Net income | 635,857 | 709,249 | 477,615 | 441,287 | 282,625 | ||||||||||||||||||
| Basic earnings per share: | |||||||||||||||||||||||
| Net income before change in accounting principle | $ | 3.83 | $ | 4.04 | $ | 2.66 | $ | 2.41 | $ | 1.51 | |||||||||||||
| Net income | 3.83 | 4.01 | 2.66 | 2.41 | 1.54 | ||||||||||||||||||
| Diluted earnings per share: | |||||||||||||||||||||||
| Net income before change in accounting principle | $ | 3.77 | $ | 3.96 | $ | 2.59 | $ | 2.34 | $ | 1.50 | |||||||||||||
| Net income | 3.77 | 3.92 | 2.59 | 2.34 | 1.53 | ||||||||||||||||||
| Total assets | $ | 5,539,283 | $ | 5,232,732 | $ | 4,666,502 | $ | 4,396,731 | $ | 4,170,980 | |||||||||||||
| Long-term debt | 923,073 | 545,811 | 822,302 | 868,387 | 870,974 | ||||||||||||||||||
| Dividends per share | $ | .86 | $ | .78 | $ | .70 | $ | .63 | $ | .59 | |||||||||||||
amounts)
| April 30, | 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||||||
| Revenues | $ | 4,872,801 | $ | 4,420,019 | $ | 4,247,880 | $ | 3,731,126 | $ | 3,311,943 | ||||||||||
| Net income before change in accounting principle | 490,408 | 623,910 | 700,452 | 477,615 | 441,287 | |||||||||||||||
| Net income | 490,408 | 623,910 | 694,093 | 477,615 | 441,287 | |||||||||||||||
| Basic earnings per share: | ||||||||||||||||||||
| Net income before change in accounting principle | $ | 1.49 | $ | 1.88 | $ | 1.98 | $ | 1.33 | $ | 1.21 | ||||||||||
| Net income | 1.49 | 1.88 | 1.96 | 1.33 | 1.21 | |||||||||||||||
| Diluted earnings per share: | ||||||||||||||||||||
| Net income before change in accounting principle | $ | 1.47 | $ | 1.85 | $ | 1.94 | $ | 1.30 | $ | 1.17 | ||||||||||
| Net income | 1.47 | 1.85 | 1.92 | 1.30 | 1.17 | |||||||||||||||
| Total assets | $ | 5,989,135 | $ | 5,538,056 | $ | 5,233,827 | $ | 4,666,502 | $ | 4,396,731 | ||||||||||
| Long-term debt | 417,539 | 923,073 | 545,811 | 822,302 | 868,387 | |||||||||||||||
| Dividends per share | $ | 0.49 | $ | 0.43 | $ | 0.39 | $ | 0.35 | $ | 0.32 | ||||||||||
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We are a diversified company with subsidiaries delivering tax, investment, mortgage and business services and products. We are the only major company offering a full range of software, online and in-office tax preparation solutions, combined with personalized financial advice concerning retirement savings, home ownership and other opportunities to help clients build a better financial future.
We are a diversified company with subsidiaries delivering tax, investment, mortgage and business services and products. We are the only major company offering a full range of software, online and in-office tax preparation solutions, combined with personalized financial advice concerning retirement savings, home ownership and other opportunities to help clients build a better financial future.
Our key strategic priorities can be summarized as follows:
Tax Services – expand access to our services through improved distribution of our digital offerings and expanding our network of retail offices, continue to improve the quality of service we provide to our clients.
Mortgage Services – sustain market share while focusing on our cost structure to lower our cost of origination, distinguish our service quality, minimize risk and volatility in performance and optimize value from secondary markets.
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| • | ||
| Business Services | ||
| Investment Services |
| Consolidated Results of Operations | (in 000s, except per share amounts) | |||||||||||||
| Restated | Restated | |||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | |||||||||||
REVENUES ... | ||||||||||||||
| Tax Services | $ | 2,358,293 | $ | 2,191,177 | $ | 1,946,763 | ||||||||
| Mortgage Services | 1,246,018 | 1,323,709 | 1,150,080 | |||||||||||
| Business Services | 573,316 | 499,210 | 434,140 | |||||||||||
| Investment Services | 239,244 | 229,470 | 200,794 | |||||||||||
| Corporate | 3,148 | 4,314 | (651 | ) | ||||||||||
| $ | 4,420,019 | $ | 4,247,880 | $ | 3,731,126 | |||||||||
| PRETAX INCOME (LOSS) ... | ||||||||||||||
| Tax Services | $ | 663,518 | $ | 638,493 | $ | 556,703 | ||||||||
| Mortgage Services | 496,093 | 688,523 | 656,324 | |||||||||||
| Business Services | 29,871 | 19,312 | (16,033 | ) | ||||||||||
| Investment Services | (75,370 | ) | (75,614 | ) | (219,421 | ) | ||||||||
| Corporate | (96,397 | ) | (107,739 | ) | (122,009 | ) | ||||||||
| 1,017,715 | 1,162,975 | 855,564 | ||||||||||||
| Income taxes | 381,858 | 447,367 | 377,949 | |||||||||||
| Net income before change in accounting principle | 635,857 | 715,608 | 477,615 | |||||||||||
| Cumulative effect of change in accounting principle | – | (6,359 | ) | – | ||||||||||
| Net income | $ | 635,857 | $ | 709,249 | $ | 477,615 | ||||||||
| Basic earnings per share | $ | 3.83 | $ | 4.01 | $ | 2.66 | ||||||||
| Diluted earnings per share | 3.77 | 3.92 | 2.59 | |||||||||||
(in 000s, except per share amounts)
Consolidated Results of Operations
| Year ended April 30, | 2006 | 2005 | 2004 | |||||||||
REVENUES – | ||||||||||||
| Tax Services | $ | 2,451,806 | $ | 2,358,293 | $ | 2,191,177 | ||||||
| Mortgage Services | 1,247,138 | 1,246,018 | 1,323,709 | |||||||||
| Business Services | 877,259 | 573,316 | 499,210 | |||||||||
| Investment Services | 287,955 | 239,244 | 229,470 | |||||||||
| Corporate | 8,643 | 3,148 | 4,314 | |||||||||
| $ | 4,872,801 | $ | 4,420,019 | $ | 4,247,880 | |||||||
PRETAX INCOME (LOSS) – | ||||||||||||
| Tax Services | $ | 589,766 | $ | 663,518 | $ | 638,493 | ||||||
| Mortgage Services | 321,616 | 496,093 | 688,523 | |||||||||
| Business Services | 53,378 | 29,871 | 19,312 | |||||||||
| Investment Services | (32,835 | ) | (75,370 | ) | (75,614 | ) | ||||||
| Corporate | (104,532 | ) | (96,397 | ) | (107,739 | ) | ||||||
| 827,393 | 1,017,715 | 1,162,975 | ||||||||||
| Income taxes | 336,985 | 393,805 | 462,523 | |||||||||
| Net income before change in accounting principle | 490,408 | 623,910 | 700,452 | |||||||||
| Cumulative effect of change in accounting principle | - | - | (6,359 | ) | ||||||||
| Net income | $ | 490,408 | $ | 623,910 | $ | 694,093 | ||||||
| Basic earnings per share | $ | 1.49 | $ | 1.88 | $ | 1.96 | ||||||
| Diluted earnings per share | 1.47 | 1.85 | 1.92 | |||||||||
CRITICAL ACCOUNTING POLICIES – ...
We consider the policies discussed below to be critical to securing an understanding of our financial statements, as they require the use of significant judgment and estimation in order to measure, at a specific point in time, matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, we caution that future events rarely develop precisely as forecasted, and estimates routinely require adjustment and may require material adjustment.
REVENUE RECOGNITION – ...We have many different revenue sources, each governed by specific revenue recognition policies. Our revenue recognition policies can be found in Item 8, note 1 to our consolidated financial statements. Additional discussion of our recognition of gains on sales of mortgage assets follows.
GAINS ON SALES OF MORTGAGE ASSETS – ...We sell substantially all of the non-prime mortgage loans we originate to the Trusts, which are qualifying special purpose entities (“QSPEs”)(QSPEs), with servicing rights generally retained. Prime mortgage loans are sold in whole loan sales, servicing released, to third-party buyers. Gains on sales of mortgage assets are recognized when control of the assets is surrendered (when loans
are sold to the Trusts) and are based on the difference between cash proceeds and the allocated cost of the assets sold.sold, including any guarantees or recourse obligations. Other components of gain on sales of mortgage loans include gains or losses on derivatives, loan sale repurchase reserves and direct origination and acquisition expenses.
We determine the allocated cost of assets sold based on the relative fair values of cash proceeds, MSRs, any guarantee or recourse liabilities to be recorded at the date of sale and the beneficial interest in Trusts, which represents our residual interest in the ultimate expected outcome from the Trusts’ disposition of the loans.loans by the Trusts. The relative fair value of the MSRs and the beneficial interest in Trust is determined using discounted cash flow models, which require various management assumptions, limited by the ultimate expected outcome from the disposition of the loans by the Trusts (see discussion below in “Valuation of Residual Interests” and “Valuation of Mortgage Servicing Rights”). The following is an example of a hypothetical gain on sale calculation:
| (in 000s) | ||||||||
| Acquisition cost of underlying mortgage loans | $ | 1,000,000 | ||||||
| Fair values: | ||||||||
| Net proceeds | $ | 990,000 | ||||||
| Beneficial interest in Trusts | 20,000 | |||||||
| MSRs | 9,000 | |||||||
| $ | 1,019,000 | |||||||
| Computation of gain on sale: | ||||||||
| Net proceeds | $ | 990,000 | ||||||
| Less allocated cost ($990,000/$1,019,000 × $1,000,000) | 971,541 | |||||||
| Recorded gain on sale | $ | 18,459 | ||||||
| Recorded beneficial interest in Trusts ($20,000/$1,019,000 × $1,000,000) | $ | 19,627 | ||||||
| Recorded value of MSRs ($9,000/$1,019,000 × $1,000,000) | $ | 8,832 | ||||||
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| (in 000s) | ||||
| Acquisition cost of underlying mortgage loans | $ | 1,000,000 | ||
| Fair values: | ||||
| Net proceeds | $ | 995,000 | ||
| Beneficial interest in Trusts | 20,000 | |||
| MSRs | 7,000 | |||
| $ | 1,022,000 | |||
| Computation of gain on sale: | ||||
| Net proceeds | $ | 995,000 | ||
| Less allocated cost ($995,000 / $1,022,000 x $1,000,000) | 973,581 | |||
| Recorded gain on sale | $ | 21,419 | ||
| Recorded beneficial interest in Trusts ($20,000 / $1,022,000 x $1,000,000) | $ | 19,570 | ||
| Recorded value of MSRs ($7,000 / $1,022,000 x $1,000,000) | $ | 6,849 | ||
Variations in the assumptions we use affect the estimated fair values which would affectand the reported gains on sales. Gains on sales of mortgage loans totaled $575.4 million, $772.1 million $915.6 million and $792.1$915.6 million for fiscal years 2006, 2005 2004 and 2003,2004, respectively.
See discussion in “Off-Balance Sheet Financing Arrangements” related to the disposition of the loans by the Trusts and subsequent securitization by the Company.
VALUATION OF RESIDUAL INTERESTS – ...We use discounted cash flow models to determine the estimated fair values of our residual interests. We develop our assumptions for expected credit losses, prepayment speeds, discount rates and interest rates based on historical experience and third-party market sources. Variations in our assumptions could materially affect the estimated fair values, which may require us to record impairments or unrealized gains. In addition, variations will also affect the amount of residual interest accretion recorded on a monthly basis. ResidualAvailable-for-sale (AFS) residual interests valued at $205.9$159.1 million and $211.0$205.9 million were recorded as of April 30, 20052006 and 2004,2005, respectively. We recorded $95.9$35.3 million in net write-ups in other comprehensive income and $12.2$34.1 million in impairments in the income statement related to ourthese residual interests during fiscal year 20052006 as actual performance differed from our assumptions. See Item 8, note 1 to our consolidated financial statements for our methodology used in valuing residual interests. See Item 8, note 65 to our consolidated financial statements for current assumptions and a sensitivity analysis of those assumptions. See Item 7A for sensitivity analysis related to interest rates.
VALUATION OF MORTGAGE SERVICING RIGHTS – ...MSRs are carried at the lower of cost or fair value. We use discounted cash flow models to determine the estimated fair values of our MSRs. Fair values take into account the historical prepayment activity of the related loans and our estimates of the remaining future cash flows to be generated through servicing the underlying mortgage loans. Variations in our assumptions could materially affect the estimated fair values, which may require us to record impairments.
Prepayment speeds are somewhat correlated with the movement of market interest rates. As market interest rates decline there is a corresponding increase in actual and expected borrower prepayments as customers refinance existing mortgages under more favorable interest rate terms. This in turn reduces the anticipated cash flows associated with servicing resulting in a potential reduction, or impairment, to the fair value of the capitalized MSR. Prepayment rates are estimated based on historical experience and third-party market sources. Many non-prime loans have a prepayment penalty in place for the first two to three years, which has the effect of making prepayment speeds more predictable, regardless of market interest rate movements. If actual prepayment rates prove to be higher than the estimate made by management, impairment of the MSRs could occur.
MSRs valued at $166.6$272.5 million and $113.8$166.6 million were recorded as of April 30, 20052006 and 2004,2005, respectively. See Item 8, note 1 to our consolidated financial statements for our methodology used in stratifying and valuing MSRs. See Item 8, note 65 to our consolidated financial statements for current assumptions and a sensitivity analysis of those assumptions.
VALUATION OF GOODWILL – ...Our goodwill impairment analysis is based on a discounted cash flow approach and market comparables, when available. This analysis, at the reporting unit level, requires significant management judgment with respect to revenue and expense growth rates,forecasts, anticipated changes in working capital, and the selection and application of an appropriate discount rate. Changes in the projections or assumptions could materially affect fair values. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could increaseeffect our conclusions regarding the existence or decrease any impairment charge.amount of potential impairment.
Our goodwill balance was $1.1 billion as of April 30, 2006 and $1.0 billion as of April 30, 2005 and $993.5 million as of April 30, 2004.2005. No goodwill impairments were identified during fiscal years 2006, 2005 or 2004. In fiscal year 2003, a
LITIGATION – ...Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical experience in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” and related pronouncements. Therefore, we have recorded reserves related to certain legal matters for which we believe it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, we have concluded that
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a loss is only reasonably possible or remote and, therefore, no liability is recorded.
INCOME TAXES – ...We calculate our current and deferred tax provision for the fiscal year based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the applicable calendar year. Adjustments based on filed returns are recorded in the appropriate periods when identified. We file a consolidated federal tax return on a calendar year basis, generally in the second fiscal quarter of the subsequent year.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered taxable income in carry-back periods, historical and forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, and tax planning strategies in determining the need for a valuation allowance against our deferred tax assets. In the event we were to determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination. Likewise, if we later determine that it is more likely than not that the deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which may result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate on a quarterly basis. As discussed in Item 9A, “Controls and Procedures,” we reported a material weakness in our internal controls over accounting for income taxes as of April 30, 2005.
OTHER SIGNIFICANT ACCOUNTING POLICIES – ...Other significant accounting policies, not involving the same level of measurement uncertaintiesjudgment of uncertainty as those discussed above, are nevertheless important to an understanding of the financial statements. These policies may require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standard setters and regulators. Although no specific conclusions reached by these standard setters appear likely tomay cause a material change in our accounting policies, outcomes cannot be predicted with confidence. Also see Item 8, note 1 to our consolidated financial statements, which discusses accounting policies we have selected when there are acceptable alternatives.
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RESULTS OF OPERATIONS ...–
Our business is divided into four reportable segments: Tax Services, Mortgage Services, Business Services and Investment Services.
TAX SERVICES
This segment primarily consists of our income tax preparation businesses
| Tax Services – Operating Statistics | (in 000s, except average fee) | |||||||||||||||
| Year ended April 30, | 2005 | 2004(1) | ||||||||||||||
| 2003(1) | ||||||||||||||||
Clients served ... | ||||||||||||||||
| United States: | ||||||||||||||||
| Company-owned offices | 10,608 | 10,627 | 10,105 | |||||||||||||
| Franchise offices | 5,428 | 5,460 | 6,488 | |||||||||||||
| 16,036 | 16,087 | 16,593 | ||||||||||||||
| Digital tax solutions: | ||||||||||||||||
Software(2) | 1,804 | 2,027 | 1,963 | |||||||||||||
Online(3) | 1,213 | 1,207 | 920 | |||||||||||||
| 19,053 | 19,321 | 19,476 | ||||||||||||||
International(4) | 2,333 | 2,253 | 2,227 | |||||||||||||
| 21,386 | 21,574 | 21,703 | ||||||||||||||
| Average fee per client served (5) ... | ||||||||||||||||
| Company-owned offices | $ | 158.19 | $ | 146.34 | $ | 137.16 | ||||||||||
| Franchise offices | 135.98 | 127.91 | 118.05 | |||||||||||||
| $ | 150.67 | $ | 140.09 | $ | 129.69 | |||||||||||
RALs (6) ... | ||||||||||||||||
| Company-owned offices | 2,667 | 2,713 | 2,768 | |||||||||||||
| Franchise offices | 1,499 | 1,508 | 1,790 | |||||||||||||
| Digital tax solutions: | ||||||||||||||||
| Software | 2 | 5 | – | |||||||||||||
| Online | 32 | 57 | 75 | |||||||||||||
| 4,200 | 4,283 | 4,633 | ||||||||||||||
| Tax Services – Operating Statistics | (in 000s, except average fee) | |||||||||||
| Year Ended April 30, | 2006 | 2005(1) | 2004(1) | |||||||||
CLIENTS SERVED – | ||||||||||||
| United States: | ||||||||||||
| Company-owned operations | 10,359 | 10,608 | 10,627 | |||||||||
| Franchise operations | 5,373 | 5,428 | 5,460 | |||||||||
| 15,732 | 16,036 | 16,087 | ||||||||||
Digital tax solutions(2) | 3,721 | 3,017 | 3,234 | |||||||||
| 19,453 | 19,053 | 19,321 | ||||||||||
International(3) | 2,459 | 2,333 | 2,253 | |||||||||
| 21,912 | 21,386 | 21,574 | ||||||||||
GROSS AVERAGE FEE PER CLIENT SERVED(4) – | ||||||||||||
| Company-owned operations | $ | 169.58 | $ | 158.19 | $ | 146.34 | ||||||
| Franchise operations | 143.52 | 135.98 | 127.91 | |||||||||
| $ | 160.68 | $ | 150.67 | $ | 140.09 | |||||||
NET AVERAGE FEE PER CLIENT SERVED(5) – | ||||||||||||
| Company-owned operations | $ | 162.91 | $ | 153.53 | $ | 142.51 | ||||||
RALs(6) – | ||||||||||||
| Company-owned operations | 2,542 | 2,667 | 2,713 | |||||||||
| Franchise operations | 1,487 | 1,499 | 1,508 | |||||||||
| 4,029 | 4,166 | 4,221 | ||||||||||
| (1) | Company-owned and franchise data for fiscal years | |
| (2) | Includes TaxCut federal units | |
| In the current year, the end of the Canadian tax season was extended from April 30 to May 1, 2006. Clients served in our international operations in fiscal year 2006 includes approximately 41,400 returns in both company-owned and franchise offices which were accepted by the client on May 1, 2006. The revenues related to these returns will be recognized in fiscal year 2007. In the prior year, the end of the Canadian tax season was extended to May 2, 2005. Clients served in our international operations in fiscal year 2005 includes approximately 47,500 returns | ||
| Calculated as gross tax preparation and related fees divided by clients served (U.S. only). | ||
| (5) | Calculated as gross tax preparation and related fees, less discounts and coupons, divided by clients served (U.S. only). | |
| (6) | Data is for tax season (January 1 – April 30) only. |
| Tax Services – Financial Results | (in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Service revenues: | ||||||||||||
| Tax preparation and related fees | $ | 1,793,325 | $ | 1,718,867 | $ | 1,589,439 | ||||||
| Other services | 204,968 | 193,163 | 172,517 | |||||||||
| 1,998,293 | 1,912,030 | 1,761,956 | ||||||||||
| Royalties | 207,728 | 197,551 | 184,882 | |||||||||
| RAL participation fees | 177,852 | 182,784 | 168,375 | |||||||||
| Other | 67,933 | 65,928 | 75,964 | |||||||||
| Total revenues | 2,451,806 | 2,358,293 | 2,191,177 | |||||||||
| Cost of services: | ||||||||||||
| Compensation and benefits | 765,868 | 726,654 | 672,066 | |||||||||
| Occupancy | 317,030 | 281,772 | 255,516 | |||||||||
| Supplies | 52,894 | 47,703 | 40,792 | |||||||||
| Depreciation and amortization | 44,846 | 54,579 | 48,808 | |||||||||
| Bad debt | 31,927 | 33,046 | 27,328 | |||||||||
| Allocated shared services and other | 102,711 | 103,560 | 92,137 | |||||||||
| 1,315,276 | 1,247,314 | 1,136,647 | ||||||||||
| Provision for RAL litigation | 70,200 | - | - | |||||||||
| Other, selling, general and administrative | 476,564 | 447,461 | 416,037 | |||||||||
| Total expenses | 1,862,040 | 1,694,775 | 1,552,684 | |||||||||
| Pretax income | $ | 589,766 | $ | 663,518 | $ | 638,493 | ||||||
| Tax Services – Financial Results | (in 000s) | |||||||||||||||
| Restated | Restated | |||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
| Service revenues: | ||||||||||||||||
| Tax preparation and related fees | $ | 1,718,867 | $ | 1,589,439 | $ | 1,437,835 | ||||||||||
| Online tax services | 49,515 | 44,915 | 25,892 | |||||||||||||
| Other service revenues | 143,648 | 127,602 | 97,794 | |||||||||||||
| 1,912,030 | 1,761,956 | 1,561,521 | ||||||||||||||
| Royalties | 197,551 | 184,882 | 174,659 | |||||||||||||
| RAL participation fees | 182,784 | 168,375 | 896 | |||||||||||||
| RAL waiver fees | – | 6,548 | 138,242 | |||||||||||||
| Software sales | 44,419 | 43,823 | 39,314 | |||||||||||||
| Other | 21,509 | 25,593 | 32,131 | |||||||||||||
| Total revenues | 2,358,293 | 2,191,177 | 1,946,763 | |||||||||||||
| Cost of services: | ||||||||||||||||
| Compensation and benefits | 726,654 | 672,066 | 591,556 | |||||||||||||
| Occupancy | 281,772 | 255,516 | 225,045 | |||||||||||||
| Depreciation and amortization | 54,579 | 48,808 | 42,505 | |||||||||||||
| Supplies | 47,703 | 40,792 | 40,992 | |||||||||||||
| Bad debt | 33,046 | 27,328 | 32,653 | |||||||||||||
| Other | 103,560 | 92,137 | 125,653 | |||||||||||||
| 1,247,314 | 1,136,647 | 1,058,404 | ||||||||||||||
| Cost of software sales | 37,819 | 41,895 | 34,842 | |||||||||||||
| Selling, general and administrative | 409,642 | 374,142 | 296,814 | |||||||||||||
| Total expenses | 1,694,775 | 1,552,684 | 1,390,060 | |||||||||||||
| Pretax income | $ | 663,518 | $ | 638,493 | $ | 556,703 | ||||||||||
FISCAL 2006 COMPARED TO FISCAL 2005 –Tax Services’ revenues increased $93.5 million, or 4.0%, compared to the prior year. We opened more than 750 new offices, 550 of which were part of the expansion of our company-owned retail distribution network. This expansion contributed incremental revenues of $36.4 million and pretax losses of $8.5 million in fiscal year 2006.
Tax preparation and related fees from our retail offices increased $74.5 million, or 4.3%, for fiscal year 2006. This increase is primarily due to an increase of 6.1% in the net average fee per U.S. client served, partially offset by a decrease of 2.3% in U.S. clients served in company-owned offices. The decrease in clients served was partially due to a number of technology problems that severely hurt the start of our filing season coupled with increased competition due to competitors’ refund lending products. Our international operations contributed $18.1 million to the increase, resulting from a 5.4% increase in clients served.
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Revenue from our digital business increased 8.2%, primarily due to a 23.3% increase in clients served, partially offset by planned reductions in unit prices.
Royalty revenue increased $10.2 million, or 5.2%, due to a 5.5% increase in the gross average fee slightly offset by a 1.0% decline in clients served in franchise offices.
Revenues earned during fiscal year 2006 in connection with RAL participations decreased $4.9 million, or 2.7%, from fiscal year 2005. This decrease is primarily due to a decrease in the number of RALs, which resulted from increased competition for clients in the early months of the tax season.
Total expenses increased $167.3 million, or 9.9%, primarily due to $70.2 million of legal reserves and related litigation fees recorded in the current year. During the current year we entered into two settlement agreements. The first was a settlement agreement regarding four separate RAL cases covering 22 states. We also entered into a settlement agreement with the plaintiffs in another RAL case. See additional discussion below and in Item 8, note 17 to the consolidated financial statements.
Cost of services for the current year increased $68.0 million, or 5.4%, from the prior year. Our real estate expansion efforts have contributed to a total increase of $43.5 million across all cost of services categories. Compensation and benefits increased $39.2 million, or 5.4%, primarily due to an increase in staff needed for our new offices and the addition of costs related to our small business initiatives in the current year. Occupancy expenses increased $35.3 million, or 12.5%, primarily as a result of higher rent expenses, due to a 9.5% increase in company-owned offices under lease and a 7.3% increase in the average rent. Depreciation declined $9.7 million, or 17.8%, primarily due to decreased capital expenditures compared to the prior year.
Other, selling, general and administrative expenses increased $29.1 million, or 6.5%, primarily due to a $31.5 million increase in corporate shared services, $20.7 million of which was related to our marketing efforts. We also incurred $7.5 million in additional corporate wages and $7.1 million in additional legal costs in the current year. During the fourth quarter of fiscal year 2006, we revised our estimate for the provision for bad debt related to our participation interests in RALs. This change decreased our provision for bad debt $18.0 million during the fourth quarter of the current fiscal year. See additional discussion in Item 8, note 1 to the consolidated financial statements.
The pretax income for fiscal year 2006 decreased $73.8 million, or 11.1%, from 2005, primarily due to the impact of the current year RAL litigation.
FISCAL 2005 COMPARED TO FISCAL 2004 ...
–Tax Services’ revenues increased $167.1 million, or 7.6%, compared to the prior year. Fiscalfiscal year 2005 was the first year of a multi-year strategy to expand our retail distribution network, to increase client growth by providing more convenient access to our services and to react to increased competition in the tax preparation market.2004. In the U.S., we opened a net 1,252 new offices, 609 of which were part of the expansion of our company-owned retail distribution network. This expansion contributed incremental revenues of $24.9 million and pretax
losses of $18.9 million. Clients servedmillion in our U.S. company-owned offices declined 0.2% from the prior year.fiscal year 2005.
Tax preparation and related fees increased $129.4 million, or 8.1%. This increase is primarily due to an 8.1%a 7.7% increase in the net average fee per U.S. client served, resulting from increases in our pricing and the complexity of returns prepared. Clients served in our U.S. company-owned offices declined 0.2% from fiscal year 2004.
Other service revenues increased $16.0$20.6 million, or 12.6%12.0%, primarily as a result of additional revenues associated with RACs and Express IRAs.
Royalty revenues increased $12.7 million, or 6.9%, primarily due to a 6.3% increase in the gross average fee per client served at our franchise offices.
Revenues earned during the currentfiscal year 2005 in connection with RAL participations increased $14.4 million, or 8.6%, over the prior year.fiscal year 2004. This increase is primarily due to an increase in the dollar amount of loans in which we purchased participation interests, resulting from an increase in the fee charged by the lender, an increase in our clients’ average refund size and the maximum loan amount allowed by the lender.
Cost of services for fiscal year 2005 increased $110.7 million, or 9.7%, over the prior year. Compensation and benefits increased $54.6 million primarily due to increased revenues and an increase in the number of tax professionals and support staff needed in new office locations. Stock-based compensation related to our seasonal associates also increased $4.1 million. Occupancy expenses increased $26.3 million, or 10.3%, as a result of an 11.4% increase in U.S. company-owned offices under lease, which also drove increases in depreciation and amortization and supply costs. Of the total increase in occupancy expenses, $10.7 million was due to our real estate expansion. Other cost of services increased $11.4 million primarily due to additional expenses associated with our POM guarantee and Express IRAs.
26
Pretax income of $663.5 million for fiscal year 2005 represents a 3.9% increase from the prior year. The segment’s operating margin declined 100 basis points to 28.1% in fiscal year 2005.
On April 19, 2006, we entered into a settlement agreement, subject to certain adjustments in fiscal year 2004 based on delinquency rates. See discussion in Item 1, “RAL Participations and 2003 Tax Season Waiver.”
We have beenare named as a defendant in a number of lawsuitsone other class-action lawsuit and one state attorney general lawsuit alleging that we engaged in wrongdoing with respect to the RAL program. We believe we have strong defenses to the various RAL Casesother lawsuits and will vigorously defend our position. Nevertheless, the amounts claimed by the plaintiffsin these lawsuits are, in some instances, very substantial, and there can be no assurances as to thetheir ultimate outcome, of the pending RAL Cases, or as to thetheir impact of the RAL Cases on our financial statements. See additional discussion of RAL Litigation in Item 8, note 17 to the consolidated financial statements and in Part I, Item 3, “Legal Proceedings,Proceedings.” for additional information.
27
MORTGAGE SERVICES
This segment is primarily engaged in the origination of non-prime mortgage loans through an independent broker network, the origination of non-prime and prime mortgage loans through a retail office network, the sale and securitization of mortgage loans and residual interests, and the servicing of non-prime loans.
| Mortgage Services – Operating Statistics | (dollars in 000s) | |||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
Volume of loans originated ... | ||||||||||||||||
| Wholesale (non-prime) | $ | 26,977,810 | $ | 20,150,992 | $ | 13,659,243 | ||||||||||
| Retail: Non-prime | 3,005,168 | 1,846,674 | 1,220,563 | |||||||||||||
| Prime | 1,018,746 | 1,258,347 | 1,697,815 | |||||||||||||
| $ | 31,001,724 | $ | 23,256,013 | $ | 16,577,621 | |||||||||||
| Loan Characteristics ... | ||||||||||||||||
Weighted average FICO score (1) | 614 | 608 | 604 | |||||||||||||
Weighted average interest rate for borrowers (“WAC”) (1) | 7.36% | 7.39% | 8.15% | |||||||||||||
Weighted average loan-to-value (1) | 78.9% | 78.1% | 78.7% | |||||||||||||
| Percentage of first mortgage loans owner-occupied | 92.6% | 92.9% | 93.0% | |||||||||||||
| Percentage with prepayment penalty | 70.8% | 73.7% | 79.9% | |||||||||||||
| Percentage of fixed-rate mortgages | 22.1% | 30.4% | 24.4% | |||||||||||||
| Percentage of adjustable-rate mortgages | 77.9% | 69.6% | 75.6% | |||||||||||||
Origination margin (% of origination volume) (2) ... | ||||||||||||||||
| Loan sale premium | 2.77% | 4.21% | 4.87% | |||||||||||||
| Accretion on beneficial interest in Trusts | 0.63% | 0.72% | 0.65% | |||||||||||||
| Gain (loss) on derivatives | 0.15% | (0.05% | ) | (0.02% | ) | |||||||||||
| Loan sale repurchase reserves | (0.13% | ) | (0.20% | ) | (0.13% | ) | ||||||||||
| MSR gain on sale | 0.44% | 0.36% | 0.36% | |||||||||||||
| 3.86% | 5.04% | 5.73% | ||||||||||||||
| Cost of acquisition | (0.54% | ) | (0.50% | ) | (0.36% | ) | ||||||||||
| Direct origination expenses | (0.68% | ) | (0.65% | ) | (0.62% | ) | ||||||||||
Net gain on sale – gross margin (3) ... | 2.64% | 3.89% | 4.75% | |||||||||||||
| Other revenues | 0.03% | 0.01% | (0.01% | ) | ||||||||||||
| Other cost of origination | (1.55% | ) | (1.68% | ) | (1.91% | ) | ||||||||||
| Net margin | 1.12% | 2.22% | 2.83% | |||||||||||||
| Total cost of origination | 2.23% | 2.33% | 2.53% | |||||||||||||
| Total cost of origination and acquisition | 2.77% | 2.83% | 2.89% | |||||||||||||
Loan delivery ... | ||||||||||||||||
| Loan sales | $ | 30,975,523 | $ | 23,234,935 | $ | 17,225,774 | ||||||||||
Execution price: (4) ... | ||||||||||||||||
| Loans originated and sold | 3.01% | 4.09% | 4.63% | |||||||||||||
| Loans acquired and sold | – | – | .18% | |||||||||||||
| 3.01% | 4.09% | 4.46% | ||||||||||||||
| Mortgage Services – Operating Statistics | (dollars in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
VOLUME OF LOANS ORIGINATED – | ||||||||||||
| Wholesale (non-prime) | $ | 36,028,794 | $ | 26,977,810 | $ | 20,150,992 | ||||||
| Retail:Non-prime | 3,260,071 | 3,005,168 | 1,846,674 | |||||||||
| Prime | 1,490,898 | 1,018,746 | 1,258,347 | |||||||||
| $ | 40,779,763 | $ | 31,001,724 | $ | 23,256,013 | |||||||
NON-PRIME LOAN CHARACTERISTICS – | ||||||||||||
| Weighted average FICO score | 622 | 614 | 608 | |||||||||
| Weighted average interest rate for borrowers (WAC) | 7.87 | % | 7.36 | % | 7.39 | % | ||||||
| Weighted average loan-to-value | 80.6 | % | 78.9 | % | 78.7 | % | ||||||
| Percentage with prepayment penalty | 72.4 | % | 70.8 | % | 73.7 | % | ||||||
ORIGINATION MARGIN (% OF ORIGINATION VOLUME) (1) – | ||||||||||||
| Loan sale premium | 1.42 | % | 2.77 | % | 4.21 | % | ||||||
| Residual cash flows from beneficial interest in Trusts | 0.51 | % | 0.63 | % | 0.72 | % | ||||||
| Gain (loss) on derivatives | 0.35 | % | 0.15 | % | (0.05 | %) | ||||||
| Loan sale repurchase reserves | (0.18 | %) | (0.13 | %) | (0.20 | %) | ||||||
| Retained MSRs | 0.61 | % | 0.44 | % | 0.36 | % | ||||||
| 2.71 | % | 3.86 | % | 5.04 | % | |||||||
| Cost of acquisition | (0.37 | %) | (0.54 | %) | (0.50 | %) | ||||||
| Direct origination expenses | (0.58 | %) | (0.68 | %) | (0.65 | %) | ||||||
Net gain on sale – gross margin(2) | 1.76 | % | 2.64 | % | 3.89 | % | ||||||
| Other revenues | (0.02 | %) | 0.03 | % | 0.01 | % | ||||||
| Other cost of origination | (1.33 | %) | (1.55 | %) | (1.68 | %) | ||||||
| Net margin | 0.41 | % | 1.12 | % | 2.22 | % | ||||||
| Total cost of origination | 1.91 | % | 2.23 | % | 2.33 | % | ||||||
| Total cost of origination and acquisition | 2.28 | % | 2.77 | % | 2.83 | % | ||||||
LOAN DELIVERY – | ||||||||||||
| Loan sales | $ | 40,272,225 | $ | 30,975,523 | $ | 23,234,935 | ||||||
Execution price(3) | 1.58 | % | 3.01 | % | 4.09 | % | ||||||
| Mortgage Services – Financial Results | (in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Components of gains on sales: | ||||||||||||
| Gain on mortgage loans | $ | 575,402 | $ | 772,061 | $ | 915,628 | ||||||
| Gain (loss) on derivatives | 141,223 | 46,853 | (11,957 | ) | ||||||||
| Gain on sales of AFS residual interests | 31,463 | 15,396 | 40,689 | |||||||||
| Impairment of AFS residual interests | (34,107 | ) | (12,235 | ) | (26,063 | ) | ||||||
| 713,981 | 822,075 | 918,297 | ||||||||||
| Interest income: | ||||||||||||
| Accretion-residual interests | 114,346 | 137,610 | 186,466 | |||||||||
| Other | 18,722 | 11,850 | 5,064 | |||||||||
| 133,068 | 149,460 | 191,530 | ||||||||||
| Loan-servicing revenue | 398,992 | 273,056 | 211,710 | |||||||||
| Other | 1,097 | 1,427 | 2,172 | |||||||||
| Total revenues | 1,247,138 | 1,246,018 | 1,323,709 | |||||||||
| Cost of services | 296,710 | 221,148 | 193,383 | |||||||||
| Cost of other revenues: | ||||||||||||
| Compensation and benefits | 293,781 | 239,997 | 206,238 | |||||||||
| Occupancy | 45,116 | 37,336 | 28,418 | |||||||||
| Other | 105,494 | 78,769 | 55,265 | |||||||||
| 444,391 | 356,102 | 289,921 | ||||||||||
| Selling, general and administrative | 184,421 | 172,675 | 151,882 | |||||||||
| Total expenses | 925,522 | 749,925 | 635,186 | |||||||||
| Pretax income | $ | 321,616 | $ | 496,093 | $ | 688,523 | ||||||
| (1) | ||
| Defined as gain on sale of mortgage loans (including gain or loss on derivatives, mortgage servicing rights and net of direct origination and acquisition expenses) divided by origination volume. | ||
| Defined as total premium received divided by total balance of loans delivered to third-party investors or securitization vehicles (excluding mortgage servicing rights and the effect of loan origination expenses). |
FISCAL 2006 COMPARED TO FISCAL 2005 –Mortgage Services’ revenues were essentially flat compared to the prior year, with higher loan servicing revenues and gains on derivatives offset by lower margins on mortgage loans sold and lower accretion.
The following table summarizes the key drivers of loan origination volumes and related gains on sales of mortgage loans:
28
(dollars in 000s)
| Year Ended April 30, | 2006 | 2005 | ||||||
| Application process: | ||||||||
| Total number of applications | 369,210 | 335,203 | ||||||
Number of sales associates(1) | 2,814 | 3,526 | ||||||
Closing ratio(2) | 60.3 | % | 58.3 | % | ||||
| Originations: | ||||||||
| Total number of originations | 222,749 | 195,392 | ||||||
| WAC | 7.87 | % | 7.36 | % | ||||
| Average loan size (all loans) | $ | 183 | $ | 159 | ||||
| Total originations | $ | 40,779,763 | $ | 31,001,724 | ||||
| Direct origination and acquisition expenses, net | $ | 387,911 | $ | 378,674 | ||||
| Revenue (loan value): | ||||||||
Net gain on sale – gross margin(3) | 1.76 | % | 2.64 | % | ||||
| (1) | Includes all direct sales and back office sales support associates. | |
| (2) | Percentage of loans funded divided by total applications in the period. | |
| (3) | Defined as gain on sale of mortgage loans (including gain or loss on derivatives, mortgage servicing rights and net of direct origination and acquisition expenses) divided by origination volume. |
The initial value of MSRs we recorded in fiscal year 2006 increased to 61 basis points from 44 basis points in the prior year, which resulted in an increase of $113.0 million in gains on sales of mortgage loans. These increases were primarily due to higher origination volumes, average loan size and interest rates, coupled with updated valuation assumptions. During fiscal year 2006 we updated our assumptions used to value our MSRs. The assumptions were updated primarily to reflect lower servicing costs, in particular interest paid to bondholders on monthly loan prepayments, and higher discount rates. These changes in assumptions increased the weighted average value of MSRs recorded during fiscal year 2006 by approximately $37.0 million (9 basis points of total retained MSRs of 61 basis points) over the prior year.
To mitigate the risk of short-term changes in market interest rates related to our loan originations and beneficial interest in Trusts, we use various derivative financial instruments. During the current year, we recorded a net $141.2 million in gains, compared to $46.9 million in the prior year, related to our interest rate swaps and other derivative instruments. This increase was primarily due to rising short-term interest rates and an increase in the average notional amount of swap arrangements to $8.4 billion in the current year, compared to $2.4 billion in fiscal year 2005. See Item 8, note 8 to the consolidated financial statements.
In fiscal year 2006, we completed sales of available-for-sale residual interests and recorded a gain of $31.5 million. These sales accelerated cash flows from these residual interests, effectively realizing previously recorded unrealized gains included in other comprehensive income. We recorded a gain of $15.4 million in the prior year on a similar transaction.
During fiscal year 2006, our available-for-sale residual interests performed better than expected in our internal valuation models, with lower credit losses than originally modeled, partially offset by higher than expected interest rates. We recorded favorable pretax mark-to-market adjustments, which increased the fair value of these residual interests $53.3 million during the year. These adjustments were recorded, net of write-downs of $18.0 million and deferred taxes of $13.5 million, in other comprehensive income and will be accreted into income throughout the remaining life of the residual interests. Offsetting this increase were impairments of $34.1 million, which were recorded in gains on sales of mortgage assets. Future changes in interest rates or other assumptions, based on market conditions or actual loan pool performance, could cause additional adjustments to the fair value of these residual interests and could cause changes to the accretion of these residual interests in future periods.
29
| Mortgage Services – Financial Results | (in 000s) | |||||||||||||||
| Restated | Restated | |||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
| Components of gains on sales: | ||||||||||||||||
| Gain on mortgage loans | $ | 772,061 | $ | 915,628 | $ | 792,072 | ||||||||||
| Gain (loss) on derivatives | 46,853 | (11,957 | ) | (4,141 | ) | |||||||||||
| Gain on sales of residual interests | 15,396 | 40,689 | 93,307 | |||||||||||||
| Impairment of residual interests | (12,235 | ) | (26,063 | ) | (54,111 | ) | ||||||||||
| 822,075 | 918,297 | 827,127 | ||||||||||||||
| Interest income: | ||||||||||||||||
| Accretion-residual interests | 137,610 | 186,466 | 146,343 | |||||||||||||
| Other | 11,850 | 5,064 | 5,421 | |||||||||||||
| 149,460 | 191,530 | 151,764 | ||||||||||||||
| Loan-servicing revenue | 273,056 | 211,710 | 168,351 | |||||||||||||
| Other | 1,427 | 2,172 | 2,838 | |||||||||||||
| Total revenues | 1,246,018 | 1,323,709 | 1,150,080 | |||||||||||||
| Cost of services | 221,300 | 193,018 | 141,419 | |||||||||||||
| Cost of non-service revenues: | ||||||||||||||||
| Compensation and benefits | 218,544 | 190,499 | 146,907 | |||||||||||||
| Occupancy | 33,155 | 25,635 | 22,701 | |||||||||||||
| Other | 72,803 | 71,634 | 74,332 | |||||||||||||
| 324,502 | 287,768 | 243,940 | ||||||||||||||
| Selling, general and administrative | 204,123 | 154,400 | 108,397 | |||||||||||||
| Total expenses | 749,925 | 635,186 | 493,756 | |||||||||||||
| Pretax income | $ | 496,093 | $ | 688,523 | $ | 656,324 | ||||||||||
The following table summarizes the key metrics related to our loan servicing business:
(dollars in 000s)
| Year Ended April 30, | 2006 | 2005 | ||||||
| Average servicing portfolio: | ||||||||
| With related MSRs | $ | 56,521,595 | $ | 41,021,448 | ||||
| Without related MSRs | 19,106,863 | 13,838,769 | ||||||
| $ | 75,628,458 | $ | 54,860,217 | |||||
| Ending servicing portfolio: | ||||||||
| With related MSRs | $ | 62,910,568 | $ | 47,543,982 | ||||
| Without related MSRs | 10,471,509 | 20,450,482 | ||||||
| $ | 73,382,077 | $ | 67,994,464 | |||||
| Number of loans serviced | 441,981 | 435,290 | ||||||
| Average delinquency rate | 5.16 | % | 4.85 | % | ||||
| Weighted average FICO score | 621 | 618 | ||||||
| Weighted average interest rate (WAC) of portfolio | 7.58 | % | 7.46 | % | ||||
| Weighted average rate earned | 0.38 | % | 0.36 | % | ||||
| Carrying value of MSRs | $ | 272,472 | $ | 166,614 | ||||
Loan servicing revenues increased $125.9 million, or 46.1%, compared to the prior year. The increase reflects a higher loan servicing portfolio resulting from our loan origination growth. The average servicing portfolio for the year increased $20.8 billion, or 37.9%, to $75.6 billion, even with lower volumes in our sub-servicing business. The weighted average rate earned on our entire servicing portfolio was 38 basis points for fiscal year 2006, compared to 36 basis points in the prior year.
Total expenses for the current year increased $175.6 million, or 23.4%, from the prior year. Cost of services increased $75.6 million, or 34.2%, mainly as a result of a higher average servicing portfolio during the current year and increased amortization of MSRs.
Cost of other revenues increased $88.3 million over fiscal year 2005, and includes a $12.6 million restructuring charge associated with the closing of some of our branch offices. See additional discussion of the restructuring charge in Item 8, note 16 to the consolidated financial statements. Compensation and benefits increased $53.8 million primarily due to an increase in the average number of sales associates during the year to support higher loan volumes and the resulting increase in origination-based incentives, coupled with $6.7 million in severance charges recorded as part of the restructuring. Occupancy expenses increased $7.8 million primarily due to $5.9 million in lease termination costs recorded as part of the restructuring. Other expenses increased $26.7 million primarily as a result of $20.1 million in additional interest expense related to mortgage loans held on our balance sheet and $5.0 million of additional depreciation and amortization of our newly implemented origination and servicing software.
Selling, general and administrative expenses increased $11.7 million primarily due to $15.3 million in additional marketing expenses, $5.1 million in additional occupancy costs and $3.2 million in higher allocated shared services. These increases were partially offset by a $15.7 million decline in compensation and benefits resulting from reductions in administrative and corporate headcount and lower bonus accruals.
Pretax income decreased $174.5 million, or 35.2%, for fiscal year 2006.
FISCAL 2005 COMPARED TO FISCAL 2004 – ...Mortgage Services’ revenues decreased $77.7 million, or 5.9%, compared to the prior year.fiscal year 2004. Revenues decreased primarily as a result of a decline in gains on sales of mortgage loans.
| (dollars in 000s) | |||||||||||
| Year Ended April 30, | 2005 | 2004 | |||||||||
| Application process: | |||||||||||
| Total number of applications | 335,203 | 269,267 | |||||||||
Number of sales associates(1) | 3,526 | 2,812 | |||||||||
Closing ratio(2) | 58.3% | 57.7% | |||||||||
| Originations: | |||||||||||
| Total number of originations | 195,392 | 155,339 | |||||||||
| WAC | 7.36% | 7.39% | |||||||||
| Average loan size (all loans) | $ | 159 | $ | 150 | |||||||
| Total originations | $ | 31,001,724 | $ | 23,256,013 | |||||||
| Non-prime origination ratio | 96.7% | 94.6% | |||||||||
| Direct origination and acquisition expenses, net | $ | 378,674 | $ | 278,785 | |||||||
| Revenue (loan value): | |||||||||||
| Net gain on sale – gross margin | 2.64% | 3.89% | |||||||||
Although origination volumes increased 33.3% over the priorfiscal year 2004, gains on sales of mortgage loans declined $143.6 million as a result of increased price competition and poorer execution in the secondary market. As a result, our net margin declined to 1.12% from 2.22% in the prior year.fiscal year 2004.
The average market interest rate for a 2-year swap increased to 3.32% in fiscal year 2005 from 1.97% in 2004, while our WAC decreased to 7.36% from 7.39% for the same periods. Because our WAC did not increase as quickly as market rates, our gross margin declined 125 basis points from last year. To mitigate the risk of short-term changes in market interest rates, we use interest rate swaps, interest rate caps and forward loan sale commitments.fiscal year 2004. During the currentfiscal year 2005, we recorded $46.9 million in net gains, compared to a net loss of $12.0 million in the prior year,2004, related to derivative instruments. See Item 8, note 9 to the consolidated financial statements.
In fiscal year 2005, we completed a sale of available-for-sale residual interests and recorded a gain of $15.4 million. This sale accelerated cash flows from these residual interests, effectively realizing previously recorded unrealized gains included in other
Impairments of available-for-sale residual interests in securitizations of $12.2 million were recognized during thefiscal year 2005 compared with $26.1 million in the prior year. The priorimpairments in fiscal year impairments2004 were due primarily to loan performance of older residuals and changes in assumptions to more closely align with the economic and interest rate environment.
Total accretion of residual interests decreased $48.9 million from the prior year.fiscal year 2004. This decrease is primarily due to the sale of previously securitized residual interests during fiscal year 2004, which eliminated future accretion on those residual interests.
During fiscal year 2005, our available-for-sale residual interests continued to perform better than expected compared
30
to internal valuation models. As a result of this performance, our residuals have produced, or are expected to produce, more cash proceeds than projected in previous valuation models. We recorded favorable pretax mark-to-market adjustments, which increased the fair value of ourthese residual interests $154.3 million during the year.fiscal year 2005. These adjustments were recorded, net of write-downs of $58.3 million and deferred taxes of $36.6 million, in other comprehensive income and will be accreted into income throughout the remaining life of thethese residual interests. Future changes in interest rates, actual loan pool performance or other assumptions could cause additional favorable or unfavorable adjustments to the fair value of the residual interests and could cause changes to the accretion of these residual interests in future periods. Additionally, sales of residual interests results in decreases to accretion income in future periods.
| (dollars in 000s) | |||||||||||
| Year Ended April 30, | 2005 | 2004 | |||||||||
| Average servicing portfolio: | |||||||||||
| With related MSRs | $ | 41,021,448 | $ | 32,039,811 | |||||||
| Without related MSRs | 13,838,769 | 6,481,069 | |||||||||
| $ | 54,860,217 | $ | 38,520,880 | ||||||||
| Number of loans serviced | 435,290 | 324,364 | |||||||||
| Average delinquency rate | 4.85% | 6.04% | |||||||||
| Weighted average FICO score | 610 | 596 | |||||||||
| Value of MSRs | $ | 166,614 | $ | 113,821 | |||||||
Loan-servicing revenues increased $61.3 million, or 29.0%, over the prior year.fiscal year 2004. The increase reflects a higher average loan-servicing portfolio. The average servicing portfolio for fiscal year 2005 increased 42.4%.
Cost of services increased $28.3$27.8 million, or 14.7%14.4%, as a result of a higher average servicing portfolio, particularly loans with MSRs, which also resulted in an increase in MSR amortization.
Cost of non-serviceother revenues increased $36.7$66.2 million, or 12.8%22.8%, over the prior year.fiscal year 2004. Compensation and benefits increased $28.0$33.8 million as a result of a 25.4% increase in the number of employees, reflecting resources needed to support higher loan production volumes.
Selling, general and administrative expenses increased $49.7$20.8 million, or 32.2%13.7%, due to $12.1 million in increased retail marketing expenses and $7.4 million in additional consulting expenses.
Pretax income for fiscal year 2005 decreased $192.4 million, or 27.9%, forfrom fiscal year 2005.
BUSINESS SERVICES
This segment offers middle-market companies accounting, tax and business consulting services, wealth management, retirement resources, payroll services, corporate finance and financial process outsourcing.
| Business Services – Operating Statistics | |||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
Accounting, tax and consulting ... | |||||||||||||||
| Chargeable hours (000s) | 2,898 | 2,598 | 2,584 | ||||||||||||
| Chargeable hours per person | 1,430 | 1,414 | 1,388 | ||||||||||||
| Net collected rate per hour | $ | 133 | $ | 124 | $ | 120 | |||||||||
| Average margin per person | $ | 112,573 | $ | 102,496 | $ | 97,117 | |||||||||
| Business Services – Financial Results | (in 000s) | ||||||||||||||
| Restated | Restated | ||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Service revenues: | |||||||||||||||
| Accounting, tax and consulting | $ | 412,473 | $ | 353,750 | $ | 337,903 | |||||||||
| Capital markets | 67,922 | 73,860 | 35,629 | ||||||||||||
| Payroll, benefits and retirement services | 27,331 | 21,172 | 20,745 | ||||||||||||
| Other services | 31,170 | 19,390 | 7,912 | ||||||||||||
| 538,896 | 468,172 | 402,189 | |||||||||||||
| Other | 34,420 | 31,038 | 31,951 | ||||||||||||
| Total revenues | 573,316 | 499,210 | 434,140 | ||||||||||||
| Cost of services: | |||||||||||||||
| Compensation and benefits | 310,950 | 256,640 | 233,303 | ||||||||||||
| Occupancy | 24,699 | 20,498 | 20,873 | ||||||||||||
| Other | 36,672 | 33,080 | 32,562 | ||||||||||||
| 372,321 | 310,218 | 286,738 | |||||||||||||
| Impairment of goodwill | – | – | 13,459 | ||||||||||||
| Selling, general and administrative | 171,124 | 169,680 | 149,976 | ||||||||||||
| Total expenses | 543,445 | 479,898 | 450,173 | ||||||||||||
| Pretax income (loss) | $ | 29,871 | $ | 19,312 | $ | (16,033 | ) | ||||||||
Business Services — Operating Statistics
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
ACCOUNTING, TAX AND BUSINESS CONSULTING - | ||||||||||||
| Chargeable hours (000s) | 4,357 | 2,898 | 2,598 | |||||||||
| Chargeable hours per person | 1,385 | 1,430 | 1,414 | |||||||||
| Net billed rate per hour | $ | 141 | $ | 133 | $ | 124 | ||||||
| Average margin per person | $ | 114,755 | $ | 112,573 | $ | 102,496 | ||||||
| Business Services — Financial Results | (in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Service revenues: | ||||||||||||
| Accounting, tax and consulting | $ | 690,817 | $ | 412,473 | $ | 353,750 | ||||||
| Capital markets | 59,553 | 67,922 | 73,860 | |||||||||
| Payroll, benefits and retirement services | 36,605 | 27,331 | 21,172 | |||||||||
| Other services | 52,501 | 31,170 | 19,390 | |||||||||
| 839,476 | 538,896 | 468,172 | ||||||||||
| Other | 37,783 | 34,420 | 31,038 | |||||||||
| Total revenues | 877,259 | 573,316 | 499,210 | |||||||||
| Cost of services: | ||||||||||||
| Compensation and benefits | 471,619 | 310,950 | 256,640 | |||||||||
| Occupancy | 56,870 | 24,699 | 20,498 | |||||||||
| Other | 65,386 | 36,672 | 33,080 | |||||||||
| 593,875 | 372,321 | 310,218 | ||||||||||
| Selling, general and administrative | 230,006 | 171,124 | 169,680 | |||||||||
| Total expenses | 823,881 | 543,445 | 479,898 | |||||||||
| Pretax income | $ | 53,378 | $ | 29,871 | $ | 19,312 | ||||||
FISCAL 2006 COMPARED TO FISCAL 2005 –Business Services’ revenues for fiscal year 2006 increased $303.9 million, or 53.0%, from the prior year. This increase was primarily due to the acquisition of American Express Tax and Business Services, Inc., which increased accounting, tax and consulting revenues $251.3 million. The remaining $27.1 million increase in tax, accounting and consulting revenues was primarily driven by increases in the net billed rate per hour and chargeable hours.
Capital markets revenues declined $8.4 million due to a 36.0% decline in the number of business valuation projects. Payroll, benefits and retirement services revenues increased $9.3 million primarily due to acquisitions completed during the third and fourth quarters of fiscal year 2005. Other service revenues increased $21.3 million as a result of acquisitions completed in the fourth quarter of fiscal year 2005 in our financial process outsourcing business and growth in wealth management services.
Total expenses increased $280.4 million, or 51.6%, for fiscal year 2006 compared to the prior year. Cost of services increased $221.6 million, primarily due to a $160.7 million increase in compensation and benefits. Compensation and benefits increased $136.0 million due to the American Express Tax and Business Services, Inc. acquisition. In addition, baseline increases in the number of personnel and the average wage per employee, driven by marketplace competition for professional staff, also contributed to the increase. Occupancy expenses increased $32.2 million and other cost of services increased $28.7 million primarily due to acquisitions.
31
Selling, general and administrative expenses increased $58.9 million primarily due to acquisitions and additional costs associated with our business development initiatives.
Pretax income for the year ended April 30, 2006 was $53.4 million, compared to pretax income of $29.9 million in the prior year.
FISCAL 2005 COMPARED TO FISCAL 2004 – ...
Business Services’ revenues for fiscal year 2005 increased $74.1 million, or 14.8%, from the prior year. This increase was primarily due to a $58.7 million increase in accounting, tax and consulting revenues resulting from an 11.5% increase in chargeable hours and a 7.3% increase in the net collectedbilled rate per hour. The increase in chargeable hours is primarily due to strong demand for our tax and accounting services as well as our consulting and risk management services. This demand stems from the current business environment and the emphasis placed on the accounting industry.
Capital markets revenues declined $5.9 million as a result of an 11.2% decrease in the number of business valuation projects. Payroll, benefits and retirement services revenues increased as a result of three acquisitions completed during the last half of the current year.fiscal year 2005.
Other service revenues increased $11.8 million due to the acquisition of our financial process outsourcing business in the second quarter of lastfiscal year 2004, coupled with overall growth in this business. Increases in reimbursable expenses and contractor revenues also contributed to higher revenues.
Cost of services increased $62.1 million, or 20.0%, for fiscal year 2005 compared to the prior year. Compensation and benefits related to our services increased $54.3 million, primarily as a result of increases in the number of personnel and the average wage per employee. The increase in the average wage is being driven by marketplace competition for professional staff. Higher expenses are also attributable to investments we are making in early-stage businesses within this segment.
Pretax income for the year ended April 30, 2005 was $29.9 million compared to $19.3 million in fiscal year 2004.
INVESTMENT SERVICES
This segment is primarily engaged in offering advice-based brokerage services and investment
| Investment Services – Operating Statistics | ||||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
Customer trades (1) | 885,796 | 1,004,235 | 860,784 | |||||||||||||
| Customer daily average trades | 3,529 | 3,923 | 3,429 | |||||||||||||
Average revenue per trade (2) | $ | 123.33 | $ | 119.36 | $ | 120.15 | ||||||||||
Customer accounts: (3) | ||||||||||||||||
| Traditional brokerage | 431,749 | 463,736 | 501,001 | |||||||||||||
| Express IRAs | 380,539 | 366,040 | 216,351 | |||||||||||||
| 812,288 | 829,776 | 717,352 | ||||||||||||||
| Ending balance of assets under administration (billions) | $ | 27.8 | $ | 26.7 | $ | 22.3 | ||||||||||
| Average assets per traditional brokerage account | $ | 63,755 | $ | 57,204 | $ | 43,991 | ||||||||||
| Average margin balances (millions) | $ | 597 | $ | 545 | $ | 577 | ||||||||||
| Average customer payables balances (millions) | $ | 975 | $ | 984 | $ | 819 | ||||||||||
| Number of advisors | 1,010 | 1,009 | 984 | |||||||||||||
| Included in the numbers above are the following relating to fee-based accounts: | ||||||||||||||||
| Customer accounts | 7,668 | 6,964 | 4,680 | |||||||||||||
| Average revenue per account | $ | 2,301 | $ | 1,572 | $ | 1,442 | ||||||||||
| Assets under administration (millions) | $ | 1,975 | $ | 1,494 | $ | 789 | ||||||||||
| Average assets per active account | $ | 260,238 | $ | 214,537 | $ | 168,522 | ||||||||||
Investment Services – Operating Statistics
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
Customer trades(1) | 974,625 | 885,796 | 1,004,235 | |||||||||
| Customer daily average trades | 3,883 | 3,529 | 3,923 | |||||||||
Average revenue per trade(2) | $ | 119.11 | $ | 123.33 | $ | 119.36 | ||||||
Customer accounts:(3) | ||||||||||||
| Traditional brokerage | 418,162 | 431,749 | 463,736 | |||||||||
| Express IRAs | 442,157 | 380,539 | 366,040 | |||||||||
| 860,319 | 812,288 | 829,776 | ||||||||||
| Ending balance of assets under administration (billions) | $ | 31.8 | $ | 27.8 | $ | 26.7 | ||||||
| Average assets per traditional brokerage account | $ | 75,222 | $ | 63,755 | $ | 57,204 | ||||||
| Average margin balances (millions) | $ | 539 | $ | 597 | $ | 545 | ||||||
| Average customer payables balances (millions) | $ | 782 | $ | 975 | $ | 984 | ||||||
| Number of advisors | 958 | 1,010 | 1,009 | |||||||||
| Included in the numbers above are the following relating to fee-based accounts: | ||||||||||||
| Customer household accounts | 9,224 | 7,668 | 6,964 | |||||||||
| Average revenue per account | $ | 2,535 | $ | 2,301 | $ | 1,572 | ||||||
| Ending balance of assets under administration (millions) | $ | 2,526 | $ | 1,975 | $ | 1,494 | ||||||
| Average assets per active account | $ | 274,981 | $ | 260,238 | $ | 214,537 | ||||||
(1) | Includes only trades on which revenues are earned (“revenue trades”). Revenues are earned on both transactional and annuitized trades. | ||
(2) | Calculated as total trade revenues divided by revenue trades. | ||
(3) | Includes only accounts with a positive balance. |
| Investment Services – Financial Results | (in 000s) | |||||||||||||||
| Restated | Restated | |||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
| Service revenues: | ||||||||||||||||
| Transactional revenue | $ | 88,516 | $ | 99,559 | $ | 91,587 | ||||||||||
| Annuitized revenue | 77,386 | 60,950 | 38,507 | |||||||||||||
| Production revenue | 165,902 | 160,509 | 130,094 | |||||||||||||
| Other service revenue | 29,206 | 35,619 | 34,311 | |||||||||||||
| 195,108 | 196,128 | 164,405 | ||||||||||||||
| Margin interest revenue | 43,698 | 33,408 | 37,300 | |||||||||||||
| Less: interest expense | (3,114 | ) | (1,358 | ) | (4,830 | ) | ||||||||||
| Net interest revenue | 40,584 | 32,050 | 32,470 | |||||||||||||
| Other | 438 | (66 | ) | (911 | ) | |||||||||||
Total revenues (1) | 236,130 | 228,112 | 195,964 | |||||||||||||
| Cost of services: | ||||||||||||||||
| Compensation and benefits | 116,552 | 108,956 | 89,473 | |||||||||||||
| Occupancy | 22,178 | 21,571 | 24,299 | |||||||||||||
| Other | 19,555 | 24,091 | 25,604 | |||||||||||||
| 158,285 | 154,618 | 139,376 | ||||||||||||||
| Impairment of goodwill | – | – | 108,792 | |||||||||||||
| Selling, general and administrative | 153,215 | 149,108 | 167,217 | |||||||||||||
| Total expenses | 311,500 | 303,726 | 415,385 | |||||||||||||
| Pretax loss | $ | (75,370 | ) | $ | (75,614 | ) | $ | (219,421 | ) | |||||||
| Investment Services – Financial Results | (in 000s) |
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Service revenues: | ||||||||||||
Transactional revenue | $ | 91,143 | $ | 88,516 | $ | 99,559 | ||||||
| Annuitized revenue | 99,331 | 77,386 | 60,950 | |||||||||
| Production revenue | 190,474 | 165,902 | 160,509 | |||||||||
| Other services | 32,256 | 29,206 | 35,619 | |||||||||
| 222,730 | 195,108 | 196,128 | ||||||||||
| Margin interest revenue | 60,795 | 43,698 | 33,408 | |||||||||
| Less: interest expense | (6,643 | ) | (3,114 | ) | (1,358 | ) | ||||||
| Net interest revenue | 54,152 | 40,584 | 32,050 | |||||||||
| Other | 4,430 | 438 | (66 | ) | ||||||||
Total revenues(1) | 281,312 | 236,130 | 228,112 | |||||||||
| Cost of services: | ||||||||||||
| Compensation and benefits | 135,256 | 116,552 | 108,956 | |||||||||
| Occupancy | 21,050 | 22,178 | 21,571 | |||||||||
| Other | 21,132 | 19,555 | 24,091 | |||||||||
| 177,438 | 158,285 | 154,618 | ||||||||||
| Selling, general and administrative | 136,709 | 153,215 | 149,108 | |||||||||
| Total expenses | 314,147 | 311,500 | 303,726 | |||||||||
| Pretax loss | $ | (32,835 | ) | $ | (75,370 | ) | $ | (75,614 | ) | |||
| (1) | Total revenues, less interest |
32
FISCAL 2006 COMPARED TO FISCAL 2005 —Investment Services’ revenues, net of interest expense, for the fiscal year 2006 increased $45.2 million, or 19.1%.
Total production revenue increased $24.6 million, or 14.8%, over the prior year. Transactional revenue, which is based on sales of individual securities, increased $2.6 million, or 3.0%, from the prior year due primarily to a 6.1% increase in transactional trading volume, partially offset by a 2.4% decrease in average revenue per transactional trade. Annuitized revenue, which is based on sales of various fee-based products, increased $21.9 million, or 28.4%, due to increased sales of annuities and insurance, wealth management accounts, mutual funds, and unit investment trusts (UITs). The shift in revenues from transactional to annuitized demonstrates our continued move toward an advice-based focus.
Annualized productivity averaged approximately $194,000 per advisor during the current year compared to $166,000 in the prior year. Increased productivity was due to higher production levels across all recruiting classes. Minimum production standards put into place during the fourth quarter of fiscal year 2005 resulted in 111 advisors increasing their production. These standards also resulted in 152 low-producing advisors leaving the company. We expect average advisor productivity to continue increasing as we enforce minimum production standards, provide additional training to advisors and increase productivity levels of newly recruited advisors.
Margin interest revenue increased $17.1 million, or 39.1%, from the prior year, as a result of higher interest rates earned, partially offset by a decline in average margin balances.
Total expenses increased $2.6 million, or 0.8%. Cost of services increased $19.2 million, or 12.1%, primarily as a result of $18.7 million of additional compensation and benefits expenses resulting from higher production revenues.
Selling, general and administrative expenses decreased $16.5 million, or 10.8%, primarily due to a $4.8 million decline in legal expenses, due in part to a favorable arbitration outcome. Current year results also improved due to reduced back-office headcount relating to cost containment efforts and gains on the disposition of certain assets during the year. These decreases were partially offset by increased bonus accruals associated with the segment’s improved performance.
The pretax loss for Investment Services for the year ended April 30, 2006 was $32.8 million compared to the prior year loss of $75.4 million.
FISCAL 2005 COMPARED TO FISCAL 2004 ...–
Investment Services’ revenues, net of interest expense, for fiscal year 2005 increased $8.0 million, or 3.5%. The increase is primarily due to higher margin interest revenue.
Production revenue increased $5.4 million, or 3.4% over the prior year.fiscal year 2004. Transactional revenue which is based on individual securities transactions, decreased $11.0 million, or 11.1%, from the prior year due primarily to an 18.7% decline in transactional trading volume. This decline was partially offset by an increase in the average revenue per trade. Annuitized revenue which consists of sales of mutual funds, insurance, fee-based products and unit investment trusts, increased $16.4 million, or 27.0%, due to increased sales of annuities, mutual funds and our fee-based wealth management accounts. Annuitized revenues represent
46.6% of total production revenues for fiscal year 2005, compared to 38.0% in the prior year. Advisor productivity averaged approximately $166,000 in the currentfiscal year 2005, essentially flat compared to the prior year.
Other service revenue declined $6.4 million, or 18.0%, from the priorfiscal year 2004 due to fewer fixed income underwriting offerings and Express IRA revenues now being recorded as part of Tax Services.
Margin interest revenue increased $10.3 million, or 30.8%, from the priorfiscal year 2004, which is primarily a result of higher interest rates earned, coupled with a 9.5% increase in average margin balances. Margin balances have increased from an average of $545.0 million in fiscal year 2004 to $597.0 million in the current year.fiscal year 2005.
Cost of services increased $3.7 million, or 2.4%, primarily due to $7.6 million of additional compensation and benefits resulting from a higher average commission rate than the priorfiscal year 2004 and other financial incentives for attracting new advisors. This increase was partially offset by declines in depreciation and other expenses.
Selling, general and administrative expenses increased $4.1 million, or 2.8%, over the priorfiscal year 2004 primarily as the result of $6.8 million in additional legal expenses, partially offset by gains of $4.6 million on the disposition of certain assets.
The pretax loss for Investment Services for fiscal year 2005 was $75.4 million compared to a loss of $75.6 million last year.
33
CORPORATE
Corporate support departments, which provide services to our operating
| Corporate – Financial Results | (in 000s) |
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Operating revenues | $ | 22,279 | $ | 13,592 | $ | 12,532 | ||||||
| Eliminations | (13,636 | ) | (10,444 | ) | (8,218 | ) | ||||||
| Total revenues | 8,643 | 3,148 | 4,314 | |||||||||
| Corporate expenses: | ||||||||||||
| Interest expense | 67,630 | 72,701 | 69,300 | |||||||||
| Other | 65,484 | 51,262 | 50,476 | |||||||||
| 133,114 | 123,963 | 119,776 | ||||||||||
| Support departments: | ||||||||||||
| Marketing | 137,065 | 117,303 | 110,507 | |||||||||
| Information technology | 116,990 | 107,306 | 110,569 | |||||||||
| Finance | 49,719 | 34,498 | 33,829 | |||||||||
| Other | 122,232 | 107,562 | 78,593 | |||||||||
| 426,006 | 366,669 | 333,498 | ||||||||||
| Allocation of shared services | (425,589 | ) | (366,742 | ) | (336,639 | ) | ||||||
| Other income, net | 20,356 | 24,345 | 4,582 | |||||||||
| Pretax loss | $ | (104,532 | ) | $ | (96,397 | ) | $ | (107,739 | ) | |||
FISCAL 2006 COMPARED TO FISCAL 2005 – Corporate expenses increased $9.2 million primarily due to a $14.2 million increase in other expenses, offset by a $5.1 million decline in interest expense. Other expenses increased due to higher finance and 2003.information technology department expenses.
| Corporate – Financial Results | (in 000s) | ||||||||||||||
| Restated | Restated | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Operating revenues | $ | 13,592 | $ | 12,532 | $ | 6,448 | |||||||||
| Eliminations | (10,444 | ) | (8,218 | ) | (7,099 | ) | |||||||||
| Total revenues | 3,148 | 4,314 | (651 | ) | |||||||||||
| Corporate expenses: | |||||||||||||||
| Interest expense | 72,701 | 69,300 | 74,482 | ||||||||||||
| Other | 51,262 | 50,476 | 56,008 | ||||||||||||
| 123,963 | 119,776 | 130,490 | |||||||||||||
| Support departments: | |||||||||||||||
| Marketing | 117,303 | 110,507 | 88,819 | ||||||||||||
| Information technology | 107,306 | 110,569 | 92,899 | ||||||||||||
| Finance | 34,498 | 33,829 | 30,232 | ||||||||||||
| Other | 107,562 | 78,593 | 65,734 | ||||||||||||
| 366,669 | 333,498 | 277,684 | |||||||||||||
| Allocation of support departments | (366,742 | ) | (336,639 | ) | (280,677 | ) | |||||||||
| Other income, net | 24,345 | 4,582 | 6,139 | ||||||||||||
| Pretax loss | $ | (96,397 | ) | $ | (107,739 | ) | $ | (122,009 | ) | ||||||
Our consolidated interest expense, both operating and non-operating, totaled $103.8 million for fiscal year 2006, an increase of $15.9 million over the prior year. Of the $103.8 million in total interest, $49.1 million related to debt incurred on previous acquisitions, with the remaining $54.7 million related to our operations recorded directly in our operating segments.
Marketing department expenses increased $19.8 million, or 16.8%, due primarily to an increase in digital advertising efforts. Information technology department expenses increased $9.7 million primarily due to higher compensation and benefits associated with higher headcount. Finance department expenses increased $15.2 million, primarily due to additional consulting expenses and increases in compensation expenses. Other support department expenses increased $14.7 million primarily due to increases in stock-based compensation expenses and legal department expenses, partially offset by a decrease in supply department expenses.
Other income declined $4.0 million primarily as a result of $17.3 million in legal recoveries we received during the prior year, partially offset by other gains recorded in the current year.
The pretax loss was $104.5 million, compared with last year’s loss of $96.4 million.
Our effective tax rate for the year increased to 40.7% compared to 38.7% in the prior year. This increase is due to higher deferred tax valuation allowances and increases in reserves for uncertain tax positions.
FISCAL 2005 COMPARED TO FISCAL 2004 – ...
Corporate expenses increased $4.2 million primarily due to higher interest expense, resulting from higher interest rates and higher average debt balances.
Marketing department expenses increased $6.8 million, or 6.1%, primarily due to additional marketing efforts in the current year.fiscal year 2005. Other support department expenses increased $29.0 million, primarily due to $15.1 million of additional stock-based compensation expenses, increases in the cost of employee insurance and supplies.
Other income increased $19.8 million primarily as a result of $17.3 million in legal recoveries.
The pretax loss was $96.4 million, compared with last year’sa loss of $107.7 million.million in fiscal year 2004.
Our effective income tax rate for fiscal year 2005 decreased to 37.5%38.7% compared to 38.5%39.8% in fiscal year 2004. The decrease is due to tax benefits realized on net operating loss carryforwards and their related benefits.carryforwards.
34
FINANCIAL CONDITION - ...
CAPITAL RESOURCES & LIQUIDITY BY SEGMENT
Our sources of capital include cash from operations, issuances of common stock and debt. We use capital primarily to fund working capital,
CASH FROM OPERATIONS – ...Operating cash flows totaled $585.7 million, $513.8 million $852.5 million and $689.7$852.5 million in fiscal years 2006, 2005 2004 and 2003,2004, respectively. Operating cash flows in fiscal year 2005 decreased2006 increased from fiscal year 20042005 primarily due to decreased cash flows from both Mortgage Services and Tax Services and increasedlower income tax payments. Tax Services and Mortgage Services contributed $529.0 million and $98.3 million, respectively, to cash from operations in the current year. Income
ISSUANCES OF COMMON STOCK – ...We issue shares of our common stock in accordance with our stock-based compensation plans out of our treasury shares. Proceeds from the issuance of common stock totaled $108.5 million, $136.1 million $120.0 million and $126.3$120.0 million in fiscal years 2006, 2005 and 2004, and 2003, respectively.
DEBT – ... In August 2004 we filed an additional shelf registration statement with the SEC for up to $1.0 billion in debt securities. On October 26, 2004, we issued $400.0 million of 5.125% Senior Notes under our shelf registration statements. The proceeds from the notes were used to repay our $250.0 million in 63/4% Senior Notes, which were due on November 1, 2004. The remaining proceeds were used for working capital, capital expenditures, repayment of other debt and other general corporate purposes.
DIVIDENDS – ...We have consistently paid quarterly dividends. Dividends paid totaled $160.0 million, $143.0 million $138.4 million and $125.9$138.4 million in fiscal years 2006, 2005 and 2004, and 2003, respectively.
SHARE REPURCHASES – ...On June 9, 2004, our Board of Directors approved an authorization to repurchase an additional 15 million shares. This authorization is in addition to the authorization of 20 million shares on June 11, 2003. During fiscal year 2005,2006, we repurchased 11.29.0 million shares pursuant to these authorizations at an aggregate price of $527.5$254.2 million or an average price of $46.98$28.18 per share. There were 15.010.5 million shares remaining under the 2004 authorization and 0.1 million shares remaining under the 2003 authorization at the end of fiscal year 2005.2006.
We plan to continue to purchase shares on the open market in accordance with the existing authorizations, subject to various factors including the price of the stock, the availability of excess cash, our ability to maintain liquidity and financial flexibility, securities laws restrictions, targeted capital levels and other investment opportunities available.
ACQUISITIONS – ...From time to time we acquire businesses that are viewed to be a good strategic fit to our organization. Total cash paid for acquisitions was $212.5 million, $37.6 million $280.9 million and $26.4$280.9 million during fiscal years 2006, 2005 and 2004, respectively. Acquisitions during fiscal year 2006 included American Express Tax and 2003, respectively.Business Services, Inc. Cash paid in fiscal year 2006 related to the acquisition of this business totaled $190.7 million. Significant acquisitions during fiscal year 2004 were the former major franchise territories we now operate as company-owned. Cash paid in fiscal year 2004 related to the acquisition of these territories totaled $243.2 million.
RESTRICTED CASH – ...We hold certain cash balances that are restricted as to use. Cash and cash equivalents –- restricted totaled $516.9$394.1 million at fiscal year end. Investment Services held $465.0$369.0 million of this total segregated in a special reserve account for the exclusive benefit of customers pursuant to Rule 15c3-3 of the Securities Exchange Act of 1934. Restricted cash of $28.1$16.4 million at April 30, 20052006 held by Business Services is related to funds held to pay payroll and related taxes on behalf of its customers. Restricted cash held by Mortgage Services totaled $23.8$8.4 million at April 30, 20052006 for outstanding commitments to fund mortgage loans.
FISCAL YEAR 20062007 OUTLOOK – ...We began construction on a new worldcorporate headquarters facility during fiscal year 2005. Estimated remaining construction costs to be incurred during fiscal year 20062007 of $103.5$63.9 million will be financed from operating cash flows.
Our Board of Directors approved an increase of the quarterly cash dividend from 2212.5 cents to 2513.5 cents per share, a 13.6%an 8.0% increase, effective with the quarterly dividend payment on October 3, 20052, 2006 to shareholders of record on September 12, 2005.11, 2006. On June 7, 2006, our Board also approved an additional authorization to repurchase 20.0 million shares.
We plan to refinance our $500.0 million in Senior Notes, which are due in April 2007.
The initial capital contribution for the H&R Block Bank will be $160.0 million, which we transferred on May 1, 2006, with an additional $10.0 million capital contribution planned during fiscal year 2007. H&R Block Bank is required to maintain a minimum leverage capital to total asset ratio of 12% during its first three years of operations.
35
A condensed consolidating statement of cash flows by segment for the fiscal year ended April 30, 20052006 follows. Generally, interest is not charged on intercompany activities between segments. Detailed consolidated statements of cash flows are located in Item 8.
| (in 000s) | |||||||||||||||||||||||||||
| Tax | Mortgage | Business | Investment | Consolidated | |||||||||||||||||||||||
| Fiscal Year 2005 | Services | Services | Services | Services | Corporate | H&R Block | |||||||||||||||||||||
| Cash provided by (used in): | |||||||||||||||||||||||||||
| Operations | $ | 528,990 | $ | 98,303 | $ | 44,657 | $ | (32,408 | ) | $ | (125,749 | ) | $ | (513,793 | ) | ||||||||||||
| Investing | (83,534 | ) | 99,906 | (37,816 | ) | 7,618 | (44,584 | ) | (58,410 | ) | |||||||||||||||||
| Financing | 3,482 | (15,126 | ) | (23,223 | ) | (1,686 | ) | (391,362 | ) | (427,915 | ) | ||||||||||||||||
| Net intercompany | (448,912 | ) | (184,156 | ) | 13,725 | 19,965 | 599,378 | – | |||||||||||||||||||
| (in 000s) | ||||||||||||||||||||||||
| Mortgage | Business | Investment | Consolidated | |||||||||||||||||||||
| Tax Services | Services | Services | Services | Corporate | H&R Block | |||||||||||||||||||
FISCAL YEAR 2006 – | ||||||||||||||||||||||||
| Cash provided by (used in): | ||||||||||||||||||||||||
| Operations | $ | 596,025 | $ | (123,903 | ) | $ | 31,258 | $ | 24,894 | $ | 57,412 | $ | 585,686 | |||||||||||
| Investing | (62,797 | ) | (309,302 | ) | (221,122 | ) | 12,615 | (107,899 | ) | (688,505 | ) | |||||||||||||
| Financing | 14,173 | - | (23,611 | ) | 14,538 | (308,136 | ) | (303,036 | ) | |||||||||||||||
| Net intercompany | (527,564 | ) | 422,418 | 233,744 | (13,470 | ) | (115,128 | ) | - | |||||||||||||||
Net intercompany activities are excluded from investing and financing activities within the segment cash flows. We believe that by excluding intercompany activities, the cash flows by segment more clearly depicts the cash generated and used by each segment. Had intercompany activities been included, those segments in a net lending situation would have been included in investing activities, and those in a net borrowing situation would have been included in financing activities.
TAX SERVICES – ...Tax Services has historically been our largest provider of annual operating cash flows. The seasonal
nature of Tax Services generally results in a large positive operating cash flow in the fourth quarter. Tax Services generated $529.0$596.0 million in operating cash flows primarily related to net income, as cash is generally collected from clients at the time services are rendered. PriorWe also received a signing bonus from HSBC during the current year cash requirements for investing activities included $243.2 million paidin connection with our new RAL participation agreement, which was recorded as deferred revenue at April 30, 2006.
Since July 1996, we have been a party to acquire former major franchisees.
agreements with HSBC and its predecessors to participate in RALs provided by a lending bank to H&R Block tax clients. During fiscal year 2006, we signed a new agreement with HSBC under which HSBC and its designated bank will provide funding of all RALs offered pursuant to a contract that expires inthrough June 2006.2011. If HSBC and its designated bank do not continue to provide funding for RALs, we could seek other RAL lenders to continue offering RALs to our clients or consider alternative funding strategies. We believe that a number of suitable lenders would be available to replace HSBC should the need arise.
We also believe that the RAL program is productive for the Company and a useful service for our customers. The RAL program is regularly reviewed both from a business perspective and to ensure compliance with applicable state and federal laws. It is our intention to continue to offer the RAL program in the foreseeable future.
Loss of the RAL program could adversely affect our operating results. In addition to the loss of revenues and income directly attributable to the RAL program, the inability to offer RALs could indirectly result in the loss of retail tax clients and associated tax preparation revenues, unless we were able to take mitigating actions. Total revenues related to the RAL program (including revenues from participation interests) were $179.3 million for the year ended April 30, 2006, representing 3.7% of consolidated revenues and contributed $106.5 million to the segment’s pretax results. Revenues related to the RAL program totaled $182.6 million for the year ended April 30, 2005, representing 4.1% of consolidated revenues and contributed $101.3 million to the segment’s pretax results. Revenues related to the RAL program totaled $174.2 million for the year ended April 30, 2004, representing 4.1% of consolidated revenues.
Our international operations are generally self-funded. Cash balances are held in Canada, Australia and the United Kingdom independently in local currencies. H&R Block Canada, Inc. (“Block Canada”)(Block Canada) has a commercial paper program for up to $125.0$225.0 million (Canadian). At April 30, 2005,2006, there was no commercial paper outstanding. The peak borrowing during fiscal year 20052006 was $124.0$133.0 million (Canadian).
MORTGAGE SERVICES – ...This segment primarily generates cash as a result of the sale and securitization of mortgage loans and residual interests and as its residual interests mature. Mortgage Services provided $98.3used $123.9 million in cash from operating activities primarily due to the sale ofhigher MSR balances and mortgage loans.loans held for sale. This segment also generated $99.9used $309.3 million in cash from investing activities primarily related to loans originated for transfer to the H&R Block Bank, partially offset by cash received from the maturity and sales of available-for-sale residual interests. We regularly sell loans as a source of liquidity. Loan sales in fiscal year 20052006 were $31.0$40.3 billion compared with $23.2$31.0 billion in fiscal year 2004.2005. Additionally, Block Financial Corporation (“BFC”)(BFC) provides a line of credit of at least $150 million for working capitalworkingcapital needs. At the end of fiscal year 20052006 there was no$372.6 million outstanding balance on this facility.
| (in 000s) | |||||||||||||||
| Restated | Restated | ||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Cash proceeds: | |||||||||||||||
| Whole loans sold by the Trusts | $ | 737,417 | $ | 741,233 | $ | 368,305 | |||||||||
| Residual cash flows from Beneficial interest in Trusts | 193,639 | 167,705 | 103,294 | ||||||||||||
| Loans securitized | 69,665 | 198,226 | 389,449 | ||||||||||||
| Sale of previously securitized residuals | 15,396 | 40,689 | 93,307 | ||||||||||||
| Gain (loss) on derivative instruments | 45,298 | (2,578 | ) | (2,056 | ) | ||||||||||
| 1,061,415 | 1,145,275 | 952,299 | |||||||||||||
| Non-cash: | |||||||||||||||
| Retained mortgage servicing rights | 137,510 | 84,274 | 60,078 | ||||||||||||
Additions (reductions) to balance sheet (1) | 15,885 | 11,490 | (10,829 | ) | |||||||||||
| 153,395 | 95,764 | 49,249 | |||||||||||||
| Portion of gain on sale from capital market transactions | $ | 1,214,810 | $ | 1,241,039 | $ | 1,001,548 | |||||||||
| Other items included in gain on sale: | |||||||||||||||
| Changes in beneficial interest in Trusts | 36,281 | 37,918 | 74,987 | ||||||||||||
| Impairments to fair value of residual interests | (12,235 | ) | (26,063 | ) | (54,111 | ) | |||||||||
| Net change in fair value of derivative instruments | 1,555 | (9,379 | ) | (2,085 | ) | ||||||||||
| Direct origination and acquisition expenses, net | (378,674 | ) | (278,785 | ) | (182,216 | ) | |||||||||
| Loan sale repurchase reserves | (39,662 | ) | (46,820 | ) | (21,295 | ) | |||||||||
| Other | – | 387 | 10,299 | ||||||||||||
| (392,735 | ) | (322,742 | ) | (174,421 | ) | ||||||||||
| Reported gains on sales of mortgage assets | $ | 822,075 | $ | 918,297 | $ | 827,127 | |||||||||
% of gain on sale from capital market transactions received as cash (2) | 87% | 92% | 95% | ||||||||||||
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To finance our prime mortgage loan originations, we use a warehouse facility with capacity up to $25 million. This annual facility bears interest at one-month LIBOR plus 140 to 200 basis points. As of April 30, 20052006 and 2004,2005, the balance outstanding under this facility was $4.4$1.6 million and $4.0$4.4 million, respectively, and is included in accounts payable, accrued expenses and other current liabilities on the consolidated balance sheets.
We believe the sources of liquidity available to the Mortgage Services segment are sufficient for its needs. Risks to the stability of these sources include, but are not limited to, adverse changes in the perception of the non-prime industry, adverse changes in the regulation of non-prime lending, changes in the rating criteria of non-prime lending by third-party rating agencies and, to a lesser degree, reduction in the availability of third parties thatwho provide credit enhancement. Past performance of the securitizations will also impact the segment’s future participation in these markets. The off-balance sheet warehouse facilities used by the Trusts are subject to annual renewal, each at a different time during the year, and any of the above events could lead to difficulty in renewing the lines. These risks are mitigated by a staggering of the renewal dates related to these warehouse lines and through the use of multiple lending institutions to secure these lines.
BUSINESS SERVICES – ...Business Services funding requirements are largely related to receivables for completed work and “work in process.” We provide funding in the normal course of business sufficient to cover theirthese working capital needs. Business Services also has future obligations and commitments, which are summarized in the tables below under “Contractual Obligations and Commercial Commitments.”
This segment generated $44.7$31.3 million in operating cash flows primarily related to net income. Additionally, Business Services used $37.8$221.1 million in investing activities primarily related to the acquisition of American Express Tax and Business Services, Inc. and contingent payments on prior acquisitions, and $23.2$23.6 million in financing activities as a result of payments on acquisition debt.
INVESTMENT SERVICES – ...Investment Services, through HRBFA, is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers.
HRBFA is required to maintain minimum net capital as defined under Rule 15c3-1 of the Securities Exchange Act of 1934 and complies with the alternative capital requirement, which requires a broker-dealer to maintain net capital equal to the greater of $250,000$1,000,000 or 2% of the combined aggregate debit balances arising from customer transactions. The net capital rule also provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than the greater of 5% of combined aggregate debit items or 120% of the minimum required net capital. At the end of fiscal year 2005,2006, HRBFA’s net capital of $121.2$121.7 million, which was 19.2%22.9% of aggregate debit items, exceeded its minimum required net capital of $12.6$10.6 million by $108.6$111.1 million. During fiscal year 2006, H&R Block Financial Corporation, HRBFA’s direct corporate parent, contributed $5.0 million of additional capital to HRBFA. During fiscal year 2005, and 2004, we contributed additional capital of $27.0 million and $32.0 million, respectively, even thoughmillion. HRBFA was in excess of the minimum net capital requirement during fiscal years 2006 and 2005, but we may continue to do socontribute additional capital in the future.
In fiscal year 2005,2006, Investment Services used $32.4provided $24.9 million infrom its operating activities primarily due to operating losses.improved performance.
To manage short-term liquidity, BFC provides HRBFA a $300 million unsecured credit facility. At the end of fiscal year 20052006 there was no outstanding balance on this facility.
HRBFA has lettersa secured letter of credit with aan unaffiliated financial institution with a credit limit of $125.0$50.0 million. There were no commitments outstandingborrowings on these lettersthis letter of credit at any time during fiscal yearyears 2006 or 2005 and no outstanding balance at April 30, 2006 or 2004.2005.
Liquidity needs relating to client trading and margin-borrowing activities are met primarily through cash balances in client brokerage accounts and working capital. We believe these sources of funds will continue to be the primary sources of liquidity for Investment Services. Stock loans have historically been used as a secondary source of funding and could be used in the future, if warranted.
Securities borrowed and securities loaned transactions are generally reported as collateralized financings. These transactions require us to deposit cash and/or collateral with the lender.counterparty. Securities loaned consist of customers’ securities owned by customers, which were purchased on margin. When loaning securities, weWe receive cash collateral approximately equal to the value of the securities loaned. The amount of cash collateral is adjusted, as required, for market fluctuations in the value of the securities loaned. Interest rates paid on the cash collateral fluctuate as short-term interest rates change.
To satisfy the margin deposit requirement of client option transactions with the Options Clearing Corporation (“OCC”)(OCC), Investment ServicesHRBFA pledges customers’ margined securities. Pledged securities at the end of fiscal year 20052006 totaled $44.6$53.0 million, an excess of $7.9$9.9 million over the margin requirement. Pledged securities at the end of fiscal year 20042005 totaled $46.3$44.6 million, an excess of $7.9 million over the margin requirement.
We believe the funding sources for Investment Services are stable. Liquidity risk within this segment is primarily limited to maintaining sufficient capital levels to obtain securities lending liquidity to support margin borrowing by customers.
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OFF-BALANCE SHEET FINANCING ARRANGEMENTS
We are party to various transactions with an off-balance sheet component, including loan commitments and QSPEs, or Trusts.
We have commitments to fund mortgage loans in our pipeline of $3.9$4.0 billion and $4.2 billion at April 30, 2006 and 2005, respectively, which are subject to conditions and loan contract verification. There is no commitment on the part of the borrower to close on the mortgage loan at this stage of the lending process and external market forces impact the probability of these loan commitments being closed. Therefore, total commitments outstanding do not necessarily represent future cash requirements. If the loan commitments are exercised, they will be funded as described below.
Our relationships with the Trusts serve to reduce our capital investment in our non-prime mortgage operations. These arrangements are primarily used to sell mortgage loans, but a portion may also be used to sell servicing advances and finance residual interests. Additionally, these arrangements have freed up cash and short-term borrowing capacity, improved liquidity and flexibility, and reduced balance sheet risk, while providing stability and access to liquidity in the secondary market for mortgage loans.
Substantially all non-prime mortgage loans we originate are sold daily to the Trusts. The Trusts purchase the loans from us using fivenine committed warehouse facilities, arranged by us, totaling $9.0$14.5 billion. These facilities are subject to various Option One performance triggers, limits and financial covenants, including tangible net worth and leverage ratios.ratios and may be subject to margin calls. In addition, these facilities contain cross-default features in which a default in one facility would trigger a default under the other facilities as well. These various facilities bear interest at one-month LIBOR plus 50 to 400 basis points and expire on various dates during the year. In addition, some of the facilities provide for the payment of minimum usage fees.
When we sell loans to the Trusts, we remove the mortgage loans from our balance sheet and record the gain on the sale, cash, MSRs, recourse reserves and a beneficial interest in Trusts, which represents our residual interest in the ultimate expected outcome from the disposition of the loans.loans by the Trusts. Our beneficial interest in Trusts totaled $215.4$188.0 million and $153.8$215.4 million at April 30, 20052006 and 2004,2005, respectively.
Subsequently, the Trusts, as directedin response to the exercise of a put option by theirthe third-party beneficial interest holders, either sell the loans directly to third-party investors or back to us to pool the loans for securitization. The decision to complete a whole loan sale or a securitization is dependent on market conditions.
For fiscal year 2006, the final disposition of loans sold by the Trusts was 77% loan sales and 23% securitizations. For fiscal year 2005, the final disposition of loans sold toby the Trusts was 92% whole loan sales and 8% securitizations. For fiscal year 2004, the final disposition was 76% wholeThe higher percentage of loan sales and 24% securitizations. The current year shift to whole loan salessale transactions versus securitizations is due to the more favorable pricing in the whole loan market. Increased whole loan sale transactions resultmarket and also results in cash being received earlier. Additionally, whole loan sales do not add residual interests to our balance sheet, and therefore, we do not retain balance sheet risk.
If the Trusts sell the mortgage loans in a whole loan sale, we receive cash for our beneficial interest in Trusts. In a securitization transaction, the Trusts transfer the loans and the corresponding right to receive all payments on the loans to our consolidated special purpose entity, after which we transfer our beneficial interest in Trusts and the loans to a securitization trust. The securitization trust meets the definition of a QSPE and is therefore not consolidated. The securitization trust issues bonds, which are supported by the cash flows from the pooled loans, to third-party investors. We retain an interest in the loans in the form of a trading residual interest and, therefore, usually assume the first risk of loss for credit losses in the loan pool. As the cash flows of the underlying loans and market conditions change, the value of our trading residual interests may also change, resulting in potential write-ups or impairment of ourthese residual interests.
At the settlement of each securitization, we record cash received and our residual interests. Additionally, we reverse the beneficial interest in Trusts. TheseThe resulting residual interests are classified as trading securities. See Item 8, note 1 to our consolidated financial statements for our methodology used in valuing our residual interests.
To accelerate the cash flowsreceipts from our residual interests, we securitize the majority of our trading residual interests in net interest margin (“NIM”)(NIM) transactions. In a NIM transaction, the trading residual interests are transferred to another QSPE (“NIM trust”)(NIM trust), which then issues bonds to third-party investors. The proceeds from the bonds are returned to us as payment for the trading residual interests. The bonds are secured by thethese pooled residual interests and are obligations of the NIM trust. We retain a subordinated interest in the NIM trust, and receive cash flows on our residual interest generally after the NIM bonds issued to the third-party investors are paid in full.
At the settlement of each NIM transaction, we remove the trading residual interests sold from our consolidated balance sheet and record the cash received and the new residual interest retained.
38
retained. These new residual interests are classified as available-for-sale securities.
In connection with the sale of mortgage loans, we provide certain representations and warranties allowing the purchaser the option of returning the purchased loans to us under certain conditions. We may recognize losses as a result of the repurchase of loans under these arrangements. We maintain reserves for the repurchase of loans based on historical trends. See Item 8, note 1716 to our consolidated financial statements.
calendar year 2007.
COMMERCIAL PAPER ISSUANCE
We participate in the U.S. and Canadian commercial paper
| Short-term | Long-term | Outlook | |||||||||||||||||
| A | Negative | ||||||||||||||||||
| Moody’s | P2 | ||||||||||||||||||
| S&P | A2 | BBB+ | Stable | ||||||||||||||||
| DBRS | R-1 (low) | A | Stable | ||||||||||||||||
The following chart provides the debt ratings for Block Canada as of April 30, 2006:
| Short-term | Long-term | Outlook | ||||||||||
| DBRS | R-1 (low) | A | Stable | |||||||||
We use capital primarily to fund working capital requirements, pay dividends, repurchase our shares and acquire businesses. Commercial paper borrowings peaked at $2.1$2.3 billion in February 20052006 related to funding of our participation interests in RALs. No CP was outstanding at April 30, 20052006 or 2004.2005.
U.S. CP issuances are supported by $2.0 billion in unsecured committed lines of credit (“CLOCs”). During fiscal year 2005, we replaced our single $2.0 billion CLOC with two $1.0 billion CLOCs. The two CLOCs are from a consortium of thirty-one banks. The first $1.0 billion CLOC is subject to annual renewal(CLOCs), which mature in August 2005, has a one-year term-out provision with a maturity date in August 20062010 and hashave an annual facility fee of ten basis points per annum. The second $1.0 billion CLOC has a maturity date of August 2009eight and has an annual facility fee of twelveone-half basis points per annum. These lines are subject to various affirmative and negative covenants, including a minimum net worth covenant.
These CLOCsfacilities were undrawn at April 30, 2005.2006. There are no rating contingencies under the CLOCs.
The Canadian issuances are supported by a credit facility provided by one bank in an amount not to exceed $125.0$225.0 million (Canadian). The Canadian CLOC is subject to annual renewal in December 2005.2006. This CLOC was undrawn at April 30, 2005.2006.
We believe the CP market to be stable. Risks to the stability of our CP market participation would be a short-term rating downgrade, adverse changes in our financial performance, non-renewal or termination of the CLOCs, adverse publicity and operational risk within the CP market. We believe if any of these events were to occur, the CLOCs, to the extent available, could be used for an orderly exit from the CP market, though at a higher cost to us. Additionally, we could turn to other sources of liquidity, including cash, debt issuance under the existing shelf registration and asset sales or securitizations.
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CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
A summary of our obligations to make future payments as of April 30, 20052006 is as follows:
| (in 000s) | ||||||||||||||||||||||
| Less Than | After | |||||||||||||||||||||
| Total | 1 Year | 1 – 3 Years | 4 – 5 Years | 5 Years | ||||||||||||||||||
| Debt | $ | 897,046 | $ | 45 | $ | 498,916 | $ | 91 | $ | 397,994 | ||||||||||||
| Long-term obligation to government | 213,360 | 106,680 | 106,680 | – | – | |||||||||||||||||
| Acquisition payments | 38,022 | 25,159 | 12,863 | – | – | |||||||||||||||||
| Pension obligation assumed | 15,929 | 2,625 | 4,545 | 3,698 | 5,061 | |||||||||||||||||
| Capital lease obligation | 13,550 | 341 | 730 | 997 | 11,482 | |||||||||||||||||
| Operating leases | 708,611 | 229,768 | 313,264 | 124,945 | 40,634 | |||||||||||||||||
| Total contractual cash obligations | $ | 1,886,518 | $ | 364,618 | $ | 936,998 | $ | 129,731 | $ | 455,171 | ||||||||||||
| (in 000s) | ||||||||||||||||||||
| Total | Less Than 1 Year | 1 - 3 Years | 4 - 5 Years | After 5 Years | ||||||||||||||||
| Debt | $ | 897,426 | $ | 499,425 | $ | - | $ | - | $ | 398,001 | ||||||||||
| Long-term obligation to government | 183,937 | 107,849 | 74,692 | 1,396 | - | |||||||||||||||
| Retirement obligation assumed | 14,264 | 2,426 | 4,176 | 3,196 | 4,466 | |||||||||||||||
| Acquisition payments | 13,895 | 7,210 | 6,458 | 91 | 136 | |||||||||||||||
| Capital lease obligation | 13,209 | 357 | 860 | 1,043 | 10,949 | |||||||||||||||
| Operating leases | 856,816 | 269,890 | 371,984 | 157,123 | 57,819 | |||||||||||||||
| Total contractual cash obligations | $ | 1,979,547 | $ | 887,157 | $ | 458,170 | $ | 162,849 | $ | 471,371 | ||||||||||
In October 2004, we issued $400.0 million of 5.125% Senior Notes, due 2014. The Senior Notes are not redeemable by the bondholders prior to maturity. The net proceeds of this transaction were used to repay the $250.0 million in 63/4% Senior Notes, which were due November 1, 2004. The remaining proceeds were used for working capital, capital expenditures, repayment of other debt and other general corporate purposes.
In April 2000, we issued $500.0 million of 81/2% Senior Notes, due 2007. The Senior Notes are not redeemable prior to maturity. The net proceeds of this transaction were used to repay a portion of the short-term borrowings that initially funded the acquisition of OLDE.OLDE Financial Corporation. We plan to refinance these Senior Notes when they come due.
As of April 30, 2006, we had $850.0 million remaining under our shelf registration for additional debt issuances. As a result of our failure to file our Form 10-Q for the fiscal quarter ended January 31, 2006 by the SEC’s prescribed due date, we will be unable to issue any debt securities under this shelf registration statement until April 2007.
Future payments related to Business Services acquisitions and capital lease obligations are included in long-term debt on our consolidated balance sheets. Our debt to total capital ratio was 32.4% at April 30, 2005, compared with 31.1% at April 30, 2004.
In connection with our acquisition of the non-attest assets of M&P in August 1999, we assumed certain pensionretirement liabilities related to M&P’s retired partners. We make payments in varying amounts on a monthly basis, which are included in other noncurrent liabilities.
Operating leases, although requiring future cash payments, are not included in our consolidated balance sheets.
A summary of our commitments as of April 30, 2005,2006, which may or may not require future payments, expire as follows:
| (in 000s) | ||||||||||||||||||||||
| Less Than | After | |||||||||||||||||||||
| Total | 1 Year | 1 - 3 Years | 4 - 5 Years | 5 Years | ||||||||||||||||||
| Commitments to fund mortgage loans | $ | 3,931,926 | $ | 3,931,926 | $ | – | $ | – | $ | – | ||||||||||||
| Commitments to sell mortgage loans | 8,707,000 | 8,707,000 | – | – | – | |||||||||||||||||
| Pledged securities | 44,609 | 44,609 | – | – | – | |||||||||||||||||
| Commitment to fund M&P | 75,000 | 75,000 | – | – | – | |||||||||||||||||
| Franchise Equity Lines of Credit | 68,949 | 20,122 | 20,476 | 28,351 | – | |||||||||||||||||
| Mortgage loan repurchase obligations | 41,233 | 41,233 | – | – | – | |||||||||||||||||
| Construction of new building | 143,116 | 103,505 | 39,611 | – | – | |||||||||||||||||
| Other commercial commitments | 8,219 | 5,221 | 2,500 | 458 | 40 | |||||||||||||||||
| Total commercial commitments | $ | 13,020,052 | $ | 12,928,616 | $ | 62,587 | $ | 28,809 | $ | 40 | ||||||||||||
| (in 000s) | ||||||||||||||||||||
| Total | Less Than 1 Year | 1 - 3 Years | 4 - 5 Years | After 5 Years | ||||||||||||||||
| Commitments to fund mortgage loans | $ | 4,032,045 | $ | 4,032,045 | $ | - | $ | - | $ | - | ||||||||||
| Commitments to sell mortgage loans | 3,052,688 | 3,052,688 | - | - | - | |||||||||||||||
| Franchise Equity Lines of Credit | 75,909 | 18,860 | 29,958 | 27,091 | - | |||||||||||||||
| Commitment to fund M&P | 75,000 | 75,000 | - | - | - | |||||||||||||||
| Construction of new building | 63,887 | 63,887 | - | - | - | |||||||||||||||
| Pledged securities | 53,026 | 53,026 | - | - | - | |||||||||||||||
| Other commercial commitments | 31,282 | 8,209 | 19,888 | 3,185 | - | |||||||||||||||
| Total commercial commitments | $ | 7,383,837 | $ | 7,303,715 | $ | 49,846 | $ | 30,276 | $ | - | ||||||||||
See discussion of commitments in Item 8, note 1716 to our consolidated financial statements.
REGULATORY ENVIRONMENT
The U.S., various state, local, provincial and foreign governments and some self-regulatory organizations have enacted statutes and ordinances, and/or adopted rules and regulations, regulating aspects of our business. These aspects include, but are not limited to, commercial income tax return preparers, income tax courses, the electronic filing of income tax returns, the
facilitation of RALs, loan originations and assistance in loan originations, mortgage lending, privacy, consumer protection, franchising, sales methods, brokers, broker-dealers and various aspects of securities transactions, financial planners, investment advisors, accountants and the accounting practice. We seek to determine the applicability of such statutes, ordinances, rules and regulations (collectively, “Laws”) and comply with those Laws.
From time to time in the ordinary course of business, we receive inquiries from governmental and self-regulatory agencies regarding the applicability of Laws to our services and products.
40
In response to past inquiries, we have agreed to comply with such Laws, convinced the authorities that such Laws were not applicable or that compliance already exists, and/or modified our activities in the applicable jurisdiction to avoid the application of all or certain parts of such Laws. We believe that the past resolution of such inquiries and our ongoing compliance with Laws have not had a material adverse effect on our consolidated financial statements. We cannot predict what effect future Laws, changes in interpretations of existing Laws, or the results of future regulator inquiries with respect to the applicability of Laws may have on our consolidated financial statements.
See additional discussion of legal matters in Item 3, “Legal Proceedings” and Item 8, note 17 to our consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
See Item 8, note 1 to our consolidated financial statements for a discussion of recently issued accounting pronouncements.
RECONCILIATION OF NON-GAAP FINANCIAL INFORMATION
We report our financial results in accordance with generally accepted accounting principles
| Origination Margin | (in 000s) | ||||||||||||||
| Restated | Restated | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Total expenses | $ | 749,925 | $ | 635,186 | $ | 493,756 | |||||||||
| Add: Expenses netted against gain on sale revenues | 378,304 | 267,780 | 162,332 | ||||||||||||
| Less: | |||||||||||||||
| Cost of services | 221,300 | 193,018 | 141,419 | ||||||||||||
| Cost of acquisition | 169,621 | 114,707 | 59,637 | ||||||||||||
| Allocated support departments | 24,161 | 21,124 | 7,630 | ||||||||||||
| Other | 20,323 | 31,378 | 28,238 | ||||||||||||
| $ | 692,824 | $ | 542,739 | $ | 419,164 | ||||||||||
| Divided by origination volume | $ | 31,001,724 | $ | 23,256,013 | $ | 16,577,621 | |||||||||
| Total cost of origination | 2.23% | 2.33% | 2.53% | ||||||||||||
| Origination Margin | (dollars in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Total Mortgage Services expenses | $ | 925,522 | $ | 749,925 | $ | 635,186 | ||||||
| Add: Expenses netted against gain on sale revenues | 387,911 | 378,304 | 267,780 | |||||||||
| Less: | ||||||||||||
| Cost of services | 296,710 | 221,148 | 193,383 | |||||||||
| Cost of acquisition | 150,981 | 169,621 | 114,707 | |||||||||
| Allocated support departments | 26,176 | 24,161 | 21,124 | |||||||||
| Other | 62,500 | 20,323 | 31,378 | |||||||||
| Total cost of origination | $ | 777,066 | $ | 692,976 | $ | 542,374 | ||||||
| Divided by origination volume | $ | 40,779,763 | $ | 31,001,724 | $ | 23,256,013 | ||||||
| Cost of origination margin | 1.91 | % | 2.23 | % | 2.33 | % | ||||||
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
INTEREST RATE RISK –
Our cash equivalents are primarily held for liquidity purposes and are comprised of high quality, short-term investments, including qualified money market funds. As of April 30, 2005,2006, our non-restricted cash and cash equivalents had an average maturity
of less than three months with an average credit quality of AAA. With such a short maturity, our portfolio’s market value is relatively insensitive to interest rate changes. We hold investments in fixed income securities at our captive insurance subsidiary. See the table below for sensitivities to changes in interest rates. See additional discussion of interest rate risk included below in Mortgage Services and Investment Services.
At April 30, 2005,2006, no commercial paper was outstanding. For fiscal year 2005,2006, the average issuance term was 2933 days and the average outstanding balance was $388.2$558.4 million. As commercial paper and bank borrowings are seasonal, interest rate risk typically increases through our third fiscal quarter and declines to zero by fiscal year-end. See Item 7, “Financial Condition” for additional information.
Our current portion of long-term debt and long-term debt at April 30, 20052006 consists primarily of fixed-rate Senior Notes; therefore, a change in interest rates would have no impact on consolidated pretax earnings. See Item 8, note 109 to our consolidated financial statements.
EQUITY PRICE RISK – ... We have exposure to the equity markets in several ways. The largest exposures areexposure, though relatively small, is through our deferred compensation plans and equity investments at our captive insurance subsidiary.plans. Within the deferred compensation plans we have mismatches in asset and liability amounts and investment choices (both fixed-income and equity). At April 30, 20052006 and 2004,2005, the impact of a 10% market value change in the combined equity assets held by our deferred compensation plans and our captive insurance subsidiaryother equity investments would be approximately $9.3$11.6 million and $8.9$9.3 million, respectively, assuming no offset for the liabilities.
41
TAX SERVICES
FOREIGN EXCHANGE RATE RISK–
MORTGAGE SERVICES
INTEREST RATE RISK – NON-PRIME ORIGINATIONS–Interest rate changes impact the value of the loans underlying our beneficial interest in Trusts, on our balance sheet or in our origination pipeline, as well as residual interests in securitizations and MSRs.
INTEREST RATE RISK – NON-PRIME ORIGINATIONS–Interest rate changes impact the value of the loans underlying our beneficial interest in Trusts, on our balance sheet or in our origination pipeline, as well as residual interests in securitizations and MSRs.
As a result of loan sales to the Trusts, we remove the mortgage loans from our balance sheet and record the gain on sale, cash, MSRs, recourse reserves and a beneficial interest in Trusts, which represents our residual interest in the ultimate expected outcome from the disposition of the loans by the Trusts. See Item 7, “Off-Balance Sheet Financing Arrangements.” At April 30, 2006, there were $7.8 billion of loans held in the Trusts and the value of our beneficial interest in Trusts was $188.0 million. At April 30, 2006, we had $236.4 million of mortgage loans held for sale and $407.5 million of mortgage loans held for investment on our balance sheet. Changes in interest rates and other market factors may result in a change in value of our beneficial interest in Trusts, mortgage loans held for sale and mortgage loans held for investment.
We are exposed to interest rate risk associated with commitments to fund approved loan applications of $4.0 billion, subject to conditions and loan contract verification. In addition, we have interest rate risk related to $1.0 billion in new loan applications which have not yet been approved, and $3.0 billion of applications which we expect to receive prior to our next anticipated change in rates charged to borrowers. Of these amounts, we estimate only $5.1 billion will likely be originated.
We use forward loan sale commitments, interest rate swaps and put options on Eurodollar futures to reduce our interest rate risk associated with non-prime loans. Forward loan sale commitments represent an obligation to sell a non-prime loan at a specific price in the future and increase in value as rates rise and decrease as rates fall. At April 30, 2006, there were $3.1 billion in forward loan sale commitments, and most of them give us the option to under- or over-deliver by five to ten percent. Forward loan sale commitments lock in the execution price on the loans that will be ultimately delivered into a loan sale. At April 30, 2006, we recorded an asset of $2.0 million reflecting the fair value of these instruments.
Interest rate swaps represent an agreement to exchange interest rate payments, whereby we pay a fixed rate and receive a floating rate. Put options on Eurodollar futures represent the right to sell a Eurodollar futures contract at a specified price in the future. These swap and put option contracts increase in value as rates rise and decrease in value as rates fall. At April 30, 2006, the interest rate swaps and put options provided interest risk coverage of $9.9 billion. At April 30, 2006, we had assets recorded at fair values of $8.8 million and $3.3 million on our balance sheet related to interest rate swaps and put options, respectively.
See table below for sensitivities to changes in interest rates.
INTEREST RATE RISK – PRIME ORIGINATIONS – ...At April 30, 2006, we had commitments to fund prime mortgage loans totaling $83.2 million. We regularly enter into rate-lock commitments with our customers to fund prime mortgage loans within specified periods of time. The fair value of rate-lock commitments is calculated based on the current market pricing of short sales of FNMA, FHLMC and GNMA mortgage-backed securities and the coupon rates of the eligible loans. At April 30, 2005,2006, we recorded an asseta liability at a fair value of $0.8$0.3 million related to rate-lock commitments.
We sell short FNMA, FHLMC and GNMA mortgage-backed securities to reduce the risk related to our prime commitments to fund fixed-rate prime loans. The position on certain, or all, of the fixed-rate mortgage loans is closed approximately 10-15 days prior to standard Public Securities Association (“PSA”)(PSA) settlement dates. At April 30, 20052006 we recorded a liabilityan asset of $0.8 million related to these instruments.
To finance our prime originations, we use a warehouse facility with capacity up to $25 million, which bears interest at one-month LIBOR plus 140 to 200 basis points. As of April 30, 2005,2006, the balance outstanding under this facility was $4.4$1.6 million.
42
DELIVERY RISK – ...We have exposure to delivery risk in our non-prime origination operations, which regularly enter into forward loan sale commitments prior to loans being originated. It is possible that we will be unable to originate the loans or that the loans originated will not meet the required characteristics of the forward loan sale commitments. Several remedies are available, although use of the remedies could reduce the execution price or the effectiveness of the forward loan sale commitment in reducing interest rate risk.
RESIDUAL INTERESTS– ...Relative to modeled assumptions, an increase or decrease in interest rates would impact the value of our residual interests and could affect accretion income related to our residual interests. Residual interests bear the interest rate risk embedded within the securitization due to an initial fixed-rate period on the loans versus a floating-rate funding cost. Residual interests also bear the on-going risk that the floating interest rate earned after the fixed period on the mortgage loans is different from the floating interest rate on the bonds sold in the securitization.
We enter into interest rate caps and swaps to mitigate interest rate risk associated with mortgage loans that will be securitized and residual interests that are classified as trading securities because they will be sold in a subsequent NIM transaction. The caps and swaps enhance the marketability of the securitization and NIM transactions. An interest rate cap represents a right to receive cash if interest rates rise above a contractual strike rate, its value therefore increases as interest rates rise. The interest rate used in our interest rate caps isand the floating rate used in swaps are based on LIBOR. At April 30, 20052006 we had no assets or liabilities recorded an asset totaling $12.5 million related to interest rate caps.
See table below for sensitivities to changes in interest rates for residual interests, caps and caps.swaps. See Item 8, note 65 to the consolidated financial statements for additional analysis of interest rate risk and other financial risks impacting residual interests.
It is our policy to use derivative instruments only for the purpose of offsetting or reducing the risk of loss associated with a defined or quantified exposure.
MORTGAGE SERVICING RIGHTS – ...Declining interest rates may cause increased refinancing activity, which reduces the life of the loans underlying the residual interests and MSRs, thereby generally reducing their fair value. The fair value of MSRs generally increases in a rising rate environment, although MSRs are recorded at the lower of cost or market value. Reductions in the fair value of these assets impact earnings through impairment charges. See Item 8, note 65 to our consolidated financial statements for further sensitivity analysis of other MSR valuation assumptions.
INVESTMENT SERVICES
INTEREST RATE RISK –
Our fixed-income trading portfolio is affected by changes in market rates and prices. The risk is the loss of income arising from adverse changes in the value of the trading portfolio. We value the trading portfolio at quoted market prices and the market value of our trading portfolio at April 30, 20052006 was approximately $6.3$16.1 million, net of $4.8$0.5 million in securities sold short. See table below for sensitivities to changes in interest rates. With respect to our fixed-income securities portfolio, we manage our market price risk exposure by limiting concentration risk, maintaining minimum credit quality and limiting inventory to anticipated retail demand and current market conditions.
43
The sensitivities of certain financial instruments to changes in interest rates as of April 30, 20052006 and 20042005 are presented below. The following table represents hypothetical instantaneous and sustained parallel shifts in interest rates and should not be relied on as an indicator of future expected results.
| (in 000s) | ||||||||||||||||||||||||||||||||||
| Basis Point Change | ||||||||||||||||||||||||||||||||||
| Fair Value at | ||||||||||||||||||||||||||||||||||
| April 30, 2005 | - 200 | - 100 | - 50 | + 50 | + 100 | + 200 | + 300 | |||||||||||||||||||||||||||
| Residual interests in securitizations – available-for-sale | $ | 205,936 | $ | 84,845 | $ | 30,417 | $ | 13,637 | $ | (13,520 | ) | $ | (28,174 | ) | $ | (51,466 | ) | $ | (75,296 | ) | ||||||||||||||
| Interest rate caps | 12,458 | – | 205 | 4,580 | 20,746 | 29,262 | 46,751 | 64,195 | ||||||||||||||||||||||||||
| Investments at captive insurance subsidiary | 9,968 | 1,079 | 522 | 256 | (248 | ) | (487 | ) | (942 | ) | (1,368 | ) | ||||||||||||||||||||||
| Fixed income – trading (net) | 6,252 | 1,958 | 893 | 426 | (390 | ) | (749 | ) | (1,383 | ) | (1,921 | ) | ||||||||||||||||||||||
| Interest rate swaps | (1,325 | ) | (84,723 | ) | (43,024 | ) | (19,524 | ) | 19,524 | 43,024 | 84,723 | 123,771 | ||||||||||||||||||||||
| Basis Point Change | ||||||||||||||||||||||||||||||||||
| Fair Value at | ||||||||||||||||||||||||||||||||||
| April 30, 2004 | - 50 | + 50 | + 100 | + 200 | + 300 | |||||||||||||||||||||||||||||
| Residual interests in securitizations – available-for-sale | $ | 210,973 | $ | 45,449 | $ | (18,563 | ) | $ | (32,709 | ) | $ | (46,527 | ) | $ | (48,090 | ) | ||||||||||||||||||
| Investments at captive insurance subsidiary | 44,667 | 1,079 | (1,069 | ) | (1,591 | ) | (3,146 | ) | (4,667 | ) | ||||||||||||||||||||||||
| Fixed income – trading (net) | 13,639 | 677 | (637 | ) | (1,228 | ) | (2,271 | ) | (3,164 | ) | ||||||||||||||||||||||||
| (in 000s) | ||||||||||||||||||||||||||||||||||||
| Carrying Value at | Basis Point Change | |||||||||||||||||||||||||||||||||||
| April 30, 2006 | -300 | -200 | -100 | -50 | +50 | +100 | +200 | +300 | ||||||||||||||||||||||||||||
| Mortgage loans held for investment | $ | 407,538 | $ | 16,285 | $ | 10,885 | $ | 5,485 | $ | 2,785 | $ | (2,672 | ) | $ | (5,301 | ) | $ | (9,592 | ) | $ | (15,020 | ) | ||||||||||||||
| Mortgage loans held for sale | 236,399 | 9,253 | 6,113 | 3,057 | 1,528 | (1,549 | ) | (3,146 | ) | (6,356 | ) | (8,866 | ) | |||||||||||||||||||||||
| Beneficial interest in Trusts – trading | 188,014 | 298,013 | 199,029 | 100,039 | 50,542 | (51,789 | ) | (103,365 | ) | (189,389 | ) | (270,970 | ) | |||||||||||||||||||||||
| Residual interests in securitizations – available-for-sale | 159,058 | 32,692 | 13,543 | 4,795 | 2,503 | (4,181 | ) | (8,798 | ) | (17,931 | ) | (21,232 | ) | |||||||||||||||||||||||
| Fixed income – trading (net) | 15,609 | 4,323 | 2,617 | 1,174 | 509 | (751 | ) | (1,359 | ) | (2,368 | ) | (3,274 | ) | |||||||||||||||||||||||
| Interest rate swaps | 8,831 | (523,639 | ) | (344,606 | ) | (170,090 | ) | (84,500 | ) | 83,466 | 165,791 | 327,397 | 484,929 | |||||||||||||||||||||||
| Investments at captive insurance subsidiary | 8,508 | 1,260 | 814 | 395 | 195 | (189 | ) | (372 | ) | (723 | ) | (1,054 | ) | |||||||||||||||||||||||
| Put options on Eurodollar futures | 3,282 | - | 10 | 347 | 1,183 | 8,549 | 15,671 | 31,539 | 47,955 | |||||||||||||||||||||||||||
| Forward loan sale commitments | 1,961 | (158,345 | ) | (105,563 | ) | (52,782 | ) | (26,391 | ) | 26,391 | 52,782 | 105,563 | 158,345 | |||||||||||||||||||||||
| Carrying Value at | Basis Point Change | |||||||||||||||||||||||||||||||||||
| April 30, 2005 | -200 | -100 | -50 | +50 | +100 | +200 | +300 | |||||||||||||||||||||||||||||
| Residual interests in securitizations – available-for-sale | $ | 205,936 | $ | 84,845 | $ | 30,417 | $ | 13,637 | $ | (13,520 | ) | $ | (28,174 | ) | $ | (51,466 | ) | $ | (75,296 | ) | ||||||||||||||||
| Interest rate caps | 12,458 | - | 205 | 4,580 | 20,746 | 29,262 | 46,751 | 64,195 | ||||||||||||||||||||||||||||
| Investments at captive insurance subsidiary | 9,968 | 1,079 | 522 | 256 | (248 | ) | (487 | ) | (942 | ) | (1,368 | ) | ||||||||||||||||||||||||
| Fixed income – trading (net) | 6,252 | 1,958 | 893 | 426 | (390 | ) | (749 | ) | (1,383 | ) | (1,921 | ) | ||||||||||||||||||||||||
| Interest rate swaps | (1,325 | ) | (84,723 | ) | (43,024 | ) | (19,524 | ) | 19,524 | 43,024 | 84,723 | 123,771 | ||||||||||||||||||||||||
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
DISCUSSION OF FINANCIAL RESPONSIBILITY ...–
We at H&R Block are guided by our core values of client focus, integrity, excellence, respect and teamwork. These values govern the manner in which we serve clients and each other, and are embedded in the execution and delivery of our responsibilities to our shareholders. H&R Block’s Management is responsible for the integrity and objectivity of the information contained in this document. Management is responsible for the consistency of reporting this information and for ensuring that accounting principles generally accepted in the United States are used. In discharging this responsibility, Management maintains an extensive program of internal audits and requirerequires the management teams of our individual subsidiaries to certify their respective financial information. Our system of internal control over financial reporting also includes formal policies and procedures, including a Code of Business Ethics and Conduct program designed to encourage and assist all employees and directors in living up to high standards of integrity.
The Audit Committee of the Board of Directors, composed solely of outside and independent directors, meets periodically with management, the independent auditors and the chief internal auditor to review matters relating to our financial statements, internal audit activities, internal accounting controls and non-audit services provided by the independent auditors. The independent auditors and the chief internal auditor have full access to the Audit Committee and meet, both with and without management present, to discuss the scope and results of their audits, including internal control, audit and financial matters.
KPMG LLP audited our 2005 and 2004 consolidated financial statements and PricewaterhouseCoopers LLP audited our 2003 consolidated financial statements. Their audits were conducted in accordance with the standards of the Public Company Accounting Oversight Board (U.S.).
44
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING ...–
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)(COSO) as of April 30, 2005.2006.
Based on our assessment, management determined that a material weakness existed in the Company’s internal controls over accounting for income taxes as of April 30, 2005. Specifically, the Company did not maintain sufficient resources in the corporate tax function to accurately identify, evaluate and report, in a timely manner, non-routine and complex transactions. In addition, the Company had not completed the requisite historical analysis and related reconciliations to ensure tax balances were appropriately stated prior to the completion of the Company’s internal control activities. These deficiencies resulted in errors in the Company’s accounting for income taxes. These errors were corrected prior to issuance of the consolidated financial statements as of and for the year ended April 30, 2005. In the aggregate, these deficiencies represent a material weakness in internal control over financial reporting on the basis that there is a more than remote likelihood that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected by its internal control over financial reporting. Because of this material weakness in internal control over financial reporting, management concluded that, as of April 30, 2005,2006, the Company’s internal control over financial reporting was not effective based on the criteria set forth by COSO. The Company’s external auditors, KPMG, LLP, an independent registered public accounting firm, have issued an audit report on our assessment of the Company’s internal control over financial reporting.
Mark A. Ernst
Chairman of the Board, President and Chief Executive Officer
William L. Trubeck
Executive Vice President and Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ....–
The Board of Directors and Stockholders of H&R Block, Inc.:
We have audited the accompanying consolidated balance sheets of H&R Block, Inc. and its subsidiaries (the Company) as of April 30, 20052006 and 2004,2005, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-yearthree-year period ended April 30, 2005.2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of H&R Block, Inc. and its subsidiaries as of April 30, 20052006 and 2004,2005, and the results of their operations and their cash flows for each of the years in the two-yearthree-year period ended April 30, 2005,2006, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting to adopt Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” during the year ended April 30, 2004.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of April 30, 2005,2006, based on criteria established inInternal Control – Control–Integrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)(COSO), and our report dated JulyJune 29, 20052006 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.
Kansas City, Missouri
June 29,
45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ....
–
The Board of Directors and Stockholders of H&R Block, Inc.:
The Board of Directors and Stockholders of H&R Block, Inc.:
We have audited management’s assessment, included in the accompanyingManagement’s Report On Internal Control Over Financial Reporting (Item 9A(b)),that H&R Block, Inc. and subsidiaries (the Company) did not maintainmaintained effective internal control over financial reporting as of April 30, 2005, because of the effect of the material weakness identified in management’s assessment that the Company’s controls and procedures over accounting for income taxes were ineffective,2006, based on criteria established inInternal Control – Control–Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)(COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of H&R Block, Inc. and subsidiaries as of April 30, 20052006 and 2004,2005, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-yearthree-year period ended April 30, 2005. The aforementioned material weakness was considered in determining the nature, timing,2006, and extent of audit tests applied in our audit of the fiscal year 2005 consolidated financial statements, and this report does not affect our report dated JulyJune 29, 2005, which2006 expressed an unqualified opinion on those consolidated financial statements.
Kansas City, Missouri
June 29,
46
| CONSOLIDATED STATEMENTS OF INCOME | ||||||||||||
| AND COMPREHENSIVE INCOME | (Amounts in 000s, except per share amounts) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
REVENUES– | ||||||||||||
| Service revenues | $ | 3,463,111 | $ | 2,920,586 | $ | 2,639,367 | ||||||
| Other revenues: | ||||||||||||
| Gains on sales of mortgage assets, net | 713,981 | 822,075 | 918,297 | |||||||||
| Product and other revenues | 492,502 | 478,443 | 460,421 | |||||||||
| Interest income | 203,207 | 198,915 | 229,795 | |||||||||
| 4,872,801 | 4,420,019 | 4,247,880 | ||||||||||
OPERATING EXPENSES– | ||||||||||||
| Cost of services | 2,383,299 | 1,999,068 | 1,794,866 | |||||||||
| Cost of other revenues | 522,992 | 448,021 | 382,518 | |||||||||
| Selling, general and administrative | 1,112,585 | 920,677 | 846,157 | |||||||||
| 4,018,876 | 3,367,766 | 3,023,541 | ||||||||||
| Operating income | 853,925 | 1,052,253 | 1,224,339 | |||||||||
| Interest expense | 49,059 | 62,367 | 71,218 | |||||||||
| Other income, net | 22,527 | 27,829 | 9,854 | |||||||||
| Income before taxes | 827,393 | 1,017,715 | 1,162,975 | |||||||||
| Income taxes | 336,985 | 393,805 | 462,523 | |||||||||
| Net income before change in accounting principle | 490,408 | 623,910 | 700,452 | |||||||||
| Cumulative effect of change in accounting principle for multiple deliverable revenue arrangements, less tax benefit of $4,031 | - | - | (6,359 | ) | ||||||||
NET INCOME | $ | 490,408 | $ | 623,910 | $ | 694,093 | ||||||
BASIC EARNINGS PER SHARE– | ||||||||||||
| Before change in accounting principle | $ | 1.49 | $ | 1.88 | $ | 1.98 | ||||||
| Cumulative effect of change in accounting principle | - | - | (0.02 | ) | ||||||||
| Net income | $ | 1.49 | $ | 1.88 | $ | 1.96 | ||||||
DILUTED EARNINGS PER SHARE– | ||||||||||||
| Before change in accounting principle | $ | 1.47 | $ | 1.85 | $ | 1.94 | ||||||
| Cumulative effect of change in accounting principle | - | - | (0.02 | ) | ||||||||
| Net income | $ | 1.47 | $ | 1.85 | $ | 1.92 | ||||||
COMPREHENSIVE INCOME– | ||||||||||||
| Net income | $ | 490,408 | $ | 623,910 | $ | 694,093 | ||||||
| Unrealized gains on securities, net of taxes: | ||||||||||||
| Unrealized holding gains arising during the period, less taxes of $13,585, $36,670, and $64,174 | 22,059 | 59,409 | 103,886 | |||||||||
| Reclassification adjustment for gains included in income, less taxes of $40,846, $40,661 and $67,561 | (66,188 | ) | (65,848 | ) | (109,385 | ) | ||||||
| Change in foreign currency translation adjustments | (2,641 | ) | 8,946 | 12,355 | ||||||||
| $ | 443,638 | $ | 626,417 | $ | 700,949 | |||||||
| (Amounts in 000s, except per share amounts) | ||||||||||||||||
| Restated(1) | Restated(1) | |||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
REVENUES ... | ||||||||||||||||
| Service revenues | $ | 2,920,586 | $ | 2,639,367 | $ | 2,295,936 | ||||||||||
| Other revenues: | ||||||||||||||||
| Gains on sales of mortgage assets, net | 822,075 | 918,297 | 827,127 | |||||||||||||
| Product and other revenues | 478,443 | 460,421 | 412,995 | |||||||||||||
| Interest income | 198,915 | 229,795 | 195,068 | |||||||||||||
| 4,420,019 | 4,247,880 | 3,731,126 | ||||||||||||||
OPERATING EXPENSES ... | ||||||||||||||||
| Cost of service revenues | 1,999,220 | 1,794,501 | 1,625,937 | |||||||||||||
| Cost of other revenues | 416,421 | 380,365 | 300,749 | |||||||||||||
| Impairment of goodwill | – | – | 122,251 | |||||||||||||
| Selling, general and administrative | 952,125 | 848,675 | 760,864 | |||||||||||||
| 3,367,766 | 3,023,541 | 2,809,801 | ||||||||||||||
| Operating income | 1,052,253 | 1,224,339 | 921,325 | |||||||||||||
| Interest expense | 62,367 | 71,218 | 76,723 | |||||||||||||
| Other income, net | 27,829 | 9,854 | 10,962 | |||||||||||||
| Income before taxes | 1,017,715 | 1,162,975 | 855,564 | |||||||||||||
| Income taxes | 381,858 | 447,367 | 377,949 | |||||||||||||
| Net income before change in accounting principle | 635,857 | 715,608 | 477,615 | |||||||||||||
| Cumulative effect of change in accounting principle for multiple deliverable revenue arrangements, less tax benefit of $4,031 | – | (6,359 | ) | – | ||||||||||||
NET INCOME | $ | 635,857 | $ | 709,249 | $ | 477,615 | ||||||||||
BASIC EARNINGS PER SHARE ... | ||||||||||||||||
| Before change in accounting principle | $ | 3.83 | $ | 4.04 | $ | 2.66 | ||||||||||
| Cumulative effect of change in accounting principle | – | (.03 | ) | – | ||||||||||||
| Net income | $ | 3.83 | $ | 4.01 | $ | 2.66 | ||||||||||
DILUTED EARNINGS PER SHARE ... | ||||||||||||||||
| Before change in accounting principle | $ | 3.77 | $ | 3.96 | $ | 2.59 | ||||||||||
| Cumulative effect of change in accounting principle | – | (.04 | ) | – | ||||||||||||
| Net income | $ | 3.77 | $ | 3.92 | $ | 2.59 | ||||||||||
COMPREHENSIVE INCOME ... | ||||||||||||||||
| Net income | $ | 635,857 | $ | 709,249 | $ | 477,615 | ||||||||||
| Unrealized gains on securities, net of taxes: | ||||||||||||||||
| Unrealized holding gains arising during the period, less taxes of $36,670, $64,174, and $70,983 | 59,409 | 103,886 | 114,885 | |||||||||||||
| Reclassification adjustment for gains included in income, less taxes of $40,661, $67,561 and $72,370 | (65,848 | ) | (109,385 | ) | (117,073 | ) | ||||||||||
| Change in foreign currency translation adjustments | 8,946 | 12,355 | 17,415 | |||||||||||||
| $ | 638,364 | $ | 716,105 | $ | 492,842 | |||||||||||
See accompanying notes to consolidated financial statements.
47
| CONSOLIDATED BALANCE SHEETS – | (Amounts in 000s, except share and per share amounts) | |||||||||||
| April 30, | 2006 | 2005 | ||||||||||
ASSETS | ||||||||||||
CURRENT ASSETS – | ||||||||||||
| Cash and cash equivalents | $ | 694,358 | $ | 1,100,213 | ||||||||
| Cash and cash equivalents – restricted | 394,069 | 516,909 | ||||||||||
| Receivables from customers, brokers, dealers and clearing organizations, less allowance for doubtful accounts of $1,783 and $1,151 | 496,577 | 590,226 | ||||||||||
| Receivables, less allowance for doubtful accounts of $64,480 and $34,201 | 503,188 | 341,706 | ||||||||||
| Mortgage loans held for sale | 236,399 | 77,082 | ||||||||||
| Prepaid expenses and other current assets | 499,356 | 444,498 | ||||||||||
| Total current assets | 2,823,947 | 3,070,634 | ||||||||||
| Residual interests in securitizations – available-for-sale | 159,058 | 205,936 | ||||||||||
| Beneficial interest in Trusts – trading | 188,014 | 215,367 | ||||||||||
| Mortgage servicing rights | 272,472 | 166,614 | ||||||||||
| Mortgage loans held for investment, net | 407,538 | - | ||||||||||
| Property and equipment, net | 443,785 | 330,150 | ||||||||||
| Intangible assets, net | 219,494 | 247,092 | ||||||||||
| Goodwill, net | 1,100,452 | 1,015,947 | ||||||||||
| Other assets | 374,375 | 286,316 | ||||||||||
| Total assets | $ | 5,989,135 | $ | 5,538,056 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
LIABILITIES– | ||||||||||||
| Current portion of long-term debt | $ | 506,992 | $ | 25,545 | ||||||||
| Accounts payable to customers, brokers and dealers | 781,303 | 950,684 | ||||||||||
| Accounts payable, accrued expenses and other current liabilities | 768,505 | 564,749 | ||||||||||
| Accrued salaries, wages and payroll taxes | 330,946 | 318,644 | ||||||||||
| Accrued income taxes | 505,690 | 375,174 | ||||||||||
| Total current liabilities | 2,893,436 | 2,234,796 | ||||||||||
| Long-term debt | 417,539 | 923,073 | ||||||||||
| Other noncurrent liabilities | 530,361 | 430,919 | ||||||||||
| Total liabilities | 3,841,336 | 3,588,788 | ||||||||||
COMMITMENTS AND CONTINGENCIES | ||||||||||||
STOCKHOLDERS’ EQUITY– | ||||||||||||
| Common stock, no par, stated value $0.01 per share, 800,000,000 shares authorized, 435,890,796 shares issued at April 30, 2006 and 2005 | 4,359 | 4,359 | ||||||||||
| Convertible preferred stock, no par, stated value $0.01 per share, 500,000 shares authorized | - | - | ||||||||||
| Additional paid-in capital | 653,053 | 598,388 | ||||||||||
| Accumulated other comprehensive income | 21,948 | 68,718 | ||||||||||
| Retained earnings | 3,492,059 | 3,161,682 | ||||||||||
| Less treasury shares, at cost | (2,023,620 | ) | (1,883,879 | ) | ||||||||
| Total stockholders’ equity | 2,147,799 | 1,949,268 | ||||||||||
| Total liabilities and stockholders’ equity | $ | 5,989,135 | $ | 5,538,056 | ||||||||
| (Amounts in 000s, except share and per share amounts) | ||||||||||||
| Restated(1) | ||||||||||||
| April 30, | 2005 | 2004 | ||||||||||
ASSETS | ||||||||||||
CURRENT ASSETS ... | ||||||||||||
| Cash and cash equivalents | $ | 1,100,213 | $ | 1,072,745 | ||||||||
| Cash and cash equivalents – restricted | 516,909 | 545,428 | ||||||||||
| Receivables from customers, brokers, dealers and clearing organizations, less allowance for doubtful accounts of $1,151 and $1,103 | 590,226 | 625,076 | ||||||||||
| Receivables, less allowance for doubtful accounts of $38,879 and $53,418 | 418,788 | 329,219 | ||||||||||
| Prepaid expenses and other current assets | 444,498 | 381,024 | ||||||||||
| Total current assets | 3,070,634 | 2,953,492 | ||||||||||
| Residual interests in securitizations – available-for-sale | 205,936 | 210,973 | ||||||||||
| Beneficial interest in Trusts – trading | 215,367 | 153,818 | ||||||||||
| Mortgage servicing rights | 166,614 | 113,821 | ||||||||||
| Property and equipment, net | 330,150 | 273,303 | ||||||||||
| Intangible assets, net | 247,092 | 293,477 | ||||||||||
| Goodwill, net | 1,015,947 | 993,467 | ||||||||||
| Other assets | 287,543 | 240,381 | ||||||||||
| Total assets | $ | 5,539,283 | $ | 5,232,732 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
LIABILITIES ... | ||||||||||||
| Current portion of long-term debt | $ | 25,545 | $ | 275,669 | ||||||||
| Accounts payable to customers, brokers and dealers | 950,684 | 1,065,793 | ||||||||||
| Accounts payable, accrued expenses and other | 564,749 | 461,640 | ||||||||||
| Accrued salaries, wages and payroll taxes | 318,644 | 280,367 | ||||||||||
| Accrued income taxes | 349,298 | 413,868 | ||||||||||
| Total current liabilities | 2,208,920 | 2,497,337 | ||||||||||
| Long-term debt | 923,073 | 545,811 | ||||||||||
| Other noncurrent liabilities | 430,919 | 369,769 | ||||||||||
| Total liabilities | 3,562,912 | 3,412,917 | ||||||||||
COMMITMENTS AND CONTINGENCIES | ||||||||||||
STOCKHOLDERS’ EQUITY ... | ||||||||||||
| Common stock, no par, stated value $.01 per share, 800,000,000 shares authorized, 217,945,398 shares issued at April 30, 2005 and 2004 | 2,179 | 2,179 | ||||||||||
| Convertible preferred stock, no par, stated value $.01 per share, 500,000 shares authorized | – | – | ||||||||||
| Additional paid-in capital | 600,568 | 545,065 | ||||||||||
| Accumulated other comprehensive income | 68,718 | 66,211 | ||||||||||
| Retained earnings | 3,188,785 | 2,695,916 | ||||||||||
| Less treasury shares, at cost | (1,883,879 | ) | (1,489,556 | ) | ||||||||
| Total stockholders’ equity | 1,976,371 | 1,819,815 | ||||||||||
| Total liabilities and stockholders’ equity | $ | 5,539,283 | $ | 5,232,732 | ||||||||
See accompanying notes to consolidated financial statements.
48
| CONSOLIDATED STATEMENTS OF CASH FLOWS – | (Amounts in 000s) | |||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
CASH FLOWS FROM OPERATING ACTIVITIES– | ||||||||||||
| Net income | $ | 490,408 | $ | 623,910 | $ | 694,093 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 191,703 | 183,867 | 179,131 | |||||||||
| Provision for bad debt | 39,746 | 52,221 | 53,663 | |||||||||
| Provision for deferred taxes on income | (43,409 | ) | (40,023 | ) | (2,081 | ) | ||||||
| Accretion of residual interests in securitizations | (114,346 | ) | (137,610 | ) | (186,466 | ) | ||||||
| Impairment of available-for-sale residual interests in securitizations | 34,107 | 12,235 | 26,063 | |||||||||
| Realized gain on sale of previously securitized residual interests | (31,463 | ) | (15,396 | ) | (40,689 | ) | ||||||
| Additions to trading residual interests in securitizations, net | (350,861 | ) | (115,657 | ) | (327,996 | ) | ||||||
| Proceeds from net interest margin transactions | 295,159 | 98,743 | 310,358 | |||||||||
| Additions to mortgage servicing rights | (250,537 | ) | (137,510 | ) | (84,274 | ) | ||||||
| Amortization and impairment of mortgage servicing rights | 144,679 | 84,717 | 69,718 | |||||||||
| Stock-based compensation | 57,020 | 44,139 | 25,718 | |||||||||
| Cumulative effect of change in accounting principle | - | - | 6,359 | |||||||||
| Changes in assets and liabilities, net of acquisitions: | ||||||||||||
| Cash and cash equivalents – restricted | 122,840 | 28,519 | (107,186 | ) | ||||||||
| Receivables from customers, brokers, dealers and clearing organizations | 88,954 | 33,892 | (108,846 | ) | ||||||||
| Receivables | (136,121 | ) | (121,177 | ) | 26,294 | |||||||
| Mortgage loans held for sale: | ||||||||||||
| Originations and purchases | (40,358,579 | ) | (31,003,456 | ) | (23,255,483 | ) | ||||||
| Sales and principal repayments | 40,256,802 | 30,990,566 | 23,246,815 | |||||||||
| Prepaid expenses and other current assets | (61,948 | ) | (53,858 | ) | 26,978 | |||||||
| Beneficial interest in Trusts | 47,015 | (61,549 | ) | (17,222 | ) | |||||||
| Accounts payable to customers, brokers and dealers | (169,381 | ) | (115,109 | ) | 203,099 | |||||||
| Accounts payable, accrued expenses and other current liabilities | 130,274 | 113,419 | (104,563 | ) | ||||||||
| Accrued salaries, wages and payroll taxes | (5,643 | ) | 38,277 | 70,521 | ||||||||
| Accrued income taxes | 101,093 | (20,281 | ) | 110,021 | ||||||||
| Other non-current liabilities | 125,482 | 26,527 | 35,965 | |||||||||
| Other, net | (17,308 | ) | 4,387 | 2,473 | ||||||||
| Net cash provided by operating activities | 585,686 | 513,793 | 852,463 | |||||||||
CASH FLOWS FROM INVESTING ACTIVITIES– | ||||||||||||
| Available-for-sale securities: | ||||||||||||
| Purchases of available-for-sale securities | (9,216 | ) | (10,175 | ) | (11,434 | ) | ||||||
| Cash received from residual interests in securitizations | 80,539 | 136,045 | 193,606 | |||||||||
| Cash proceeds from sale of previously securitized residuals | 62,396 | 16,485 | 53,391 | |||||||||
| Sales of other available-for-sale securities | 11,218 | 9,752 | 15,410 | |||||||||
| Mortgage loans originated and held for investment, net | (407,538 | ) | - | - | ||||||||
| Purchases of property and equipment, net | (250,510 | ) | (209,458 | ) | (123,826 | ) | ||||||
| Payments made for business acquisitions, net of cash acquired | (212,543 | ) | (37,621 | ) | (280,865 | ) | ||||||
| Other, net | 37,149 | 36,562 | 26,332 | |||||||||
| Net cash used in investing activities | (688,505 | ) | (58,410 | ) | (127,386 | ) | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES– | ||||||||||||
| Repayments of commercial paper and other short-term borrowings | (7,048,881 | ) | (5,941,623 | ) | (4,618,853 | ) | ||||||
| Proceeds from issuance of commercial paper and other short-term borrowings | 7,048,881 | 5,941,623 | 4,618,853 | |||||||||
| Repayments of Senior Notes | - | (250,000 | ) | - | ||||||||
| Proceeds from issuance of Senior Notes | - | 395,221 | - | |||||||||
| Payments on acquisition debt | (26,819 | ) | (25,664 | ) | (59,003 | ) | ||||||
| Dividends paid | (160,031 | ) | (142,988 | ) | (138,397 | ) | ||||||
| Acquisition of treasury shares | (260,312 | ) | (530,022 | ) | (519,862 | ) | ||||||
| Proceeds from issuance of common stock | 108,507 | 136,102 | 119,956 | |||||||||
| Other, net | 35,619 | (10,564 | ) | 31,681 | ||||||||
| Net cash used in financing activities | (303,036 | ) | (427,915 | ) | (565,625 | ) | ||||||
| Net increase (decrease) in cash and cash equivalents | (405,855 | ) | 27,468 | 159,452 | ||||||||
| Cash and cash equivalents at beginning of the year | 1,100,213 | 1,072,745 | 913,293 | |||||||||
| Cash and cash equivalents at end of the year | $ | 694,358 | $ | 1,100,213 | $ | 1,072,745 | ||||||
| (Amounts in 000s) | ||||||||||||||||||
| Restated(1) | Restated(1) | |||||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES ... | ||||||||||||||||||
| Net income | $ | 635,857 | $ | 709,249 | $ | 477,615 | ||||||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||
| Depreciation and amortization | 183,867 | 179,131 | 169,092 | |||||||||||||||
| Provision for bad debt | 52,221 | 53,663 | 49,748 | |||||||||||||||
| Provision for deferred taxes on income | (42,345 | ) | (986 | ) | (29,944 | ) | ||||||||||||
| Accretion of residual interests in securitizations | (137,610 | ) | (186,466 | ) | (146,343 | ) | ||||||||||||
| Impairment of residual interests in securitizations | 12,235 | 26,063 | 54,111 | |||||||||||||||
| Realized gain on sale of previously securitized residual interests | (15,396 | ) | (40,689 | ) | (93,307 | ) | ||||||||||||
| Additions to trading securities – residual interests in securitizations | (115,657 | ) | (327,996 | ) | (542,544 | ) | ||||||||||||
| Proceeds from net interest margin transactions | 98,743 | 310,358 | 541,791 | |||||||||||||||
| Additions to mortgage servicing rights | (137,510 | ) | (84,274 | ) | (65,345 | ) | ||||||||||||
| Amortization of mortgage servicing rights | 84,191 | 69,718 | 47,107 | |||||||||||||||
| Net change in beneficial interest in Trusts | (61,549 | ) | (17,222 | ) | (84,655 | ) | ||||||||||||
| Impairment of goodwill | – | – | 122,251 | |||||||||||||||
| Tax benefit from stock option exercises | 10,961 | 23,957 | 37,304 | |||||||||||||||
| Stock-based compensation | 44,139 | 25,718 | 2,079 | |||||||||||||||
| Cumulative effect of change in accounting principle | – | 6,359 | – | |||||||||||||||
| Changes in assets and liabilities, net of acquisitions: | ||||||||||||||||||
| Cash and cash equivalents – restricted | 28,519 | (107,186 | ) | (286,069 | ) | |||||||||||||
| Receivables for customers, brokers dealers and clearing organizations | 33,892 | (108,846 | ) | 326,824 | ||||||||||||||
| Receivables | (121,177 | ) | 26,294 | (72,423 | ) | |||||||||||||
| Mortgage loans held for sale: | ||||||||||||||||||
| Originations and purchases | (31,003,456 | ) | (23,255,483 | ) | (17,827,828 | ) | ||||||||||||
| Sales and principal repayments | 30,990,566 | 23,246,815 | 17,837,323 | |||||||||||||||
| Prepaid expenses and other current assets | (53,858 | ) | 26,978 | 43,818 | ||||||||||||||
| Accounts payable to customers, brokers and dealers | (115,109 | ) | 203,099 | (40,507 | ) | |||||||||||||
| Accounts payable, accrued expenses and other | 113,419 | (104,563 | ) | 60,454 | ||||||||||||||
| Accrued salaries, wages and payroll taxes | 38,277 | 70,521 | (42,911 | ) | ||||||||||||||
| Accrued income taxes | (29,906 | ) | 93,770 | 111,822 | ||||||||||||||
| Other, net | 20,479 | 14,481 | 40,272 | |||||||||||||||
| Net cash provided by operating activities | 513,793 | 852,463 | 689,735 | |||||||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES ... | ||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||
| Purchases of available-for-sale securities | (10,175 | ) | (11,434 | ) | (14,614 | ) | ||||||||||||
| Cash received from residual interests in securitizations | 136,045 | 193,606 | 140,795 | |||||||||||||||
| Cash proceeds from sale of previously securitized residuals | 16,485 | 53,391 | 142,486 | |||||||||||||||
| Sales of other available-for-sale securities | 9,752 | 15,410 | 14,081 | |||||||||||||||
| Purchases of property and equipment, net | (209,458 | ) | (123,826 | ) | (148,706 | ) | ||||||||||||
| Payments made for business acquisitions, net of cash acquired | (37,621 | ) | (280,865 | ) | (26,408 | ) | ||||||||||||
| Other, net | 36,562 | 26,332 | 19,895 | |||||||||||||||
| Net cash provided by (used in) investing activities | (58,410 | ) | (127,386 | ) | 127,529 | |||||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES ... | ||||||||||||||||||
| Repayments of commercial paper | (5,191,623 | ) | (4,618,853 | ) | (9,925,516 | ) | ||||||||||||
| Proceeds from issuance of commercial paper | 5,191,623 | 4,618,853 | 9,925,516 | |||||||||||||||
| Repayments of Senior Notes | (250,000 | ) | – | – | ||||||||||||||
| Proceeds from issuance of Senior Notes | 395,221 | – | – | |||||||||||||||
| Payments on acquisition debt | (25,664 | ) | (59,003 | ) | (57,469 | ) | ||||||||||||
| Dividends paid | (142,988 | ) | (138,397 | ) | (125,898 | ) | ||||||||||||
| Acquisition of treasury shares | (530,022 | ) | (519,862 | ) | (317,570 | ) | ||||||||||||
| Proceeds from issuance of common stock | 136,102 | 119,956 | 126,325 | |||||||||||||||
| Other, net | (10,564 | ) | 31,681 | (2,572 | ) | |||||||||||||
| Net cash used in financing activities | (427,915 | ) | (565,625 | ) | (377,184 | ) | ||||||||||||
| Net increase in cash and cash equivalents | 27,468 | 159,452 | 440,080 | |||||||||||||||
| Cash and cash equivalents at beginning of the year | 1,072,745 | 913,293 | 473,213 | |||||||||||||||
| Cash and cash equivalents at end of the year | $ | 1,100,213 | $ | 1,072,745 | $ | 913,293 | ||||||||||||
See accompanying notes to consolidated financial statements.
49
| CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY– | (Amounts in 000s, except per share amounts) | |||||||||||||||||||||||||||||||||||||||||
| Convertible | Accumulated | |||||||||||||||||||||||||||||||||||||||||
| Preferred | Additional | Other | ||||||||||||||||||||||||||||||||||||||||
| Common Stock | Stock | Paid-in | Comprehensive | Retained | Treasury Stock | Total | ||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Income (Loss) | Earnings | Shares | Amount | Equity | |||||||||||||||||||||||||||||||||
| Balances at April 30, 2003 | 435,891 | $ | 4,359 | - | $ | - | $ | 494,213 | $ | 59,355 | $ | 2,125,064 | (76,688 | ) | $ | (1,093,593 | ) | $ | 1,589,398 | |||||||||||||||||||||||
| Net income | - | - | - | - | - | - | 694,093 | - | - | 694,093 | ||||||||||||||||||||||||||||||||
| Unrealized translation gain | - | - | - | - | - | 12,355 | - | - | - | 12,355 | ||||||||||||||||||||||||||||||||
| Change in net unrealized gain on marketable securities | - | - | - | - | - | (5,499 | ) | - | - | - | (5,499 | ) | ||||||||||||||||||||||||||||||
| Stock-based compensation expense | - | - | - | - | 25,718 | - | - | - | - | 25,718 | ||||||||||||||||||||||||||||||||
| Shares issued for: | ||||||||||||||||||||||||||||||||||||||||||
| Stock options | - | - | - | - | 21,585 | - | - | 7,856 | 117,975 | 139,560 | ||||||||||||||||||||||||||||||||
| Restricted shares | - | - | - | - | 385 | - | - | 145 | 2,103 | 2,488 | ||||||||||||||||||||||||||||||||
| ESPP | - | - | - | - | 984 | - | - | 255 | 3,821 | 4,805 | ||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | - | - | - | - | - | - | - | (21,266 | ) | (519,862 | ) | (519,862 | ) | |||||||||||||||||||||||||||||
| Cash dividends paid – $0.39 per share | - | - | - | - | - | - | (138,397 | ) | - | - | (138,397 | ) | ||||||||||||||||||||||||||||||
| Balances at April 30, 2004 | 435,891 | 4,359 | - | - | 542,885 | 66,211 | 2,680,760 | (89,698 | ) | (1,489,556 | ) | 1,804,659 | ||||||||||||||||||||||||||||||
| Net income | - | - | - | - | - | - | 623,910 | - | - | 623,910 | ||||||||||||||||||||||||||||||||
| Unrealized translation gain | - | - | - | - | - | 8,946 | - | - | - | 8,946 | ||||||||||||||||||||||||||||||||
| Change in net unrealized gain on marketable securities | - | - | - | - | - | (6,439 | ) | - | - | - | (6,439 | ) | ||||||||||||||||||||||||||||||
| Stock-based compensation expense | - | - | - | - | 44,139 | - | - | - | - | 44,139 | ||||||||||||||||||||||||||||||||
| Shares issued for: | ||||||||||||||||||||||||||||||||||||||||||
| Stock options | - | - | - | - | 15,892 | - | - | 6,959 | 124,263 | 140,155 | ||||||||||||||||||||||||||||||||
| Restricted shares | - | - | - | - | (5,718 | ) | - | - | 352 | 6,098 | 380 | |||||||||||||||||||||||||||||||
| ESPP | - | - | - | - | 1,190 | - | - | 301 | 5,338 | 6,528 | ||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | - | - | - | - | - | - | - | (22,564 | ) | (530,022 | ) | (530,022 | ) | |||||||||||||||||||||||||||||
| Cash dividends paid – $0.43 per share | - | - | - | - | - | - | (142,988 | ) | - | - | (142,988 | ) | ||||||||||||||||||||||||||||||
| Balances at April 30, 2005 | 435,891 | 4,359 | - | - | 598,388 | 68,718 | 3,161,682 | (104,650 | ) | (1,883,879 | ) | 1,949,268 | ||||||||||||||||||||||||||||||
| Net income | - | - | - | - | - | - | 490,408 | - | - | 490,408 | ||||||||||||||||||||||||||||||||
| Unrealized translation loss | - | - | - | - | - | (2,641 | ) | - | - | - | (2,641 | ) | ||||||||||||||||||||||||||||||
| Change in net unrealized gain on marketable securities | - | - | - | - | - | (44,129 | ) | - | - | - | (44,129 | ) | ||||||||||||||||||||||||||||||
| Stock-based compensation expense | - | - | - | - | 57,020 | - | - | - | - | 57,020 | ||||||||||||||||||||||||||||||||
| Shares issued for: | ||||||||||||||||||||||||||||||||||||||||||
| Stock options | - | - | - | - | 5,831 | - | - | 5,492 | 102,068 | 107,899 | ||||||||||||||||||||||||||||||||
| Restricted shares | - | - | - | - | (9,649 | ) | - | - | 616 | 11,160 | 1,511 | |||||||||||||||||||||||||||||||
| ESPP | - | - | - | - | 1,463 | - | - | 398 | 7,343 | 8,806 | ||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | - | - | - | - | - | - | - | (9,234 | ) | (260,312 | ) | (260,312 | ) | |||||||||||||||||||||||||||||
| Cash dividends paid – $0.49 per share | - | - | - | - | - | - | (160,031 | ) | - | - | (160,031 | ) | ||||||||||||||||||||||||||||||
| Balances at April 30, 2006 | 435,891 | $ | 4,359 | - | $ | - | $ | 653,053 | $ | 21,948 | $ | 3,492,059 | (107,378 | ) | $ | (2,023,620 | ) | $ | 2,147,799 | |||||||||||||||||||||||
| (Amounts in 000s, except per share amounts) | |||||||||||||||||||||||||||||||||||||||||||
| Convertible | Accumulated | ||||||||||||||||||||||||||||||||||||||||||
| Common Stock | Preferred Stock | Additional | Other | Treasury Stock | |||||||||||||||||||||||||||||||||||||||
| Paid-In | Comprehensive | Retained | Total | ||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Income (Loss) | Earnings | Shares | Amount | Equity | ||||||||||||||||||||||||||||||||||
Balances at April 30, 2002 (1) | 217,945 | $ | 2,179 | – | $ | – | $ | 468,052 | $ | 44,128 | $ | 1,767,702 | (36,820 | ) | $ | (912,641 | ) | $ | 1,369,420 | ||||||||||||||||||||||||
Prior year adjustment (2) | – | – | – | – | – | – | 5,645 | – | – | 5,645 | |||||||||||||||||||||||||||||||||
Balances at April 30, 2002 (2) | 217,945 | 2,179 | – | – | 468,052 | 44,128 | 1,773,347 | (36,820 | ) | (912,641 | ) | 1,375,065 | |||||||||||||||||||||||||||||||
Net income (2) | – | – | – | – | – | – | 477,615 | – | – | 477,615 | |||||||||||||||||||||||||||||||||
| Unrealized translation gain | – | – | – | – | – | 17,415 | – | – | – | 17,415 | |||||||||||||||||||||||||||||||||
Change in net unrealized gain on marketable securities (2) | – | – | – | – | – | (2,188 | ) | – | – | – | (2,188 | ) | |||||||||||||||||||||||||||||||
| Shares issued for: | |||||||||||||||||||||||||||||||||||||||||||
| Stock options | – | – | – | – | 27,241 | – | – | 5,070 | 135,409 | 162,650 | |||||||||||||||||||||||||||||||||
| Restricted shares | – | – | – | – | 5 | – | – | (64 | ) | (1,306 | ) | (1,301 | ) | ||||||||||||||||||||||||||||||
| ESPP | – | – | – | – | 1,095 | – | – | 94 | 2,515 | 3,610 | |||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | – | – | – | – | – | – | – | (6,624 | ) | (317,570 | ) | (317,570 | ) | ||||||||||||||||||||||||||||||
| Cash dividends paid – $.70 per share | – | – | – | – | – | – | (125,898 | ) | – | – | (125,898 | ) | |||||||||||||||||||||||||||||||
Balances at April 30, 2003 (2) | 217,945 | 2,179 | – | – | 496,393 | 59,355 | 2,125,064 | (38,344 | ) | (1,093,593 | ) | 1,589,398 | |||||||||||||||||||||||||||||||
Net income (2) | – | – | – | – | – | – | 709,249 | – | – | 709,249 | |||||||||||||||||||||||||||||||||
| Unrealized translation gain | – | – | – | – | – | 12,355 | – | – | – | 12,355 | |||||||||||||||||||||||||||||||||
Change in net unrealized gain on marketable securities (2) | – | – | – | – | – | (5,499 | ) | – | – | – | (5,499 | ) | |||||||||||||||||||||||||||||||
| Stock-based compensation expense | – | – | – | – | 25,718 | – | – | – | – | 25,718 | |||||||||||||||||||||||||||||||||
| Shares issued for: | |||||||||||||||||||||||||||||||||||||||||||
| Stock options | – | – | – | – | 21,585 | – | – | 3,928 | 117,975 | 139,560 | |||||||||||||||||||||||||||||||||
| Restricted shares | – | – | – | – | 385 | – | – | 72 | 2,103 | 2,488 | |||||||||||||||||||||||||||||||||
| ESPP | – | – | – | – | 984 | – | – | 127 | 3,821 | 4,805 | |||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | – | – | – | – | – | – | – | (10,633 | ) | (519,862 | ) | (519,862 | ) | ||||||||||||||||||||||||||||||
| Cash dividends paid – $.78 per share | – | – | – | – | – | – | (138,397 | ) | – | – | (138,397 | ) | |||||||||||||||||||||||||||||||
Balances at April 30, 2004 (2) | 217,945 | 2,179 | – | – | 545,065 | 66,211 | 2,695,916 | (44,850 | ) | (1,489,556 | ) | 1,819,815 | |||||||||||||||||||||||||||||||
| Net income | – | – | – | – | – | – | 635,857 | – | – | 635,857 | |||||||||||||||||||||||||||||||||
| Unrealized translation gain | – | – | – | – | – | 8,946 | – | – | – | 8,946 | |||||||||||||||||||||||||||||||||
| Change in net unrealized gain on marketable securities | – | – | – | – | – | (6,439 | ) | – | – | – | (6,439 | ) | |||||||||||||||||||||||||||||||
| Stock-based compensation expense | – | – | – | – | 44,139 | – | – | – | – | 44,139 | |||||||||||||||||||||||||||||||||
| Shares issued for: | |||||||||||||||||||||||||||||||||||||||||||
| Stock options | – | – | – | – | 15,892 | – | – | 3,479 | 124,263 | 140,155 | |||||||||||||||||||||||||||||||||
| Restricted shares | – | – | – | – | (5,718 | ) | – | – | 176 | 6,098 | 380 | ||||||||||||||||||||||||||||||||
| ESPP | – | – | – | – | 1,190 | – | – | 151 | 5,338 | 6,528 | |||||||||||||||||||||||||||||||||
| Acquisition of treasury shares | – | – | – | – | – | – | – | (11,281 | ) | (530,022 | ) | (530,022 | ) | ||||||||||||||||||||||||||||||
| Cash dividends paid – $.86 per share | – | – | – | – | – | – | (142,988 | ) | – | – | (142,988 | ) | |||||||||||||||||||||||||||||||
| Balances at April 30, 2005 | 217,945 | $ | 2,179 | – | $ | – | $ | 600,568 | $ | 68,718 | $ | 3,188,785 | (52,325 | ) | $ | (1,883,879 | ) | $ | 1,976,371 | ||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS–
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS– ...Our operating subsidiaries provide a variety of financial services to the general public, principally in the U.S. Specifically, we offer tax return preparation; origination, sale and servicing of non-prime and prime mortgages; investment services through a broker-dealer; tax preparation and related software; refund anticipation loans offered by a third-party lending institution; and accounting, tax and consulting services to business clients. Tax preparation services are also provided in Canada, Australia and the United Kingdom.
PRINCIPLES OF CONSOLIDATION– ...The consolidated financial statements include the accounts of the Company and our wholly-owned and majority-owned subsidiaries. All material intercompany transactions and balances have been eliminated.
Some of our subsidiaries operate in regulated industries, and their underlying accounting records reflect the policies and requirements of these industries.
RECLASSIFICATIONS–RECLASSIFICATIONS ...Certain reclassifications have been made to prior year amounts to conform to the current year presentation. The previously reported International Tax Operations segment has been aggregated with U.S. Tax Operations in the Tax Services segment.
These reclassifications had no effect on the results of operations or stockholders’ equity as previously reported. Adjustments related to the restatement of previously issued financial statements are detailed in note 2.
MANAGEMENT ESTIMATES– ...The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
During the fourth quarter of fiscal year 2006, we revised our estimate for the provision for bad debt related to our participation interests in RALs. The change was made as a result of incorporating an additional year of collections data into the model, updating the assumption for the collection period and reviewing the modeled slope of the collection curve. These revisions decreased our provision for bad debt $18.0 million, increased net income $10.7 million and increased basic and diluted earnings per share $0.03 in the current year.
CASH AND CASH EQUIVALENTS – ...Cash and cash equivalents include cash on hand, cash due from banks and securities purchased under agreements to resell. For purposes of the consolidated balance sheets and consolidated statements of cash flows, all non-restricted highly liquid instruments purchased with an original maturity of three months or less are considered to be cash equivalents. Book overdrafts included in accounts payable totaled $92.7$128.7 million and $104.8$92.7 million at April 30, 2006 and 2005, and 2004, respectively.
Our broker-dealer purchases securities under agreements to resell and accounts for them as collateralized financings. The securities are carried at the amounts at which the securities will be subsequently resold, as specified in the respective agreements. It is our policy to take possession of securities, subject to resale agreements. The securities are revalued daily and collateral added whenever necessary to bring market value of the underlying collateral to a level equal to or greater than the repurchase amount specified in the contracts.
CASH AND CASH EQUIVALENTS – RESTRICTED– ...Cash and cash equivalents – restricted consists primarily of securities purchased under agreements to resell and cash which has been segregated in a special reserve account for the exclusive benefit of customers pursuant to federal regulations under Rule 15c3-3 of the Securities Exchange Act of 1934. Also included are cash balances held for outstanding commitments to fund mortgage loans and funds held to pay payroll and related taxes on behalf of customers.
MARKETABLE SECURITIES – TRADING – ...Certain marketable debt securities held by our broker-dealer are classified as trading, carried at market value based on quoted prices and marked to market through the consolidated income statements. Certain residual interests in securitizations of
mortgage loans are classified as trading based on management’s intentions, carried at market value based on discounted cash flow models and marked to market through the consolidated income statements. These securities are included in prepaid expenses and other current assets on the consolidated balance sheets.
RECEIVABLES FROM CUSTOMERS, BROKERS, DEALERS AND CLEARING ORGANIZATIONS AND ACCOUNTS PAYABLE TO CUSTOMERS, BROKERS AND DEALERS – ...Customer receivables and payables consist primarily of amounts due on margin and cash transactions. These receivables are collateralized by customers’ securities held, which are not reflected in the accompanying consolidated financial statements.
Receivables from brokers are collateralized by securities in our physical possession, or on deposit with us, or receivables from customers or other brokers. The allowance for doubtful accounts represents an amount considered by management to be adequate to cover potential losses.estimated losses as of the balance sheet date.
Securities borrowed and securities loaned transactions are generally reported as collateralized financing.financings. These
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transactions require deposits of cash and/or collateral with the lender. Securities loaned consist of securities owned by customers that were purchased on margin. When loaning securities, cash collateral approximately equal to the value of the securities loaned is received. The amount of cash collateral is adjusted, as required, for market fluctuations in the value of the securities loaned. Interest rates paid on the cash collateral fluctuate as short-term interest rates change.
RECEIVABLES – ...Receivables consist primarily of Business Services’ accounts receivable and mortgage loans held for sale. Mortgage loans held for sale are carried at the lower of aggregate cost or market value as determined by outstanding commitments from investors or current investor-yield requirements calculated on an aggregate basis.receivable. The allowance for doubtful accounts requires management’s judgment regarding current market indicators concerning general economic trends to establish an amount considered by management to be adequate to cover potentialestimated losses related to our non-mortgage loan receivable balance.as of the balance sheet date.
MORTGAGE LOANS HELD FOR SALE –Mortgage loans held for sale are either loans originated but not yet sold or loans repurchased from investors and pending resale. Loans held for sale are carried at the lower of amortized cost or fair value as determined by outstanding commitments from investors or current investor-yield requirements calculated on an aggregate basis. Loan origination and processing fees and related direct origination costs are deferred until the related loan is sold.
RESIDUAL INTERESTS IN SECURITIZATIONS – ...Residual interests classified as available-for-sale securities are carried at marketfair value based on discounted cash flow models with unrealized gains included in other comprehensive income. The residual interests are accreted over the estimated life of the securitization structure. If the carrying value exceeds marketfair value, the residual is written down to marketfair value with the realized loss, net of any unrealized gain previously recorded in other comprehensive income, included in gains on sales of mortgage assets in the consolidated income statements.
We estimate future cash flows from these residuals and value them using assumptions we believe to be consistent with those of unaffiliated third-party purchasers. We estimate the fair value of residuals by computing the present value of the excess of the weighted-average interest rate on the loans sold plus estimated collectioncollections of prepayment penalty fee income over the sum of (1) the coupon on the securitization bonds, (2) a contractual servicing fee paid to the servicer of the loans, which is usually Option One, (3) expected losses to be incurred on the portfolio of the loans sold, as projected to occur, over the lives of the loans, (4) fees payable to the trustee and insurer, if applicable, and (5) payments made to investors on NIM bonds, if applicable. The residual valuation takes into consideration the current and expected interest rate environment, including projected changes in future interest rates and the timing of such changes.environment. Prepayment and loss assumptions used in estimating the cash flows are based on evaluation of the actual experience of the servicing portfolio, the characteristics of the applicable loan portfolio, as well as also taking into consideration the current and expected economic and interest rate environment and its expected impact. The estimated cash flows are discounted at an interest rate we believe an unaffiliated third-party purchaser would require as a rate of return on a financial instrument with a similar risk profile. We evaluate, and adjust if necessary, the fair values of residual interests quarterly by updating the actual performance and expected assumptions in the discounted cash flow models based on current information and events and by estimating, or validating with third-party experts, if necessary, what a market participant would use in determining the current fair value. To the extent that actual excess cash flows are different from estimated excess cash flows, the fair value of the residual would increase or decrease.
BENEFICIAL INTEREST IN TRUSTS – TRADING– ...The beneficial interest in Trusts is recorded as a result of daily non-prime whole loan sales to Trusts. The beneficial interest is classified as a trading security, based on management’s intentions, is carried at marketfair value and is marked to market through the consolidated income statements. MarketFair value is calculated as the present value of estimated future cash flows, limited by the ultimate expected outcome from the disposition of the loans by the Trusts.
MORTGAGE SERVICING RIGHTS– ...MSRs retained in the sale of mortgage loans are recorded at allocated carrying amounts based on relative fair values at the time of the sale. The MSRs are carried at the lower of cost or fair value. Fair values of MSRs are determined based on the present value of estimated future cash flows related to servicing loans. Assumptions used in estimating the value of MSRs include market discount rates and
anticipated prepayment speeds including default, estimated ancillary fee income, estimated third-party servicing costs and other economic factors. The prepayment speeds are estimated using our historical experience and third-party market sources. The MSRs are amortized to earnings in proportion to, and over the period of, estimated net future servicing income. MSRs are reviewed quarterly for potential impairment. Impairment is assessed based on the fair value of each risk stratum. MSRs are stratified by the fiscalcalendar year of the loan sale date, which approximates date of origination, and loan type, usually 6-month adjustable,primarily 2- toand 3-year adjustable and fixed rate.
MORTGAGE LOANS HELD FOR INVESTMENT–Mortgage loans held for investment are loans originated with the ability and intent to hold to maturity. Loans held for investment are carried at amortized cost less a valuation allowance for credit losses incurred as of the balance sheet date. A loan’s cost includes loan origination and processing fees and related direct origination costs.
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PROPERTY AND EQUIPMENT – ...Buildings and equipment are initially recorded at cost and are depreciated over the estimated useful life of the assets using the straight-line method. Leasehold improvements are initially recorded at cost and are amortized over the lesser of the term of the respective lease or the estimated useful life, using the straight-line method. Estimated useful lives are 15 to 40 years for buildings, 3 to 5 years for computers and other equipment and up to 8 years for leasehold improvements.
We capitalize certain allowable costs associated with software developed or purchased for internal use. These costs are typically amortized over 36 months using the straight-line method.
We are capitalizing interest costs during construction of our new corporate headquarters facility for qualified expenditures based upon interest rates in place during the construction period. Capitalized interest costs will be amortized over lives which are consistent with the constructed assets.
Substantially all of the operations of our subsidiaries are conducted in leased premises. For all lease agreements, including those with escalating rent payments or rent holidays, we recognize rent expense on a straight-line basis.
INTANGIBLE ASSETS AND GOODWILL– ... We account for intangible assets and goodwill in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”). We test goodwill and other indefinite life intangible assets for impairment annually or more frequently, whenever events occur or circumstances change which would, more likely than not, reduce the fair value of a reporting unit below its carrying value. We have defined our reporting units as our operating segments or one level below. The first step of the impairment test is to compare the estimated fair value of the reporting unit to its carrying value. If the carrying value is less than fair value, no impairment exists. If the carrying value is greater than fair value, a second step is performed to determine the fair value of goodwill and the amount of impairment loss, if any. These tests were completed and no indications of goodwill impairment were found during fiscal year 2006, 2005 or 2004. During fiscal year 2003, impairment charges of $108.8 million and $13.5 million were recorded in the Investment Services and Business Services segments, respectively.
In addition, long-lived assets, including intangible assets with finite lives, are assessed for impairment whenever events or circumstances indicate the carrying value may not be fully recoverable by comparing the carrying value to future undiscounted cash flows. To the extent there is impairment, an analysis is performed based on several criteria, including, but not limited to, revenue trends, discounted operating cash flows and other operating factors to determine the impairment amount. No material impairment adjustments to other intangible assets or other long-lived assets were made during the three-year period ended April 30, 2005.2006. The weighted-average life of intangible assets with finite lives is nine years.
COMMERCIAL PAPER – ...Short-term borrowings are used to finance temporary liquidity needs and various financial activities. There was no commercial paper outstanding at April 30, 2005 and 2004.2006 or 2005.
LITIGATION–LITIGATION ...Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical experience in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies,” and related pronouncements. We record reserves related to certain legal matters for which it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, management has concluded that a loss is only reasonably possible or remote and, therefore, no liability is recorded. Management discloses the facts regarding matters assessed as reasonably possible and potential exposure, if determinable. Costs incurred with defending claims are expensed as incurred. Any receivable for insurance recoveries is recorded separately from the corresponding litigation reserve, and only if recovery is determined to be probable.
INCOME TAXES – ...We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109under the asset and liability method, which requires us to record deferred income tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. Deferred taxes are determined separately for each tax-paying component, within each tax jurisdiction, based on provisions of enacted tax law. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Our deferred tax assets include state and foreign tax loss and credit carryforwards and are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Our current deferred tax assets are included in prepaid expenses and other current assets on the consolidated balance sheets. Noncurrent deferred tax assets are included in other assets on our consolidated balance sheets.
We file a consolidated Federal tax return on a calendar year basis.
REVENUE RECOGNITION– ...Service revenues consist primarily of fees for preparation and filing of tax returns, both in offices and through our online programs, fees associated with our POM guarantee program, mortgage loan-servicing fees, fees for consulting services and brokerage commissions. Generally,
53
service revenues are recorded in the period in which the service is performed. Retail and online tax preparation revenues are recorded when a completed return is filed or accepted by the customer. POM revenues are deferred and recognized over the
term of the guarantee based upon historic and actual payment of claims. Revenues for services rendered in connection with the Business Services segment are recognizedwith fees based on a time and materials, basis.are recognized as the services are performed and amounts are earned. Investment Services’ production revenue is recognized on a trade-date basis.
Gains on sales of mortgage assets are recognized when control of the assets is surrendered (when loans are sold to Trusts) and are based on the difference between cash proceeds and the allocated cost of the assets sold.sold, including any guarantees or recourse reserves. Other components of gain on sales of mortgage loans include gains or losses on derivatives, loan sale repurchase reserves and direct origination and acquisition expenses.
Interest income consists primarily of interest earned on customer margin loan balances and mortgage loans, and accretion income. Interest income on customer margin loan balances is recognized daily as earned based on current rates charged to customers for their margin balance. Accretion income represents interest earned over the life of residual interests using the effective interest method.
Product and other revenues include royalties, RAL participation revenues and sales of software products. Franchise royalties, which are based upon the contractual percentages of franchise revenues, are recorded in the period in which the franchise provides the service. RAL participation revenue is recorded when we purchase our participation interest in the RAL. Software revenues consist mainly of tax preparation software and other personal productivity software. Sales of software are recognized when the product is sold to the end user.
Revenue recognition is evaluated separately for each unit in multiple-deliverable arrangements.
ADVERTISING EXPENSE – ...Advertising costs are expensed the first time the advertisement is run. Total advertising costs recorded in fiscal year 2006, 2005 and 2004 and 2003 totaled $239.2 million, $195.4 million and $188.3 million, and $150.8 million, respectively.
FOREIGN CURRENCY TRANSLATION– ...Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at exchange rates prevailing at the end of the year. Translation adjustments are recorded as a separate component of other comprehensive income in stockholders’ equity. Revenue and expense transactions are translated at the average of exchange rates in effect during the period.
COMPREHENSIVE INCOME– ... Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes standards for reporting and displaying comprehensive income and its components in stockholders’ equity. Our comprehensive income is comprised of net income, foreign currency translation adjustments and the change in net unrealized gains or losses on available-for-sale marketable securities. Included in stockholders’ equity at April 30, 20052006 and 2004,2005, the net unrealized holding gain on available-for-sale securities was $71.6$27.4 million and $78.0$71.6 million, respectively, and the foreign currency translation adjustment was $(2.8)$(5.5) million and $(11.8)$(2.8) million, respectively. The net unrealized holding gain on available-for-sale securities relates primarily to available-for-sale residual interests in securitizations.
STOCK-BASED COMPENSATION PLANS – ...Effective May 1, 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”)(SFAS 123), under the prospective transition method as described in Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”).Disclosure.” We recognize stock-based compensation expense for the issuance of stock options, restricted shares and options granted pursuant to our ESPPemployee stock purchase plan (ESPP) on a straight-line basis over the vesting period. Had compensation cost for all stock-based compensation plan awards been determined in accordance with the fair value accounting method prescribed under SFAS 123, our net income and earnings per share would have been as follows:
| (in 000s, except per share amounts) | |||||||||||||||
| Restated | Restated | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Net income | $ | 635,857 | $ | 709,249 | $ | 477,615 | |||||||||
| Add: Stock-based compensation expense included in reported net income, net of taxes | 28,819 | 18,029 | 1,223 | ||||||||||||
| Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of taxes | (39,544 | ) | (30,662 | ) | (21,025 | ) | |||||||||
| Pro forma net income | $ | 625,132 | $ | 696,616 | $ | 457,813 | |||||||||
| Basic earnings per share: | |||||||||||||||
| As presented | $ | 3.83 | $ | 4.01 | $ | 2.66 | |||||||||
| Pro forma | 3.77 | 3.93 | 2.55 | ||||||||||||
| Diluted earnings per share: | |||||||||||||||
| As presented | $ | 3.77 | $ | 3.92 | $ | 2.59 | |||||||||
| Pro forma | 3.71 | 3.86 | 2.50 | ||||||||||||
| (in 000s, except per share amounts) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Net income | $ | 490,408 | $ | 623,910 | $ | 694,093 | ||||||
| Add: Stock-based compensation expense included in reported net income, net of taxes | 37,254 | 28,819 | 18,029 | |||||||||
| Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of taxes | (47,428 | ) | (39,544 | ) | (30,662 | ) | ||||||
| Pro forma net income | $ | 480,234 | $ | 613,185 | $ | 681,460 | ||||||
| Basic earnings per share: | ||||||||||||
| As presented | $ | 1.49 | $ | 1.88 | $ | 1.96 | ||||||
| Pro forma | 1.46 | 1.85 | 1.92 | |||||||||
| Diluted earnings per share: | ||||||||||||
| As presented | $ | 1.47 | $ | 1.85 | $ | 1.92 | ||||||
| Pro forma | 1.44 | 1.82 | 1.89 | |||||||||
DERIVATIVE ACTIVITIES– ...We use forward loan sale commitments, interest rate swaps and other financial instruments to manage our interest rate risk related to commitments to fund mortgage loans and mortgage loans underlying our beneficial interest in Trusts. We do not enter into derivative transactions for speculative or trading purposes.
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We record derivative instruments as assets or liabilities, measured at fair value. The recognition of gains or losses resulting from changes in the values of those derivative instruments is based on the use of each derivative instrument and whether it qualifies for hedge accounting.
instruments qualify for hedge accounting treatment as of April 30, 20052006 or 2005. Gains or losses on derivative instruments are presented in our consolidated statements of income and 2004.statements of cash flows in a manner consistent with the earnings effect of the hedged item.
DISCLOSURE REGARDING CERTAIN FINANCIAL INSTRUMENTS– ...The carrying values reported in the balance sheet for cash equivalents, receivables, accounts payable, accrued liabilities and the current portion of long-term debt approximate fair market value due to the relative short-term nature of the respective instruments. Residual interests and beneficial interests in Trusts are recorded at estimated fair value as discussed above. See note 65 for the fair value of MSRs and note 109 for fair value of long-term debt.
NEW ACCOUNTING STANDARDS– ...In February 2006, Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments – An Amendment of FASB Statements No. 133 and 140” (SFAS 155), was issued. The provisions of this standard establish a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. The standard permits a hybrid financial instrument to be accounted for in its entirety if the holder irrevocably elects to measure the hybrid financial instrument at fair value, with changes in fair value recognized currently in earnings. The provisions of this standard are effective as of the beginning of our fiscal year 2008, although early adoption is permitted. Our residual interests typically have interests in derivative instruments embedded within the securitization trusts. If we elect to account for our residual interests on a fair value basis, changes in fair value will impact earnings in the period in which the change occurs. We are currently evaluating what effect the adoption of SFAS 155 will have on our consolidated financial statements.
In March 2006, Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140,” (SFAS 156), was issued. The provisions of this standard require mortgage servicing rights to be initially valued at fair value. SFAS 156 also allows servicers to choose to measure their servicing rights at fair value or to continue using the “amortization method” under SFAS 140. The provisions of this standard are effective as of the beginning of our fiscal year 2008, although early adoption is permitted. We are currently evaluating what effect the adoption of SFAS 156 will have on our consolidated financial statements.
In December 2004, Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”)(SFAS 123R) was issued. SFAS 123R requires all entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. Compensation expense must be recognized for the unvested portions of all awards outstanding as of the date of adoption. The provisions of this standard were delayed by the SEC and will be effective as of the beginning of our fiscal year 2007. We are currently evaluating what effect theThe adoption of SFAS 123R will not have a material impact on our consolidated financial statements.
In August 2003, we adopted Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”)(EITF 00-21). EITF 00-21 requires consideration received in connection with arrangements involving multiple revenue generating activities be measured and allocated to each separate unit of accounting. Revenue recognition is determined separately for each unit of accounting within the arrangement. EITF 00-21 impacts revenue recognition related to tax preparation in our premium tax offices where POM guarantees are included in the price of a completed tax return. Prior to the adoption of EITF 00-21, revenues related to POM guarantees at premium offices were recorded in the same period as tax preparation revenues. Beginning May 1, 2003, revenues related to POM guarantees are now initially deferred and recognized over the guarantee period in proportion to POM claims paid. As a result of the adoption of EITF 00-21, we recorded a cumulative effect of a change in accounting principle of $6.4 million, net of a tax benefit of $4.0 million, as of May 1, 2003.
Revenues recognized during fiscal year 2004, which were initially recognized in prior periods and recorded as part of the cumulative effect of a change in accounting principle, totaled $36.3 million.
| (in 000s, except per share amounts) | |||||||||||
| Net income | $ | 477,615 | $ | 475,969 | |||||||
| Earnings per share: | |||||||||||
| Basic | $ | 2.66 | $ | 2.65 | |||||||
| Diluted | 2.59 | 2.59 | |||||||||
55
and debt totaling $7.8 billion, which we would be required to consolidate into our financial statements under the provisions of this exposure draft. The final standard for this exposure draft is scheduled to be issued in the first quarter of calendar year 2007.
The estimated impact of these new accounting standards reflects current views. There may be material differences between these estimates and the actual impact of these standards.
56
| (in 000s, except per share amounts) | ||||||||||||||||||||||||||
| Year Ended April 30, | 2004 | 2003 | ||||||||||||||||||||||||
| As Previously | As Previously | |||||||||||||||||||||||||
| Reported(1) | Adjustments | Restated | Reported(1) | Adjustments | Restated | |||||||||||||||||||||
| Gains on sales of mortgage assets, net | $ | 913,699 | $ | 4,598 | $ | 918,297 | $ | 864,701 | $ | (37,574 | ) | $ | 827,127 | |||||||||||||
| Interest income | 211,359 | 18,436 | 229,795 | 193,889 | 1,179 | 195,068 | ||||||||||||||||||||
| Total revenues | 4,224,846 | 23,034 | 4,247,880 | 3,767,521 | (36,395 | ) | 3,731,126 | |||||||||||||||||||
| Cost of service revenues | 1,787,089 | 7,412 | 1,794,501 | 1,623,601 | 2,336 | 1,625,937 | ||||||||||||||||||||
| Cost of other revenues | 375,713 | 4,652 | 380,365 | 295,975 | 4,774 | 300,749 | ||||||||||||||||||||
| Impairment of goodwill | – | – | – | 35,777 | 86,474 | 122,251 | ||||||||||||||||||||
| Selling, general and administrative | 836,523 | 12,152 | 848,675 | 755,203 | 5,661 | 760,864 | ||||||||||||||||||||
| Total operating expenses | 2,999,325 | 24,216 | 3,023,541 | 2,710,556 | 99,245 | 2,809,801 | ||||||||||||||||||||
| Operating income | 1,225,521 | (1,182 | ) | 1,224,339 | 1,056,965 | (135,640 | ) | 921,325 | ||||||||||||||||||
| Income before taxes | 1,164,157 | (1,182 | ) | 1,162,975 | 987,077 | (131,513 | ) | 855,564 | ||||||||||||||||||
| Income taxes | 459,901 | (12,534 | ) | 447,367 | 407,013 | (29,064 | ) | 377,949 | ||||||||||||||||||
| Net income | 697,897 | 11,352 | 709,249 | 580,064 | (102,449 | ) | 477,615 | |||||||||||||||||||
| Basic earnings per share | $ | 3.94 | $ | 0.07 | $ | 4.01 | $ | 3.23 | $ | (0.57 | ) | $ | 2.66 | |||||||||||||
| Diluted earnings per share | 3.86 | 0.06 | 3.92 | 3.15 | (0.56 | ) | 2.59 | |||||||||||||||||||
| Reclassification adjustment for gains included in income | $ | (95,150 | ) | $ | (14,235 | ) | $ | (109,385 | ) | $ | (139,566 | ) | $ | 22,493 | $ | (117,073 | ) | |||||||||
| Comprehensive income | 718,988 | (2,883 | ) | 716,105 | 572,798 | (79,956 | ) | 492,842 | ||||||||||||||||||
| (in 000s) | ||||||||||||||
| April 30, | 2004 | |||||||||||||
| As Previously | ||||||||||||||
| Reported(1) | Adjustments | Restated | ||||||||||||
| Intangible assets, net | $ | 325,829 | $ | (32,352 | ) | $ | 293,477 | |||||||
| Goodwill, net | 959,418 | 34,049 | 993,467 | |||||||||||
| Property and equipment, net | 279,220 | (5,917 | ) | 273,303 | ||||||||||
| Other assets | 308,714 | (68,333 | ) | 240,381 | ||||||||||
| Total assets | 5,295,468 | (62,736 | ) | 5,232,732 | ||||||||||
| Accrued salaries, wages and payroll taxes | 268,747 | 11,620 | 280,367 | |||||||||||
| Accrued income taxes | 405,668 | 8,200 | 413,868 | |||||||||||
| Other noncurrent liabilities | 382,168 | (12,399 | ) | 369,769 | ||||||||||
| Total liabilities | 3,398,459 | 14,458 | 3,412,917 | |||||||||||
| Accumulated other comprehensive income | 57,953 | 8,258 | 66,211 | |||||||||||
| Retained earnings | 2,781,368 | (85,452 | ) | 2,695,916 | ||||||||||
| Total stockholders’ equity | 1,897,009 | (77,194 | ) | 1,819,815 | ||||||||||
| Total liabilities and stockholders’ equity | 5,295,468 | (62,736 | ) | 5,232,732 | ||||||||||
| (in 000s) | ||||||||||||||||||||||||||
| Year Ended April 30, | 2004 | 2003 | ||||||||||||||||||||||||
| As Previously | As Previously | |||||||||||||||||||||||||
| Reported(1) | Adjustments | Restated | Reported(1) | Adjustments | Restated | |||||||||||||||||||||
| Net income | $ | 697,897 | $ | 11,352 | $ | 709,249 | $ | 580,064 | $ | (102,449 | ) | $ | 477,615 | |||||||||||||
| Depreciation and amortization | 172,038 | 7,093 | 179,131 | 161,821 | 7,271 | 169,092 | ||||||||||||||||||||
| Provision for deferred taxes on income | 11,459 | (12,445 | ) | (986 | ) | 10,574 | (40,518 | ) | (29,944 | ) | ||||||||||||||||
| Accretion of residual interests in securitizations | (168,029 | ) | (18,436 | ) | (186,465 | ) | (145,165 | ) | (1,178 | ) | (146,343 | ) | ||||||||||||||
| Impairment of residual interests in securitizations | 30,661 | (4,598 | ) | 26,063 | 54,111 | – | 54,111 | |||||||||||||||||||
| Realized gain on sale of previously securitized residual interests | (40,689 | ) | – | (40,689 | ) | (130,881 | ) | 37,574 | (93,307 | ) | ||||||||||||||||
| Impairment of goodwill | – | – | – | 35,777 | 86,474 | 122,251 | ||||||||||||||||||||
| Accounts payable, accrued expenses and deposits | (105,737 | ) | 1,174 | (104,563 | ) | 57,658 | 2,796 | 60,454 | ||||||||||||||||||
| Accrued salaries, wages and payroll taxes | 58,468 | 12,053 | 70,521 | (42,772 | ) | (139 | ) | (42,911 | ) | |||||||||||||||||
| Accrued income taxes | 93,710 | 60 | 93,770 | 99,715 | 12,107 | 111,822 | ||||||||||||||||||||
| Net cash provided by operating activities | 856,210 | (3,747 | ) | 852,463 | 691,926 | (2,191 | ) | 689,735 | ||||||||||||||||||
| Purchases of property and equipment, net | (127,573 | ) | 3,747 | (123,826 | ) | (150,897 | ) | 2,191 | (148,706 | ) | ||||||||||||||||
| Net cash provided by (used in) investing activities | (131,133 | ) | 3,747 | (127,386 | ) | 125,338 | 2,191 | 127,529 | ||||||||||||||||||
NOTE 3:2: BUSINESS COMBINATIONS AND DISPOSALS
| (in 000s) | |||||||||||||||
| Business | Asset Acquired | Estimated Life | Asset Value at Acquisition | ||||||||||||
Fiscal year 2005 ... | |||||||||||||||
| Non-accounting firm Business Services acquisitions | Property and equipment | $ | 2,497 | ||||||||||||
| Goodwill | 9,666 | ||||||||||||||
| Customer relationships | 10 years | 7,730 | |||||||||||||
| Noncompete agreements | 15 years | 100 | |||||||||||||
| Weighted average life | 10 years | $ | 19,993 | ||||||||||||
Fiscal year 2004 ... | |||||||||||||||
| Former major franchise territories | Property and equipment | $ | 2,697 | ||||||||||||
| Goodwill | 205,313 | ||||||||||||||
| Customer relationships | 10 years | 18,167 | |||||||||||||
| Noncompete agreements | 3 years | 17,069 | |||||||||||||
| Weighted average life | 7 years | $ | 243,246 | ||||||||||||
| Accounting firms | Goodwill | $ | 3,923 | ||||||||||||
| Customer relationships | 10 years | 1,794 | |||||||||||||
| Noncompete agreements | 15 years | 747 | |||||||||||||
| Weighted average life | 11 years | $ | 6,464 | ||||||||||||
Fiscal year 2003 ... | |||||||||||||||
| Accounting firms | Goodwill | $ | 2,404 | ||||||||||||
| Customer relationships | 10 years | 2,242 | |||||||||||||
| Noncompete agreements | 15 years | 728 | |||||||||||||
| Weighted average life | 11 years | $ | 5,374 | ||||||||||||
| (in 000s) | ||||||||||||
| Asset Acquired | Weighted Average Life | Asset Value at Acquisition | ||||||||||
FISCAL YEAR 2006– | ||||||||||||
| American Express Tax and Business Services, Inc. | Property and equipment | $ | 17,759 | |||||||||
| Goodwill | 72,123 | |||||||||||
| Customer relationships | 11 years | 18,800 | ||||||||||
| Noncompete agreements | 6 years | 3,900 | ||||||||||
| Trade name | 2 years | 2,600 | ||||||||||
| Other assets | 128,998 | |||||||||||
| Liabilities | (53,442 | ) | ||||||||||
| Weighted average life | 9 years | $ | 190,738 | |||||||||
| Other | Goodwill | $ | 13,616 | |||||||||
| Customer relationships | 9 years | 8,397 | ||||||||||
| Noncompete agreements | 9 years | 2,024 | ||||||||||
| Other assets (liabilities) | (4,353 | ) | ||||||||||
| Weighted average life | 9 years | $ | 19,684 | |||||||||
FISCAL YEAR 2005– | ||||||||||||
| Non-accounting firm Business Services acquisitions | Property and equipment | $ | 2,497 | |||||||||
| Goodwill | 9,666 | |||||||||||
| Customer relationships | 10 years | 7,730 | ||||||||||
| Noncompete agreements | 15 years | 100 | ||||||||||
| Weighted average life | 10 years | $ | 19,993 | |||||||||
FISCAL YEAR 2004– | ||||||||||||
| Former major franchise territories | Property and equipment | $ | 2,697 | |||||||||
| Goodwill | 205,313 | |||||||||||
| Customer relationships | 10 years | 18,167 | ||||||||||
| Noncompete agreements | 3 years | 17,069 | ||||||||||
| Weighted average life | 7 years | $ | 243,246 | |||||||||
| Accounting firms | Goodwill | $ | 3,923 | |||||||||
| Customer relationships | 10 years | 1,794 | ||||||||||
| Noncompete agreements | 15 years | 747 | ||||||||||
| Weighted average life | 11 years | $ | 6,464 | |||||||||
During fiscal year 2006, we acquired all outstanding common stock of American Express Tax and Business Services, Inc. for an aggregate purchase price of $190.7 million. The customer relationships will be amortized based on estimated customer retention and have a weighted average life of 11 years. The noncompete agreements will be amortized on a straight-line basis and have a weighted average life of six years. Goodwill recognized in this transaction is included in the Business Services segment and is not deductible for tax purposes. The preliminary purchase price allocations are subject to change and will be adjusted based upon resolution of several matters including, but not limited to, the following:
| • | Determination of the post-closing adjustment and final purchase price; | |
| • | Determination of final liabilities relating to planned exit activities; and | |
| • | Determination of the tax basis of acquired assets and liabilities, and deferred tax balances of the acquired business. |
During fiscal year 2005, our Business Services segment acquired six businesses. Cash payments related to these acquisitions totaled $19.5 million, with additional cash payments of $0.1 million over the next five years. Goodwill recognized in these transactions is included in the Business Services segment and all but $3.8 million is deductible for tax purposes.
57
During fiscal year 2004, we made payments of $243.2 million related to the acquisition of primarily assets and stock in the franchise territories of ten former major franchisees. The customer relationships will be amortized based on estimated customer retention over ten years. The noncompete agreements will be amortized on a straight-line basis over three years. Goodwill recognized in these transactions is included in the Tax Services segment and all but $3.9 million is deductible for tax purposes.
During fiscal year 2004, we acquired three accounting firms. Cash payments related to these acquisitions totaled $6.2 million, with additional cash payments of $1.0 million over the next five years. The purchase agreements also provide for possible future contingent consideration of approximately $3.0 million. Goodwill recognized in these transactions is deductible for tax purposes and is included in the Business Services segment.
During fiscal year 2003, we acquired two accounting firms. Cash payments related to these acquisitions totaled $2.6 million, with additional cash payments of $2.8 million over the next five years. The purchase agreements also provide for possible future contingent consideration of approximately $0.3 million. Goodwill recognized in these transactions was $2.4 million, which is deductible for tax purposesyears 2006, 2005 and is included in the Business Services segment.
and 2004, we also paid $2.1 million, $3.4 million and $27.3 million, respectively, for contingent payments on prior acquisitions.
NOTE 4:3: EARNINGS PER SHARE
Basic earnings per share is computed using the weighted-average number of common shares outstanding. The dilutive effect of potential common shares outstanding is included in diluted earnings per share. The computations of basic and diluted earnings per share before change in accounting principle are as follows:
| (in 000s, except per share amounts) | |||||||||||||||
| Restated | Restated | ||||||||||||||
| Year ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Net income before change in accounting | $ | 635,857 | $ | 715,608 | $ | 477,615 | |||||||||
| Basic weighted average common shares | 165,806 | 177,076 | 179,638 | ||||||||||||
| Dilutive potential shares from stock options and restricted stock | 3,006 | 3,725 | 4,439 | ||||||||||||
| Convertible preferred stock | 1 | 1 | 1 | ||||||||||||
| Dilutive weighted average common shares | 168,813 | 180,802 | 184,078 | ||||||||||||
| Earnings per share: | |||||||||||||||
| Basic | $ | 3.83 | $ | 4.04 | $ | 2.66 | |||||||||
| Diluted | 3.77 | 3.96 | 2.59 | ||||||||||||
| (in 000s, except per share amounts) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Net income before change in accounting principle | $ | 490,408 | $ | 623,910 | $ | 700,452 | ||||||
| Basic weighted average common shares | 328,118 | 331,612 | 354,152 | |||||||||
| Dilutive potential shares from stock options and restricted stock | 5,067 | 6,011 | 7,449 | |||||||||
| Convertible preferred stock | 2 | 2 | 2 | |||||||||
| Dilutive weighted average common shares | 333,187 | 337,625 | 361,603 | |||||||||
| Earnings per share: | ||||||||||||
| Basic | $ | 1.49 | $ | 1.88 | $ | 1.98 | ||||||
| Diluted | 1.47 | 1.85 | 1.94 | |||||||||
Diluted earnings per share excludes the impact of common shares issuable upon the lapse of certain restrictions or the exercise of options to purchase 0.68.7 million, 2.41.2 million, and 2.64.8 million shares of stock for 2006, 2005 and 2004, and 2003, respectively, because the options’ exercise prices were greater than the average market price of the common shares and therefore, the effect would be antidilutive.
respectively.
NOTE 5:4: MARKETABLE SECURITIES AVAILABLE-FOR-SALE
The amortized cost and market value of marketable securities classified as available-for-sale at April 30, 20052006 and 20042005 are summarized below:
| (in 000s) | ||||||||||||||||||||||||||||||||||
| 2005 | 2004 (Restated) | |||||||||||||||||||||||||||||||||
| Gross | Gross | Gross | Gross | |||||||||||||||||||||||||||||||
| Amortized | Unrealized | Unrealized | Market | Amortized | Unrealized | Unrealized | Market | |||||||||||||||||||||||||||
| Cost | Gains | Losses(1) | Value | Cost | Gains | Losses(1) | Value | |||||||||||||||||||||||||||
| Municipal bonds | $ | 9,797 | $ | 172 | $ | (1 | ) | $ | 9,968 | $ | 8,846 | $ | 27 | $ | (78 | ) | $ | 8,795 | ||||||||||||||||
| Common stock | 4,250 | 308 | (129 | ) | 4,429 | 4,661 | 450 | (82 | ) | 5,029 | ||||||||||||||||||||||||
| Residual interests | 90,525 | 115,411 | – | 205,936 | 85,100 | 125,873 | – | 210,973 | ||||||||||||||||||||||||||
| $ | 104,572 | $ | 115,891 | $ | (130 | ) | $ | 220,333 | $ | 98,607 | $ | 126,350 | $ | (160 | ) | $ | 224,797 | |||||||||||||||||
| (in 000s) | ||||||||||||||||||||||||||||||||
| 2006 | 2005 | |||||||||||||||||||||||||||||||
| Gross | Gross | Gross | Gross | |||||||||||||||||||||||||||||
| Amortized | Unrealized | Unrealized | Market | Amortized | Unrealized | Unrealized | Market | |||||||||||||||||||||||||
| Cost | Gains | Losses(1) | Value | Cost | Gains | Losses(1) | Value | |||||||||||||||||||||||||
| Municipal bonds | $ | 8,556 | $ | 5 | $ | (53 | ) | $ | 8,508 | $ | 9,797 | $ | 172 | $ | (1 | ) | $ | 9,968 | ||||||||||||||
| Common stock | 3,998 | 382 | (100 | ) | 4,280 | 4,250 | 308 | (129 | ) | 4,429 | ||||||||||||||||||||||
| Residual interests | 114,922 | 44,136 | - | 159,058 | 90,525 | 115,411 | - | 205,936 | ||||||||||||||||||||||||
| $ | 127,476 | $ | 44,523 | $ | (153 | ) | $ | 171,846 | $ | 104,572 | $ | 115,891 | $ | (130 | ) | $ | 220,333 | |||||||||||||||
(1) Gross unrealized losses have been in a continuous loss position for less than 12 months.
58
We monitor our available-for-sale investment portfolio for impairment and consider many factors in determining whether the impairment is deemed to be other-than-temporary. These factors include, but are not limited to, the length of time the security has had a market value less than the cost basis, the severity of the loss, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, external credit ratings and recent downgrades in such ratings. Impairments of fair value of available-for-sale residual interests realized during fiscal years 2006 and 2005 totaled $34.1 million and $12.2 million, respectively.
Proceeds from the sales of available-for-sale securities were $73.6 million, $26.2 million $68.8 million and $156.6$68.8 million during fiscal years 2006, 2005 2004 and 2003,2004, respectively. Gross realized gains on those sales during fiscal years 2006, 2005 and 2004 and 2003 were $32.1 million, $15.8 million $41.8 million and $93.9$41.8 million, respectively; gross realized losses were $0.2 million, $0.3 million $0.1 million and $0.7$0.1 million, respectively.
Contractual maturities of available-for-sale debt securities at April 30, 20052006 occur at varying dates over the next fivefour to tennine years. Because expected maturities differ from contractual maturities due to the issuers’ rights to prepay certain obligations
or the seller’s rights to call certain obligations, the first call date, put date or auction date for municipal bonds and notes is considered the contractual maturity date.
NOTE 6:5: MORTGAGE BANKING ACTIVITIES
We originate mortgage loans and sell most non-prime loans the same day the loans are funded to Trusts. These Trusts meet the criteria of QSPEs and are therefore not consolidated. The sale is recorded in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”)(SFAS 140). The Trusts purchase the loans from us using fivenine warehouse facilities we arrange. As a result of the whole loan sales to the Trusts, we remove the mortgage loans from our balance sheet and record the gain on the sale, cash, MSRs, recourse reserves and a beneficial interest in Trusts, which represents our residual interest in the ultimate expected outcome from the disposition of the loans.loans by the Trusts. The beneficial interest in Trusts was $215.4$188.0 million and $153.8$215.4 million at April 30, 20052006 and 2004,2005, respectively.
The Trusts, as directedin response to the exercise of a put option by theirthe third-party beneficial interest holders, either sell the loans directly to third-party investors or back to us to pool the loans for securitization. The decision to complete a whole loan sale or a securitization is dependent on market conditions. If the Trusts choose to sell the mortgage loans, we receive cash for our beneficial interest in Trusts. In a securitization transaction, the Trusts transfer the loans to one of our consolidated subsidiaries, and we transfer our beneficial interest in Trusts and the loans to a securitization trust. The securitization trust meets the definition of a QSPE and is therefore not consolidated. The securitization trust issues bonds, which are supported by the cash flows from the pooled loans, to third-party investors. We retain an interest in the loans in the form of a trading residual interest and usually assume the first risk of loss for credit losses in the loan pool. As the cash flows of the underlying loans and market conditions change, the value of ourthese residual interestinterests may also change, resulting in either additional unrealized gains or impairment of the value of the residual interests. These residual interests are classified as trading securities. We held no trading residual interests as of April 30, 20052006 and 2004,2005, as all trading residuals had been securitized.
Activity related to trading residual interests in securitizations consists of the following:
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Balance, beginning of year | $ | - | $ | - | ||||
| Additions (resulting from securitization of mortgage loans) | 353,882 | 110,305 | ||||||
| Cash received | (12,858 | ) | - | |||||
| Accretion | 5,950 | - | ||||||
| Change of fair value | 9,837 | 5,352 | ||||||
| Residuals securitized in NIM transactions | (356,811 | ) | (115,657 | ) | ||||
| Balance, end of year | $ | - | $ | - | ||||
To accelerate the cash flows from our trading residual interests, we securitize the majority of ourthese residual interests in NIM transactions. In a NIM transaction, the trading residual interests are transferred to another QSPE (“NIM trust”)(NIM trust), which then issues bonds to third-party investors. The proceeds from the bonds are returned to us as payment for the residual interests. The bonds are secured by the pooled residual interests and are obligations of the NIM trust. We retain a subordinated interest in the NIM trust, and receive cash flows on our residual interest generally after the bonds issued to the third-party investors are paid in full. Residual interests retained from NIM securitizations may also be bundled and sold in a subsequent securitization. TheseThe new residual interests are classified as available-for-sale securities. See note 5.4.
59
Activity related to available-for-sale residual interests in securitizations consists of the following:
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Balance, beginning of year | $ | 205,936 | $ | 210,973 | ||||
| Additions (resulting from NIM transactions) | 61,651 | 16,914 | ||||||
| Cash received | (80,539 | ) | (136,045 | ) | ||||
| Cash proceeds from sales and securitizations of residual interests | (62,396 | ) | (16,485 | ) | ||||
| Accretion | 108,396 | 137,610 | ||||||
| Impairments of fair value | (34,107 | ) | (12,235 | ) | ||||
| Other | (1,583 | ) | - | |||||
| Change in unrealized holding gains arising during the period | (38,300 | ) | 5,204 | |||||
| Balance, end of year | $ | 159,058 | $ | 205,936 | ||||
Prime mortgage loans are sold in whole loan sales, servicing released, to third-party buyers.
| (in 000s) | ||||||||||
| Restated | ||||||||||
| April 30, | 2005 | 2004 | ||||||||
| Balance, beginning of year | $ | 210,973 | $ | 264,337 | ||||||
| Additions (resulting from NIM transactions) | 16,914 | 9,007 | ||||||||
| Cash received | (136,045 | ) | (193,606 | ) | ||||||
| Cash received on sales of residual interests | (16,485 | ) | (53,391 | ) | ||||||
| Accretion | 137,610 | 184,253 | ||||||||
| Impairments of fair value | (12,235 | ) | (26,063 | ) | ||||||
| Other | – | (6,203 | ) | |||||||
| Change in unrealized holding gains arising during the period | 5,204 | 32,639 | ||||||||
| Balance, end of year | $ | 205,936 | $ | 210,973 | ||||||
We sold $31.0$40.3 billion and $23.2$31.0 billion of mortgage loans in whole loan sales to the Trusts and other buyers during the years ended April 30, 20052006 and 2004,2005, respectively. Gains totaling $772.1$575.4 million and $915.6$772.1 million were recorded on these sales, respectively.
Cash flows from theavailable-for-sale residual interests of $136.0$80.5 million and $193.6$136.0 million were received from the securitization trusts for the years ended April 30, 20052006 and 2004,2005, respectively. An additional $16.5$62.4 million and $53.4$16.5 million was received during fiscal years 20052006 and 2004,2005, respectively, as a result of the sale of previously securitized residuals, as discussed below. Cash received on theavailable-for-sale residual interests is included in investing activities on the consolidated statements of cash flows.
During fiscal year 2006, we completed sales of previously securitized residual interests and recorded gains of $31.5 million. We received cash proceeds of $62.4 million from the transactions and retained a $10.0 million available-for-sale residual interest. During fiscal year 2005, we completed sales of previously securitized residual interests and recorded gains of $15.4 million. We received cash proceeds of $16.5 million from the transactions and retained a $21.5 million available-for-sale residual interest. These sales accelerate cash flows from the residual interests, effectively realizing previously recorded unrealized gains included in other comprehensive income.
Aggregate net unrealized gains on available-for-sale residual interests, which had not yet been accreted into income, totaled $115.4$44.1 million and $125.9$115.4 million at April 30, 20052006 and 2004,2005, respectively. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and may be recognized in income in future periods either through accretion or upon further securitization of the related residual interest.
Included in prepaid expenses and other current assets on our consolidated balance sheets as of April 30, 2006 and 2005, and 2004, is $231.0$255.2 million and $212.3$231.0 million, respectively, in default advances, escrow advances and principal and interest advances related to the servicing of non-prime loans.
Activity related to mortgage servicing rights consists of the following:
| (in 000s) | ||||||||||
| April 30, | 2005 | 2004 | ||||||||
| Balance, beginning of year | $ | 113,821 | $ | 99,265 | ||||||
| Additions | 137,510 | 84,274 | ||||||||
| Amortization | (84,191 | ) | (69,718 | ) | ||||||
| Impairments of fair value | (526 | ) | – | |||||||
| Balance, end of year | $ | 166,614 | $ | 113,821 | ||||||
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Balance, beginning of year | $ | 166,614 | $ | 113,821 | ||||
| Additions | 250,537 | 137,510 | ||||||
| Amortization | (144,359 | ) | (84,191 | ) | ||||
| Impairments of fair value | (320 | ) | (526 | ) | ||||
| Balance, end of year | $ | 272,472 | $ | 166,614 | ||||
Additions to MSRs during fiscal year 2006 increased primarily as a result of higher origination volumes, higher average loan balances and higher interest rates. In addition, during fiscal year 2006 we updated our assumptions used to value MSRs. The assumptions were updated primarily to reflect lower servicing costs, in particular interest paid to bondholders on monthly loan prepayments, and higher discount rates. The change in assumptions increased the weighted average value of MSRs recorded during fiscal year 2006 by approximately $37.0 million (0.09% of loans originated). These changes in assumptions, coupled with increases in origination volumes, average loan size and interest rates, increased gains on sales of mortgage loans by $113.0 million over the prior year.
Estimated amortization of MSRs for fiscal years 2006, 2007, 2008, 2009, 2010 and 20102011 is $89.7$147.5 million, $49.8$76.1 million, $20.0$32.4 million, $5.8$11.8 million and $1.3$4.7 million, respectively. The carrying value of MSRs approximates fair value at April 30, 2005 and 2004.
60
The key assumptions we used to originally estimate the cash flows and values of our available-for-sale residual interests are as follows:
| 2005 | 2004 | 2003 | ||||||||||||
| Estimated credit losses | 2.72% | 3.63% | 3.60% | |||||||||||
| Discount rate | 25.00% | 16.25% | 13.03% | |||||||||||
| Variable returns to third-party beneficial interest holders | LIBOR forward curve at valuation date | |||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| Estimated credit losses | 2.55% | 2.72% | 3.63% | |||||||||
| Discount rate | 25.00% | 25.00% | 16.25% | |||||||||
| Variable returns to third-party beneficial interest holders | LIBOR forward curve at closing date | |||||||||||
The key assumptions we used to estimate the cash flows and values of our residual interests and MSRs at April 30 are
as follows:
as follows:
| April 30, | 2005 | 2004 | ||||||||
| Estimated credit losses – residual interests | 3.03% | 4.16% | ||||||||
| Discount rate – residual interests | 21.01% | 19.09% | ||||||||
| Discount rate – MSRs | 12.80% | 12.80% | ||||||||
| Variable returns to third-party beneficial interest holders | LIBOR forward curve at valuation date | |||||||||
| April 30, | 2006 | 2005 | ||||||||||
| Estimated credit losses – residual interests | 3.07% | 3.03% | ||||||||||
| Discount rate – residual interests | 21.98% | 21.01% | ||||||||||
| Discount rate – MSRs | 18.00% | 12.80% | ||||||||||
| Variable returns to third-party beneficial interest holders | LIBOR forward curve at valuation date | |||||||||||
We originate both adjustable and fixed rate mortgage loans. A key assumption used to estimate the cash flows and values of the residual interests is average annualized prepayment speeds. Prepayment speeds include voluntary prepayments, involuntary prepayments and scheduled principal payments. Prepayment rate assumptions are as follows:
| Months Outstanding Without | |||||||||||||||
| Prepayment Penalty | |||||||||||||||
| Prior to | |||||||||||||||
| Penalty | |||||||||||||||
| Expiration | Zero – 3 | Remaining Life | |||||||||||||
| Adjustable rate mortgage loans: | |||||||||||||||
| With prepayment penalties | 30% | 70% | 44% | ||||||||||||
| Without prepayment penalties | 36% | 53% | 40% | ||||||||||||
| Fixed rate mortgage loans: | |||||||||||||||
| With prepayment penalties | 29% | 46% | 42% | ||||||||||||
| Prior to | Months Outstanding Without | |||||||||||
| Penalty | Prepayment Penalty | |||||||||||
| Expiration | Zero - 3 | Remaining Life | ||||||||||
| Adjustable rate mortgage loans: | ||||||||||||
| With prepayment penalties | 31% | 72% | 39% | |||||||||
| Without prepayment penalties | 35% | 52% | 35% | |||||||||
| Fixed rate mortgage loans: | ||||||||||||
| With prepayment penalties | 30% | 48% | 38% | |||||||||
For fixed rate mortgages without prepayment penalties, we use an average prepayment rate of 35%32% over the life of the loans. Prepayment rate is projected based on actual paydown including voluntary, involuntary and scheduled principal payments.
Expected static pool credit losses are as follows:
| Mortgage Loans Securitized in | |||||||||||||||||||||||
| 2005 | 2004 | 2003 | 2002 | Prior | |||||||||||||||||||
| As of: | |||||||||||||||||||||||
| April 30, 2005 | 2.83% | 2.30% | 2.08% | 2.53% | 4.52% | ||||||||||||||||||
| April 30, 2004 | – | 3.92% | 4.35% | 3.58% | 4.46% | ||||||||||||||||||
| Mortgage Loans Securitized in | ||||||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | Prior | |||||||||||||||||||
| As of: | ||||||||||||||||||||||||
| April 30, 2006 | 3.05% | 2.48% | 2.18% | 2.13% | 2.69% | 4.75% | ||||||||||||||||||
| April 30, 2005 | - | 2.83% | 2.30% | 2.08% | 2.53% | 4.52% | ||||||||||||||||||
| April 30, 2004 | - | - | 3.92% | 4.35% | 3.58% | 4.46% | ||||||||||||||||||
Static pool credit losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets.
At April 30, 2005,2006, the sensitivities of the current fair value of the residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are presented in the following
table. These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
| (in 000s) | ||||||||||||
| Residential Mortgage Loans | ||||||||||||
| Available-for-sale | Beneficial interest | |||||||||||
| Residuals | in Trusts | MSRs | ||||||||||
| Carrying amount/fair value of residuals | $ | 159,058 | $ | 188,014 | $ | 272,472 | ||||||
| Weighted average life (in years) | 1.9 | 1.9 | 1.3 | |||||||||
| $ impact on fair value: | ||||||||||||
| Prepayments (including defaults): | ||||||||||||
| Adverse 10% | $ | 4,330 | $ | (11,656 | ) | $ | (39,163 | ) | ||||
| Adverse 20% | 13,924 | (17,892 | ) | (65,779 | ) | |||||||
| Credit losses: | ||||||||||||
| Adverse 10% | $ | (46,560 | ) | $ | (6,399 | ) | Not applicable | |||||
| Adverse 20% | (75,445 | ) | (12,796 | ) | Not applicable | |||||||
| Discount rate: | ||||||||||||
| Adverse 10% | $ | (5,657 | ) | $ | (5,972 | ) | $ | (4,368 | ) | |||
| Adverse 20% | (10,948 | ) | (11,687 | ) | (8,607 | ) | ||||||
| Variable interest rates: | ||||||||||||
| Adverse 10% | $ | (4,143 | ) | $ | (53,757 | ) | Not applicable | |||||
| Adverse 20% | (8,590 | ) | (107,183 | ) | Not applicable | |||||||
| (in 000s) | ||||||||||||||||
| Residential Mortgage Loans | ||||||||||||||||
| NIM | Beneficial interest | |||||||||||||||
| Residuals | in Trusts | MSRs | ||||||||||||||
| Carrying amount/fair value of residuals | $ | 205,936 | $ | 215,367 | $ | 166,614 | ||||||||||
| Weighted average life (in years) | 1.3 | 2.3 | 1.2 | |||||||||||||
| $ impact on fair value: | ||||||||||||||||
| Prepayments (including defaults): | ||||||||||||||||
| Adverse 10% | $ | (2,458 | ) | $ | (12,950 | ) | $ | (23,801 | ) | |||||||
| Adverse 20% | 8,293 | (20,572 | ) | (40,525 | ) | |||||||||||
| Credit losses: | ||||||||||||||||
| Adverse 10% | $ | (32,731 | ) | $ | (6,962 | ) | Not applicable | |||||||||
| Adverse 20% | (64,368 | ) | (13,917 | ) | Not applicable | |||||||||||
| Discount rate: | ||||||||||||||||
| Adverse 10% | $ | (5,158 | ) | $ | (5,492 | ) | $ | (2,175 | ) | |||||||
| Adverse 20% | (10,023 | ) | (10,730 | ) | (4,301 | ) | ||||||||||
| Variable interest rates: | ||||||||||||||||
| Adverse 10% | $ | (9,991 | ) | $ | (36,552 | ) | Not applicable | |||||||||
| Adverse 20% | (20,700 | ) | (73,646 | ) | Not applicable | |||||||||||
Increases in prepayment rates related to available-for-sale residuals can generate a positive impact to fair value when reductions in estimated credit losses and prepayment penalties exceed the adverse impact to accretion from accelerating the life of the available-for-sale residual interest.
61
Mortgage loans which have been securitized at April 30, 20052006 and 2004,2005, past due sixty days or more and the related net credit losses are presented below:
| (in 000s) | ||||||||||||||||||||||||||
| Total Principal | Principal Amount of Loans | Net Credit Losses | ||||||||||||||||||||||||
| Amount of Loans Outstanding | 60 Days or More Past Due | (net of recoveries) | ||||||||||||||||||||||||
| April 30, | April 30, | Year Ended April 30, | ||||||||||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||
| Residual mortgage loans | $ | 10,300,805 | $ | 15,732,953 | $ | 1,128,376 | $ | 1,286,069 | $ | 132,015 | $ | 159,253 | �� | |||||||||||||
| Warehouse | 6,742,387 | 3,244,141 | – | – | – | – | ||||||||||||||||||||
| Total loans | $ | 17,043,192 | $ | 18,977,094 | $ | 1,128,376 | $ | 1,286,069 | $ | 132,015 | $ | 159,253 | ||||||||||||||
| (in 000s) | ||||||||||||||||||||||||
| Total Principal | Principal Amount of Loans | Credit Losses | ||||||||||||||||||||||
| Amount of Loans Outstanding | 60 Days or More Past Due | (net of recoveries) | ||||||||||||||||||||||
| April 30, | April 30, | Year Ended April 30, | ||||||||||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||||
| Securitized mortgage loans | $ | 10,046,032 | $ | 10,300,805 | $ | 1,012,414 | $ | 1,128,376 | $ | 115,976 | $ | 132,015 | ||||||||||||
| Mortgage loans in warehouse Trusts | 7,845,834 | 6,742,387 | - | - | - | - | ||||||||||||||||||
| Total loans | $ | 17,891,866 | $ | 17,043,192 | $ | 1,012,414 | $ | 1,128,376 | $ | 115,976 | $ | 132,015 | ||||||||||||
NOTE 7:6: GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying amount of goodwill by segment for the year ended April 30, 2005,2006, are as follows:
| (in 000s) | ||||||||||||||||||
| Restated | ||||||||||||||||||
| 2004 | Additions | Other | 2005 | |||||||||||||||
| Tax Services | $ | 350,044 | $ | 10,175 | $ | 562 | $ | 360,781 | ||||||||||
| Mortgage Services | 152,467 | – | – | 152,467 | ||||||||||||||
| Business Services | 317,002 | 11,513 | 230 | 328,745 | ||||||||||||||
| Investment Services | 173,954 | – | – | 173,954 | ||||||||||||||
| $ | 993,467 | $ | 21,688 | $ | 792 | $ | 1,015,947 | |||||||||||
| (in 000s) | ||||||||||||||||
| 2005 | Additions | Other | 2006 | |||||||||||||
| Tax Services | $ | 360,781 | $ | 15,338 | $ | 396 | $ | 376,515 | ||||||||
| Mortgage Services | 152,467 | - | - | 152,467 | ||||||||||||
| Business Services | 328,745 | 70,401 | (1,630 | ) | 397,516 | |||||||||||
| Investment Services | 173,954 | - | - | 173,954 | ||||||||||||
| $ | 1,015,947 | $ | 85,739 | $ | (1,234 | ) | $ | 1,100,452 | ||||||||
Goodwill and other indefinite life intangible assets were tested for impairment in the fourth quarter of fiscal year 2005.2006. An independent valuation firm was engaged to assist in the test for selected reporting units. No impairment existed at any of our reporting units during fiscal year 2006, 2005 or 2004. In light of unsettled market conditions and the severe decline of comparable business valuations in the investment industry, we engaged an independent valuation firm in fiscal year 2003 to perform the goodwill impairment test on the Investment Services segment in accordance with SFAS 142. Based on this valuation, a goodwill impairment charge of $108.8 million was recorded during fiscal year 2003. Also during 2003, our annual impairment test resulted in an impairment of $13.5 million for a reporting unit within the Business Services segment. No other impairments were identified.
The goodwill and intangible assets previously includedadded in Corporate as of April 30, 2004 have been reclassifiedthe Business Services segment relate primarily to the acquisition of American Express Tax and Business Services, segment to more appropriately reflect our segment reporting.Inc., as discussed in note 2.
The components of intangible assets are as follows:
| (in 000s) | ||||||||||||||||||||||||
| April 30, | 2006 | 2005 | ||||||||||||||||||||||
| Gross | Gross | |||||||||||||||||||||||
| Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||||
| Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||
| Tax Services: | ||||||||||||||||||||||||
| Customer relationships | $ | 27,257 | $ | (10,842 | ) | $ | 16,415 | $ | 23,717 | $ | (7,207 | ) | $ | 16,510 | ||||||||||
| Noncompete agreements | 18,879 | (17,686 | ) | 1,193 | 17,677 | (11,608 | ) | 6,069 | ||||||||||||||||
| Business Services: | ||||||||||||||||||||||||
| Customer relationships | 153,844 | (81,178 | ) | 72,666 | 130,585 | (68,433 | ) | 62,152 | ||||||||||||||||
| Noncompete agreements | 32,534 | (14,300 | ) | 18,234 | 27,796 | (11,274 | ) | 16,522 | ||||||||||||||||
| Trade name - amortizing | 4,050 | (1,823 | ) | 2,227 | 1,450 | (995 | ) | 455 | ||||||||||||||||
| Trade name - non-amortizing | 55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | ||||||||||||||||
| Investment Services: | ||||||||||||||||||||||||
| Customer relationships | 293,000 | (235,010 | ) | 57,990 | 293,000 | (198,385 | ) | 94,615 | ||||||||||||||||
| $ | 585,201 | $ | (365,707 | ) | $ | 219,494 | $ | 549,862 | $ | (302,770 | ) | $ | 247,092 | |||||||||||
| -----------------------------------------------------------------------------------------------------------------------(in-000s) | |||||||||||||||||||||||||||
| April 30, | 2005 | 2004 (Restated) | |||||||||||||||||||||||||
| Gross | Gross | ||||||||||||||||||||||||||
| Carrying | Accumulated | Carrying | Accumulated | ||||||||||||||||||||||||
| Amount | Amortization | Net | Amount | Amortization | Net | ||||||||||||||||||||||
| Tax Services: | |||||||||||||||||||||||||||
| Customer relationships | $ | 23,717 | $ | (7,207 | ) | $ | 16,510 | $ | 19,011 | $ | (3,377 | ) | $ | 15,634 | |||||||||||||
| Noncompete agreements | 17,677 | (11,608 | ) | 6,069 | 17,364 | (5,724 | ) | 11,640 | |||||||||||||||||||
| Business Services: | |||||||||||||||||||||||||||
| Customer relationships | 130,585 | (68,433 | ) | 62,152 | 121,229 | (56,313 | ) | 64,916 | |||||||||||||||||||
| Noncompete agreements | 27,796 | (11,274 | ) | 16,522 | 27,424 | (8,670 | ) | 18,754 | |||||||||||||||||||
| Trade name – amortizing | 1,450 | (995 | ) | 455 | 1,450 | (926 | ) | 524 | |||||||||||||||||||
| Trade name – non-amortizing | 55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | |||||||||||||||||||
| Investment Services: | |||||||||||||||||||||||||||
| Customer relationships | 293,000 | (198,385 | ) | 94,615 | 293,000 | (161,760 | ) | 131,240 | |||||||||||||||||||
| $ | 549,862 | $ | (302,770 | ) | $ | 247,092 | $ | 535,115 | $ | (241,638 | ) | $ | 293,477 | ||||||||||||||
Amortization of intangible assets for the years ended April 30, 2006, 2005 and 2004 and 2003 was $64.0 million, $61.4 million $61.5 million and $51.8$61.5 million, respectively. Estimated amortization of intangible assets for fiscal years 2006, 2007, 2008, 2009, 2010 and 20102011 is $60.6$54.5 million, $51.6$36.9 million, $34.4$14.0 million, $11.7$12.3 million and $9.8$11.0 million, respectively.
62
NOTE 8:7: PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
| (in 000s) | ||||||||||
| Restated | ||||||||||
| April 30, | 2005 | 2004 | ||||||||
| Land | $ | 23,716 | $ | 29,925 | ||||||
| Buildings | 67,031 | 71,923 | ||||||||
| Computers and other equipment | 568,986 | 498,373 | ||||||||
| Capitalized software | 153,794 | 137,784 | ||||||||
| Leasehold improvements | 175,048 | 114,537 | ||||||||
| 988,575 | 852,542 | |||||||||
| Less: Accumulated depreciation and amortization | 658,425 | 579,239 | ||||||||
| $ | 330,150 | $ | 273,303 | |||||||
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Land | $ | 17,152 | $ | 23,716 | ||||
| Buildings | 50,232 | 67,031 | ||||||
| Computers and other equipment | 592,610 | 568,986 | ||||||
| Capitalized software | 180,591 | 153,794 | ||||||
| Leasehold improvements | 189,283 | 175,048 | ||||||
| Construction in process | 118,709 | - | ||||||
| 1,148,577 | 988,575 | |||||||
| Less: Accumulated depreciation and amortization | 704,792 | 658,425 | ||||||
| $ | 443,785 | $ | 330,150 | |||||
Depreciation and amortization expense for 2006, 2005 and 2004 and 2003 was $127.7 million, $122.5 million $117.6 million and $117.3$117.6 million, respectively. Included in depreciation and amortization expense is amortization of capitalized software of $28.0 million, $23.6 million $28.2 million and $29.9$28.2 million, respectively.
As of April 30, 20052006 and 2004,2005, we have property and equipment under capital lease with a cost of $16.8$22.1 million and $14.1$16.8 million, respectively, and accumulated depreciation of $4.9 million and $4.2 million, respectively. During the current fiscal year we entered into an agreement to lease furniture, fixtures and $2.5 million, respectively.equipment in conjunction with the purchase of Industrial Revenue Bonds from the City of Kansas City, Missouri as discussed further in note 16. Assets under this capital lease at April 30, 2006 totaled $5.3 million. We also have ana separate agreement to lease real estate and buildings under a noncancelable capital lease for the next 1615 years with an option to purchase after threetwo years.
Total assets under this capital lease at April 30, 2006 totaled $16.8 million.
During fiscal year 2006, we capitalized interest costs of $4.7 million relating to the construction of our new corporate headquarters.
NOTE 9:8: DERIVATIVE INSTRUMENTS
A summary of our derivative instruments as of April 30, 2005 is as follows:
| (in 000s) | ||||||||||||||||||||
| Asset (Liability) | Gain (Loss) in the | |||||||||||||||||||
| Balance at April 30, | Year Ended April 30, | |||||||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2004 | ||||||||||||||||
| Interest rate swaps | $ | 8,831 | $ | (1,325 | ) | $ | 137,192 | $ | 47,192 | $ | (2,703 | ) | ||||||||
| Put options on Eurodollar futures | 3,282 | - | 1,071 | - | - | |||||||||||||||
| Forward loans sale commitments | 1,961 | - | 1,961 | - | - | |||||||||||||||
| Interest rate caps | - | 12,458 | 802 | (106 | ) | - | ||||||||||||||
| Rate-lock equivalents | (317 | ) | 801 | (1,118 | ) | 2,187 | (13,917 | ) | ||||||||||||
| Prime short sales | 777 | (805 | ) | 1,315 | (2,420 | ) | 4,663 | |||||||||||||
| $ | 14,534 | $ | 11,129 | $ | 141,223 | $ | 46,853 | $ | (11,957 | ) | ||||||||||
| (in 000s) | ||||||||||||||||||||||
| Asset (Liability) | Gain (Loss) in the | |||||||||||||||||||||
| Balance at April 30, | Year Ended April 30, | |||||||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | 2003 | ||||||||||||||||||
| Interest rate swaps | $ | (1,325 | ) | $ | – | $ | 47,192 | $ | (2,703 | ) | $ | (5,194 | ) | |||||||||
| Interest rate caps | 12,458 | – | (106 | ) | – | – | ||||||||||||||||
| Rate-lock equivalents | 801 | (1,386 | ) | 2,187 | (13,917 | ) | 6,158 | |||||||||||||||
| Prime short sales | (805 | ) | 2,080 | (2,420 | ) | 4,663 | (5,105 | ) | ||||||||||||||
| $ | 11,129 | $ | 694 | $ | 46,853 | $ | (11,957 | ) | $ | (4,141 | ) | |||||||||||
We use interest rate swaps, put options on Eurodollar futures and forward loan sale commitments to reduce interest rate risk associated with non-prime loans. We generally enter into interest rate swap arrangements related to existing loan applications with rate-lock commitments and beginning at the end of our second quarter, for rate-lock commitmentsapplications we expect to makereceive prior to our next anticipated change in the next 30 days.rates charged to borrowers. Interest rate swaps represent an agreement to exchange interest rate payments, effectively converting ourwhereby we pay a fixed financing costs intorate and receive a floating rate. Put options on Eurodollar futures represent the right to sell a Eurodollar futures contract at a specified price in the future. These swap and put option contracts increase in value as rates rise and decrease in value as rates fall. As a result, these contracts increase in value as rates rise and decrease in value as rates fall. The average notional amount of swap arrangements during fiscal years 2006 and 2005 was $8.4 billion and $2.4 billion, respectively.
We enter into forward loan sale commitments to manage market risk associated with commitments to fund mortgage loans. The notional value and the contract value of the forward commitments at April 30, 2006 were $3.1 billion. Most of our forward commitments give us the option to under- or over-deliver by five to ten percent.
We generally enter into interest rate caps or swaps to mitigate interest rate risk associated with mortgage loans that will be securitized and trading residual interests that are classified as trading securities because they will be sold in a subsequent NIM transaction. The caps and swaps enhance the marketability of the securitization and NIM transactions. An interest rate cap represents a right to receive cash if interest rates rise above a contractual strike rate, its value therefore increases as interest rates rise. The interest raterates used in our interest rate caps isand the floating rates used in swaps are based on LIBOR.
We sell short FNMA, FHLMC and GNMA mortgage-backed securities to reduce our risk related to our commitments to fund fixed-rate prime loans. The position on certain or all of the fixed-ratefixed-
63
rate mortgage loans is closed approximately 10-15 days prior to standard Public Securities Association (“PSA”)(PSA) settlement dates.
None of our derivative instruments qualify for hedge accounting treatment as of April 30, 20052006 and 2004.
2005.
NOTE 10:9: LONG-TERM DEBT
The components of long-term debt and capital lease obligations are as follows:
| (in 000s) | ||||||||||
| April 30, | 2005 | 2004 | ||||||||
Senior Notes, 81/2%, due April 2007 | $ | 498,825 | $ | 498,225 | ||||||
| Senior Notes, 5.125%, due October 2014 | 397,766 | – | ||||||||
| Business Services acquisition obligations, due from May 2005 to January 2008 | 38,022 | 60,768 | ||||||||
| Capital lease obligations | 13,550 | 12,512 | ||||||||
| Other obligations | 455 | – | ||||||||
Senior Notes, 63/4%, due November 2004 | – | 249,975 | ||||||||
| 948,618 | 821,480 | |||||||||
| Less: Current portion | 25,545 | �� | 275,669 | |||||||
| $ | 923,073 | $ | 545,811 | |||||||
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| | | | ||||||||
Senior Notes, 81/2%, due April 2007 | $ | 499,425 | $ | 498,825 | ||||
| Senior Notes, 5.125%, due October 2014 | 398,001 | 397,766 | ||||||
| Business Services acquisition obligations, due from May 2006 to January 2008 | 13,439 | 38,022 | ||||||
| Capital lease obligations | 13,209 | 13,550 | ||||||
| Other obligations | 457 | 455 | ||||||
| 924,531 | 948,618 | |||||||
| Less: Current portion | 506,992 | 25,545 | ||||||
| $ | 417,539 | $ | 923,073 | |||||
On October 26, 2004, we issued $400.0 million of 5.125% Senior Notes under a shelf registration statement. The Senior Notes are due October 30, 2014, and are not redeemable by the bondholders prior to maturity. The net proceeds of this transaction were used to repay the $250.0 million in 63/4% Senior Notes.Notes that were due in November 2004. The remaining proceeds were used for working capital, capital expenditures, repayment of other debt and other general corporate purposes.
On April 13, 2000, we issued $500.0 million of 81/2% Senior Notes under a shelf registration statement. The Senior Notes are due April 15, 2007, and are not redeemable prior to maturity. The net proceeds of this transaction were used to repay a portion of the short-term borrowings that initially funded the acquisition of OLDE Financial Corporation and Financial Marketing Services, Inc.
As of April 30, 2006, we had $850.0 million remaining under aour shelf registration statement. The Senior Notes werefor additional debt issuances. As a result of our failure to file our Form 10-Q for the fiscal quarter ended January 31, 2006 by the SEC’s prescribed due November 1, 2004, and the net proceeds were useddate, we will be unable to repay short-term borrowings, which initially funded the acquisition of Option One.issue any debt securities under our shelf registration statement until April 2007.
We have obligations related to Business Services acquisitions of $38.0$13.4 million and $60.8$38.0 million at April 30, 20052006 and 2004,2005, respectively. The current portion of these amounts is included in the current portion of long-term debt on the consolidated balance sheet. The long-term portions are due from May 20062007 to January 2008.
We have a capitalized lease obligation of $13.6$13.2 million at April 30, 20052006 that is collateralized by land and buildings. The obligation is due in 1615 years.
The aggregate payments required to retire long-term debt are $25.5$507.0 million, $511.5 million, $1.0$6.8 million, $0.5 million, $0.6 million, $0.6 million and $409.5$409.1 million in 2006, 2007, 2008, 2009, 2010, 2011 and beyond, respectively.
Based upon borrowing rates currently available for indebtedness with similar terms, the fair value of long-term debt was approximately $981.8 million and $893.5$900.2 million at April 30, 2005 and 2004, respectively.
2006.
NOTE 11:10: OTHER NONCURRENT ASSETS AND LIABILITIES
We have deferred compensation plans that permit directors and certain employees to defer portions of their compensation and accrue income on the deferred amounts. Their deferred compensation and our matching amounts have been accrued. Included in other noncurrent liabilities are $115.4is $153.2 million and $93.4$115.4 million at April 30, 20052006 and 2004,2005, respectively, reflecting the liability under these plans. We may purchase whole-life insurance contracts on certain director and employee participants to recover distributions made or to be made under the plans and record theplans. The cash surrender value of the policies is recorded in other noncurrent assets.assets and totaled $127.4 million and $108.8 million at April 30, 2006 and 2005, respectively.
We have recorded $213.4$183.9 million and $178.7$213.4 million for obligations to certain government agencies at April 30, 20052006 and 2004,2005, respectively.
In connection with our acquisition of the non-attest assets of McGladrey & Pullen, LLP (“M&P”)(M&P) in August 1999, we assumed certain pensionretirement liabilities related to M&P’s retired partners. We make payments in varying amounts on a monthly basis. Included in other noncurrent liabilities at April 30, 2006 and 2005 and 2004 are $15.9$14.3 million and $17.5$15.9 million, respectively, related to this liability.
NOTE 12:11: STOCKHOLDERS’ EQUITY
We are authorized to issue 6.0 million shares of Preferred Stock, without par value. At April 30, 2005,2006, we had 5.6 million shares of authorized but unissued Preferred Stock. Of the unissued shares, 0.6 million shares have been designated as Participating Preferred Stock in connection with our shareholder rights plan.
64
On March 8, 1995, our Board of Directors authorized the issuance of a series of 0.5 million shares of nonvoting Preferred Stock designated as Convertible Preferred Stock, without par value. In April 1995, 0.4 million shares of Convertible Preferred Stock were issued in connection with an acquisition. In addition,
options to purchase 51,828 shares of Convertible Preferred Stock were issued as a part of the acquisition and 37,399 shares of Convertible Preferred Stock were issued in connection with these options. Each share of Convertible Preferred Stock became convertible on April 5, 1998 into foursixteen shares of Common Stock of the Company, (eight shares after a two-for-one stock split in August 2001), subject to adjustment upon certain events. The holders of the Convertible Preferred Stock are not entitled to receive dividends paid in cash, property or securities and, in the event of any dissolution, liquidation or wind-up of the Company, will share ratably with the holders of Common Stock then outstanding in the assets of the Company after any distribution or payments are made to the holders of Participating Preferred Stock or the holders of any other class or series of stock of the Company with preference over the Common Stock.
We grant restricted shares to selected employees under our stock-based compensation plans. Upon the grant of restricted shares, unearned compensation is recorded as an offset to additional paid in capital and is amortized as compensation expense over the restricted period. The balance of unearned compensation related to restricted shares at April 30, 2006 and 2005 was $42.6 million and 2004 was $23.7 million, and $15.0 million, respectively.
NOTE 13:12: STOCK-BASED COMPENSATION AND RETIREMENT BENEFITS
We have four stock-based compensation plans: the 2003 Long-Term Executive Compensation Plan, the 1989 Stock Option Plan for Outside Directors, the 1999 Stock Option Plan for Seasonal Employees, and the 2000 ESPP. The shareholders have approved all of our stock-based compensation plans.
The 2003 Plan replaced the 1993 Long-Term Executive Compensation Plan, effective July 1, 2003. The 1993 Plan terminated at that time, except with respect to outstanding awards thereunder. The shareholders had approved the 1993 Plan in September 1993 to replace the 1984 Long-Term Executive Compensation Plan, which terminated at that time except with respect to outstanding awards thereunder. Under the 2003 and 1989 plans, options may be granted to selected employees and outside directors to purchase our Common Stock for periods not exceeding 10 years at a price that is not less than 100% of fair market value on the date of the grant.
Options granted under the 2003 Plan are exercisable either (1) starting one year after the date of the grant, (2) starting one, two or three years after the date of the grant on a cumulative basis at the annual rate of 331/3% of the total number of option shares, or (3) starting three years after the date of the grant on a cumulative basis at the rate of 40%, 30%, and 30% over the following three years. In addition, certain option grants have accelerated vesting provisions based on our stock price reaching specified levels.
Options granted under the 1989 Plan for Outside Directors prior to June 30, 2004 are exercisable starting one year after the date of grant on a cumulative basis at an annual rate of 331/3% of the total number of option shares. Beginning with the grant on June 30, 2004, options granted under this Plan are fully vested and immediately exercisable as of the date of grant.
Under the 2003 and 1989 plans, restricted shares of our common stock may be granted to selected employees. Restricted shares granted vest either (1) starting one or three years after the grant on a cumulative basis at an annual rate of 331/3% of the total number of shares, or (2) at the end of three years.
The 1999 Stock Option Plan for Seasonal Employees provided for the grant of options on June 30, 2005, 2004 2003 and 20022003 at the market price on the date of the grant. The options are exercisable during September through November in each of the two years following the calendar year of the grant, subject to certain conditions.
65
Changes during the years ended April 30, 2006, 2005 2004 and 20032004 under the stock-based compensation plans were as follows:
| (shares in 000s) | ||||||||||||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||||||||||||
| Weighted- | Weighted- | Weighted- | ||||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||||
| Shares | Exercise Price | Shares | Exercise Price | Shares | Exercise Price | |||||||||||||||||||||
| Options outstanding, beginning of year | 14,482 | $ | 35.86 | 15,772 | $ | 32.14 | 15,910 | $ | 26.33 | |||||||||||||||||
| Options granted | 3,802 | 47.73 | 3,744 | 44.05 | 5,364 | 44.32 | ||||||||||||||||||||
| Options exercised | (3,479 | ) | 37.24 | (3,927 | ) | 29.11 | (5,098 | ) | 24.65 | |||||||||||||||||
| Options expired/cancelled | (1,253 | ) | 44.42 | (1,107 | ) | 34.51 | (404 | ) | 34.53 | |||||||||||||||||
| Options outstanding, end of year | 13,552 | 38.04 | 14,482 | 35.86 | 15,772 | 32.14 | ||||||||||||||||||||
| Shares exercisable, end of year | 6,634 | 31.78 | 6,668 | 30.78 | 6,836 | 25.21 | ||||||||||||||||||||
| Restricted shares granted | 490 | 47.78 | 514 | 43.93 | 45 | 44.64 | ||||||||||||||||||||
| Restricted shares vested | 175 | 43.31 | 72 | 23.79 | 63 | 21.02 | ||||||||||||||||||||
| Restricted shares outstanding, end of year | 777 | 46.40 | 510 | 43.92 | 100 | 29.15 | ||||||||||||||||||||
| Shares reserved for future option or restricted stock grants, end of year | 9,889 | 9,880 | 14,563 | |||||||||||||||||||||||
| (shares in 000s) | ||||||||||||||||||||||||
| 2006 | 2005 | 2004 | ||||||||||||||||||||||
| Weighted-Average | Weighted-Average | Weighted-Average | ||||||||||||||||||||||
| Shares | Exercise Price | Shares | Exercise Price | Shares | Exercise Price | |||||||||||||||||||
| Options outstanding, beginning of year | 27,103 | $ | 19.02 | 28,964 | $ | 17.93 | 31,544 | $ | 16.07 | |||||||||||||||
| Options granted | 6,918 | 29.11 | 7,604 | 23.86 | 7,488 | 22.03 | ||||||||||||||||||
| Options exercised | (5,479 | ) | 18.17 | (6,959 | ) | 18.62 | (7,854 | ) | 14.56 | |||||||||||||||
| Options expired/cancelled | (2,494 | ) | 24.04 | (2,506 | ) | 22.21 | (2,214 | ) | 17.26 | |||||||||||||||
| Options outstanding, end of year | 26,048 | 21.40 | 27,103 | 19.02 | 28,964 | 17.93 | ||||||||||||||||||
| Shares exercisable, end of year | 14,693 | 18.51 | 13,268 | 15.89 | 13,336 | 15.39 | ||||||||||||||||||
| Restricted shares granted | 1,745 | 26.69 | 980 | 23.89 | 1,028 | 21.97 | ||||||||||||||||||
| Restricted shares vested | 616 | 22.96 | 352 | 21.66 | 144 | 11.90 | ||||||||||||||||||
| Restricted shares outstanding, end of year | 2,455 | 25.54 | 1,554 | 23.20 | 1,020 | 21.96 | ||||||||||||||||||
| Shares reserved for future option or restricted stock grants, end of year | 27,356 | 9,889 | 9,880 | |||||||||||||||||||||
A summary of stock options outstanding and exercisable at April 30, 20052006 follows:
| (shares in 000s) | ||||||||||||||||||||||
| Outstanding | Exercisable | |||||||||||||||||||||
| Number | Weighted-Average | Weighted- | Number | Weighted- | ||||||||||||||||||
| Outstanding | Remaining | Average | Exercisable | Average | ||||||||||||||||||
| at April 30 | Contractual Life | Exercise Price | at April 30 | Exercise Price | ||||||||||||||||||
$ 16.13 – 21.91 | 1,740 | 4 years | $ | 18.15 | 1,713 | $ | 18.16 | |||||||||||||||
$ 22.13 – 27.81 | 1,231 | 4 years | 25.98 | 1,228 | 25.97 | |||||||||||||||||
$ 32.10 – 39.96 | 2,925 | 7 years | 33.34 | 1,503 | 33.46 | |||||||||||||||||
$ 40.00 – 46.26 | 3,983 | 8 years | 44.45 | 2,081 | 44.03 | |||||||||||||||||
$ 47.00 – 58.95 | 3,673 | 9 years | 48.30 | 109 | 54.07 | |||||||||||||||||
| 13,552 | 6,634 | |||||||||||||||||||||
| (shares in 000s) | ||||||||||||||||||||
| Outstanding | Exercisable | |||||||||||||||||||
| Number | Weighted-Average | Weighted- | Number | Weighted- | ||||||||||||||||
| Outstanding | Remaining | Average | Exercisable | Average | ||||||||||||||||
| at April 30 | Contractual Life | Exercise Price | at April 30 | Exercise Price | ||||||||||||||||
$8.06 – 10.95 | 2,575 | 3 years | $ | 9.11 | 2,575 | $ | 9.11 | |||||||||||||
$11.06 – 13.91 | 1,764 | 3 years | 13.13 | 1,764 | 13.13 | |||||||||||||||
$16.05 – 19.98 | 4,900 | 6 years | 16.69 | 2,728 | 16.74 | |||||||||||||||
$20.00 – 24.95 | 10,330 | 7 years | 23.25 | 7,279 | 23.30 | |||||||||||||||
$25.25 – 29.48 | 6,479 | 9 years | 29.14 | 347 | 28.96 | |||||||||||||||
| 26,048 | 14,693 | |||||||||||||||||||
The ESPP provides the option to purchase shares of our Common Stock through payroll deductions to a majority of the employees of our subsidiaries. The purchase price of the stock is 90% of the lower of either the fair market value of our Common Stock on the first trading day within the Option Period or on the last trading day within the Option Period. The Option Periods are six-month periods beginning January 1 and July 1 each year. During fiscal years 2006 and 2005, 397,786 and 2004, 150,488 and 127,246300,976 shares, respectively, were purchased under the ESPP out of a total authorized 6.0 million shares.
During fiscal years 2006, 2005 and 2004, we recorded compensation expense under the fair value method using the Black-Scholes option-pricing model on the date of the grant. The pro forma effect on fiscal year 2003 is disclosed in note 1. The following weighted-average assumptions and fair values were used for
stock option grants and ESPP options during the followingthose periods:
| Year ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Stock option grants – management: | |||||||||||||||
| Risk-free interest rate | 3.86% | 2.64% | 3.82% | ||||||||||||
| Expected life | 5 years | 5 years | 5 years | ||||||||||||
| Expected volatility | 32.07% | 31.13% | 29.30% | ||||||||||||
| Dividend yield | 1.84% | 1.63% | 1.59% | ||||||||||||
| Weighted average fair value | $ | 11.73 | $ | 10.01 | $ | 10.24 | |||||||||
| Stock option grants – seasonal: | |||||||||||||||
| Risk-free interest rate | 2.60% | 1.21% | 2.82% | ||||||||||||
| Expected life | 2 years | 2 years | 2 years | ||||||||||||
| Expected volatility | 27.65% | 31.97% | 28.71% | ||||||||||||
| Dividend yield | 1.85% | 1.66% | 1.39% | ||||||||||||
| Weighted average fair value | $ | 6.58 | $ | 6.06 | $ | 5.91 | |||||||||
| ESPP options: | |||||||||||||||
| Risk-free interest rate | 2.17% | .97% | 1.45% | ||||||||||||
| Expected life | 6 months | 6 months | 6 months | ||||||||||||
| Expected volatility | 21.18% | 38.14% | 44.38% | ||||||||||||
| Dividend yield | 1.82% | 1.55% | 1.60% | ||||||||||||
| Weighted average fair value | $ | 7.67 | $ | 9.96 | $ | 9.02 | |||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Stock option grants - management: | ||||||||||||
| Risk-free interest rate | 3.68 | % | 3.86 | % | 2.64 | % | ||||||
| Expected life | 5 years | 5 years | 5 years | |||||||||
| Expected volatility | 27.28 | % | 32.07 | % | 31.13 | % | ||||||
| Dividend yield | 1.72 | % | 1.84 | % | 1.63 | % | ||||||
| Weighted average fair value | $ | 6.23 | $ | 5.87 | $ | 5.01 | ||||||
| Stock option grants - seasonal: | ||||||||||||
| Risk-free interest rate | 3.61 | % | 2.60 | % | 1.21 | % | ||||||
| Expected life | 2 years | 2 years | 2 years | |||||||||
| Expected volatility | 23.28 | % | 27.65 | % | 31.97 | % | ||||||
| Dividend yield | 1.71 | % | 1.85 | % | 1.66 | % | ||||||
| Weighted average fair value | $ | 3.70 | $ | 3.29 | $ | 3.03 | ||||||
| ESPP options: | ||||||||||||
| Risk-free interest rate | 3.96 | % | 2.17 | % | 0.97 | % | ||||||
| Expected life | 6 months | 6 months | 6 months | |||||||||
| Expected volatility | 25.06 | % | 21.18 | % | 38.14 | % | ||||||
| Dividend yield | 1.91 | % | 1.82 | % | 1.55 | % | ||||||
| Weighted average fair value | $ | 4.55 | $ | 3.84 | $ | 4.98 | ||||||
66
We have 401(k) defined contribution plans covering all full-time employees following the completion of an eligibility period. Our contributions to these plans are discretionary and totaled $37.3 million, $33.4 million $28.9 million and $20.7$28.9 million for fiscal years 2006, 2005 and 2004, and 2003, respectively.
NOTE 14:13: SHAREHOLDER RIGHTS PLAN
On July 25, 1998, the rights under a shareholder rights plan, adopted by our Board of Directors on March 25, 1998, became effective. The 1998 plan was adopted to deter coercive or unfair takeover tactics and to prevent a potential acquirer from gaining control of the Company without offering a fair price to all of our stockholders. Under the 1998 plan, a dividend of one right (a “Right”) per share was declared and paid on each share of our Common Stock outstanding on July 25, 1998. Rights automatically attach to shares issued after such date.
Under the 1998 plan, a Right becomes exercisable when a person or group of persons acquires beneficial ownership of 15% or more of the outstanding shares of our Common Stock without the prior written approval of our Board of Directors (an “Unapproved Stock Acquisition”), and at the close of business on the tenth business day following the commencement of, or the public announcement of an intent to commence, a tender offer that would result in an Unapproved Stock Acquisition. We may, prior to any Unapproved Stock Acquisition, amend the plan to lower such 15% threshold to not less than the greater of (1) any percentage greater than the largest percentage of beneficial ownership by any person or group of persons then known by the Company, and (2) 10% (in which case the acquisition of such lower percentage of beneficial ownership then constitutes an Unapproved Stock Acquisition and the Rights become exercisable). When exercisable, the registered holder of each Right may purchase from the Company one two-hundredthfour-hundredth of a share of a class of our Participating Preferred Stock, without par value, at a price of $107.50,$53.75, subject to adjustment. The registered holder of each Right then also has the right (the “Subscription Right”) to purchase for the exercise price of the Right, in lieu of shares of Participating Preferred Stock, a number of shares of our Common Stock having a market value equal to twice the exercise price of the Right. Following an Unapproved Stock Acquisition, if we are involved in a merger, or 50% or more of our assets or earning power are sold, the registered holder of each Right has the right (the “Merger Right”) to purchase for the exercise price of the Right a number of shares of the common stock of the surviving or purchasing company having a market value equal to twice the exercise price of the Right.
After an Unapproved Stock Acquisition, but before any person or group of persons acquires 50% or more of the outstanding shares of our Common Stock, the Board of Directors may exchange all or part of the then outstanding and exercisable Rights for Common Stock at an exchange ratio of one share of Common Stock per Right (the “Exchange”). Upon any such Exchange, the right of any holder to exercise a Right terminates. Upon the occurrence of any of the events giving rise to the exercisability of the Subscription Right or the Merger Right or the ability of the Board of Directors to effect the Exchange, the Rights held by the acquiring person or group under the new plan will become void as they relate to the Subscription Right, the Merger Right or the Exchange.
We may redeem the Rights at a price of $.000625$0.0003125 per Right at any time prior to the earlier of (1) an Unapproved Stock
Acquisition, or (2) the expiration of the rights. The Rights under the plan will expire on March 25, 2008, unless extended by the Board of Directors. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including the right to vote or to receive dividends. The issuance of the Rights alone has no dilutive effect and does not affect reported earnings per share.
67
NOTE 15:14: INCOME TAXES
The components of income upon which domestic and foreign income taxes have been provided are as follows:
| (in 000s) | ||||||||||||||
| Restated | Restated | |||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||
| Domestic | $ | 1,013,844 | $ | 1,150,450 | $ | 844,565 | ||||||||
| Foreign | 3,871 | 12,525 | 10,999 | |||||||||||
| $ | 1,017,715 | $ | 1,162,975 | $ | 855,564 | |||||||||
| (in 000s) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Domestic | $ | 808,992 | $ | 1,013,844 | $ | 1,150,450 | ||||||
| Foreign | 18,401 | 3,871 | 12,525 | |||||||||
| $ | 827,393 | $ | 1,017,715 | $ | 1,162,975 | |||||||
Deferred income tax provisions (benefits) reflect the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The current and deferred components of taxes on income are as follows:
| (in 000s) | |||||||||||||||
| Restated | Restated | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Current: | |||||||||||||||
| Federal | $ | 384,735 | $ | 389,557 | $ | 361,676 | |||||||||
| State | 37,192 | 54,169 | 40,964 | ||||||||||||
| Foreign | 2,276 | 4,627 | 5,253 | ||||||||||||
| 424,203 | 448,353 | 407,893 | |||||||||||||
| Deferred: | |||||||||||||||
| Federal | (39,770 | ) | (895 | ) | (27,610 | ) | |||||||||
| State | (1,666 | ) | (87 | ) | (1,646 | ) | |||||||||
| Foreign | (909 | ) | (4 | ) | (688 | ) | |||||||||
| (42,345 | ) | (986 | ) | (29,944 | ) | ||||||||||
| Total provision for income taxes before change in accounting principle | 381,858 | 447,367 | 377,949 | ||||||||||||
| Income tax on cumulative effect of change in accounting principle | – | (4,031 | ) | – | |||||||||||
| Income tax included in comprehensive income | (3,991 | ) | (3,387 | ) | (1,387 | ) | |||||||||
| Total income taxes | $ | 377,867 | $ | 439,949 | $ | 376,562 | |||||||||
| (in 000s) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Current: | ||||||||||||
| Federal | $ | 320,244 | $ | 379,907 | $ | 382,865 | ||||||
| State | 53,783 | 53,452 | 77,112 | |||||||||
| Foreign | 6,367 | 469 | 4,627 | |||||||||
| 380,394 | 433,828 | 464,604 | ||||||||||
| Deferred: | ||||||||||||
| Federal | (36,545 | ) | (37,681 | ) | (1,880 | ) | ||||||
| State | (6,137 | ) | (1,433 | ) | (197 | ) | ||||||
| Foreign | (727 | ) | (909 | ) | (4 | ) | ||||||
| (43,409 | ) | (40,023 | ) | (2,081 | ) | |||||||
| Total provision for income taxes before change in accounting principle | 336,985 | 393,805 | 462,523 | |||||||||
| Income tax on cumulative effect of change in accounting principle | - | - | (4,031 | ) | ||||||||
| Income tax included in comprehensive income | (27,261 | ) | (3,991 | ) | (3,387 | ) | ||||||
| Income tax included in stockholders’ equity for compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes | (9,529 | ) | (10,918 | ) | (24,730 | ) | ||||||
| Total income taxes | $ | 300,195 | $ | 378,896 | $ | 430,375 | ||||||
The following table reconciles the provision for income taxes at theour federal statutory rate of 35% to incomeour effective tax expense:rate:
| (dollars in 000s) | |||||||||||||||
| Restated | Restated | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | ||||||||||||
| Statutory tax | $ | 356,200 | $ | 407,041 | $ | 299,447 | |||||||||
| Increases in income taxes resulting from: | |||||||||||||||
| State income taxes, net of Federal income tax benefit | 25,552 | 26,652 | 24,093 | ||||||||||||
| Impairment of non-deductible goodwill | – | – | 42,788 | ||||||||||||
| Other | 106 | 13,674 | 11,621 | ||||||||||||
| Total income tax expense | $ | 381,858 | $ | 447,367 | $ | 377,949 | |||||||||
| Effective tax rate | 37.5% | 38.5% | 44.2% | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Statutory tax rate | 35.0 | % | 35.0 | % | 35.0 | % | ||||||
| Increases in income tax rate resulting from: | ||||||||||||
| State income taxes, net of Federal income tax benefit | 3.7 | % | 3.7 | % | 3.6 | % | ||||||
| Other | 2.0 | % | - | % | 1.2 | % | ||||||
| Effective tax rate | 40.7 | % | 38.7 | % | 39.8 | % | ||||||
The components of deferred taxes are as follows:
| (in 000s) | ||||||||||||
| Restated | ||||||||||||
| April 30, | 2005 | 2004 | ||||||||||
| Gross deferred tax assets: | ||||||||||||
| Accrued expenses | $ | 53,006 | $ | 55,643 | ||||||||
| Allowance for credit losses and related reserves | 35,116 | 23,099 | ||||||||||
| Net operating losses | 3,524 | 270 | ||||||||||
| Current | 91,646 | 79,012 | ||||||||||
| Residual interest income | 131,580 | 114,743 | ||||||||||
| Deferred and stock-based compensation | 61,111 | 34,724 | ||||||||||
| Property and equipment | 31,379 | 6,107 | ||||||||||
| Net operating losses | 20,018 | 23,661 | ||||||||||
| Noncurrent | 244,088 | 179,235 | ||||||||||
| 335,734 | 258,247 | |||||||||||
| Valuation allowance | (20,018 | ) | (23,661 | ) | ||||||||
| 315,716 | 234,586 | |||||||||||
| Gross deferred tax liabilities: | ||||||||||||
| Prepaid expenses and revenue deferred for tax | (13,454 | ) | (15,040 | ) | ||||||||
| Current | (13,454 | ) | (15,040 | ) | ||||||||
| Mortgage servicing rights | (61,190 | ) | (38,005 | ) | ||||||||
| Intangible assets | (100,923 | ) | (87,728 | ) | ||||||||
| Noncurrent | (162,113 | ) | (125,733 | ) | ||||||||
| Net deferred tax assets | $ | 140,149 | $ | 93,813 | ||||||||
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Gross deferred tax assets: | ||||||||
| Accrued expenses | $ | 63,058 | $ | 53,006 | ||||
| Allowance for credit losses and related reserves | 46,192 | 35,116 | ||||||
| Net operating losses | - | 3,524 | ||||||
| Current | 109,250 | 91,646 | ||||||
| Residual interest income | 146,348 | 129,323 | ||||||
| Deferred and stock-based compensation | 91,030 | 61,111 | ||||||
| Property and equipment | 43,513 | 33,767 | ||||||
| Deferred revenue | 57,836 | - | ||||||
| Net operating losses | 16,471 | 20,018 | ||||||
| Other | 394 | - | ||||||
| Noncurrent | 355,592 | 244,219 | ||||||
| 464,842 | 335,865 | |||||||
| Valuation allowance | (25,816 | ) | (20,354 | ) | ||||
| 439,026 | 315,511 | |||||||
| Gross deferred tax liabilities: | ||||||||
| Prepaid expenses and revenue deferred for tax | (16,037 | ) | (13,454 | ) | ||||
| Current | (16,037 | ) | (13,454 | ) | ||||
| Mortgage servicing rights | (101,621 | ) | (61,190 | ) | ||||
| Intangible assets | (87,992 | ) | (101,945 | ) | ||||
| Noncurrent | (189,613 | ) | (163,135 | ) | ||||
| Net deferred tax assets | $ | 233,376 | $ | 138,922 | ||||
We believe the net deferred tax asset at April 30, 20052006 of $140.1$233.4 million is more likely than not realizable. We have federal taxable income in excess of $2.3approximately $1.7 billion and substantial state taxable income in the carry-back period, as well as a history of growth in earnings and prospects for continued earnings growth.period.
As of April 30, 2005,2006, we had net operating loss carryforwards for tax purposes in various states and foreign countries of approximately $363.6$297.3 million. If not used, these carryforwards will expire in varying amounts during fiscal years 20062007 through 2024.2025.
We intend to indefinitely reinvest foreign earnings, therefore, a provision has not been made for income taxes whichthat might be payable upon remittance of such earnings. Moreover, due to the availability of foreign income tax credits, management believes the amount of federal income taxes would be immaterial in the event foreign earnings were repatriated.
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NOTE 16:15: SUPPLEMENTAL CASH FLOW INFORMATION
We made the following cash payments:
| (in 000s) | ||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||
| Income taxes paid | $ | 437,427 | $ | 331,635 | $ | 247,057 | ||||||||
| Interest paid | 82,535 | 84,551 | 84,094 | |||||||||||
| (in 000s) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Income taxes paid | $ | 270,540 | $ | 437,427 | $ | 331,635 | ||||||
| Interest paid (net of amounts capitalized) | 102,317 | 82,535 | 84,551 | |||||||||
We characterized the following as non-cash investing activities:
| (in 000s) | ||||||||||||||
| Restated | Restated | |||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||
| Additions to residual interests | $ | 16,914 | $ | 9,007 | $ | 753 | ||||||||
| Residual interest mark-to-market | 95,929 | 167,065 | 9,176 | |||||||||||
| (in 000s) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
| Additions to available-for-sale residual interests | $ | 61,651 | $ | 16,914 | $ | 9,007 | ||||||
| Residual interest mark-to-market | 35,274 | 95,929 | 167,065 | |||||||||
NOTE 17:16: COMMITMENTS, CONTINGENCIES AND RISKS
COMMITMENTS AND CONTINGENCIES ...–At April 30, 2005,2006, we maintained $2.0 billion in back-up credit facilities to support the commercial paper program and for general corporate purposes. The first $1.0 billion unsecured committed line of credit (“CLOC”) is subject to annual renewal in August 2005, has a one-year term-out provision withThese CLOCs have a maturity date inof August 20062010 and has an annual facility fee of teneight and one-half basis points per annum. The second $1.0 billion CLOC hasThese lines are subject to various affirmative and negative covenants, including a maturity dateminimum net worth covenant and limit our indebtedness.
We obtained an additional $900.0 million line of August 2009 and hascredit for the period of January 3 to February 24, 2006 to back-up peak commercial paper issuance or use as an annual facility feealternate source of twelve basis points per annum. Among other provisions,funding for RAL participations. This line was subject to various covenants, substantially similar to the credit agreement limits our indebtedness.primary CLOCs.
We maintain a revolving credit facility in an amount not to exceed $125.0$225.0 million (Canadian) in Canada to support a commercial paper program with varying borrowing levels
throughout the year, reaching its peak during February and March for the Canadian tax season.
We offer guarantees under our POM program to tax clients whereby we will assume the cost, subject to certain limits, of additional tax assessments, up to a cumulative per client limit of $5,000, attributable to tax return preparation error for which we are responsible. We defer all revenues and direct costs associated with these guarantees, recognizing these amounts over the term of the guarantee based upon historic and actual payment of claims. The related current asset is included in prepaid expenses and other current assets. The related liability is included in accounts payable, accrued expenses and other on the consolidated balance sheets. The related noncurrent asset and liability are included in other assets and other noncurrent liabilities, respectively, on the consolidated balance sheets. A loss on these POM guarantees would be recognized if the sum of expected costs for services exceeded unearned revenue. The deferred revenue liability increased in fiscal year 2004 by $61.5 million due to the change in accounting principle. The changes in the deferred revenue liability for the fiscal years ended April 30, 20052006 and 20042005 are as follows:
| (in 000s) | ||||||||||
| April 30, | 2005 | 2004 | ||||||||
| Balance, beginning of year | $ | 123,048 | $ | 49,280 | ||||||
| Amounts deferred for new guarantees issued | 77,756 | 81,803 | ||||||||
| Revenue recognized on previous deferrals | (70,042 | ) | (69,522 | ) | ||||||
| Adjustment resulting from change in accounting principle | – | 61,487 | ||||||||
| Balance, end of year | $ | 130,762 | $ | 123,048 | ||||||
| (in 000s) | ||||||||
| April 30, | 2006 | 2005 | ||||||
| Balance, beginning of year | $ | 130,762 | $ | 123,048 | ||||
| Amounts deferred for new guarantees issued | 78,900 | 77,756 | ||||||
| Revenue recognized on previous deferrals | (67,978 | ) | (70,042 | ) | ||||
| Balance, end of year | $ | 141,684 | $ | 130,762 | ||||
We have commitments to fund mortgage loans to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The commitments to fund loans amounted to $3.9$4.0 billion and $2.6$4.2 billion at April 30, 20052006 and 2004,2005, respectively. External market forces impact the probability of commitments being exercised, and therefore, total commitments outstanding do not necessarily represent future cash requirements.
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We are responsible for servicing mortgage loans for others of $47.5$62.9 billion and subservicing loans of $20.5$10.5 billion at April 30, 2005.2006.
We are required, under the terms of our securitizations, to build and/or maintain overcollateralization (“OC”)(OC) to specified levels, using the excess cash flows received, until specified percentages of the securitized portfolio are attained. We fund the OC account from the proceeds of the sale. Future cash flows to the residual holder are used to amortize the bonds until a specific percentage of either the original or current balance is retained, which is specified in the securitization agreement. The bondholders’ recourse to us for credit losses is limited to the future excess cash flows received and the amount of OC held by the trust. Upon maturity of the bonds, any remaining amounts in the trust are distributed. The estimated future cash flows to be distributed to us are included as part of the residual valuation and are valued based upon anticipated distribution from the OC account. As of April 30, 2006 and 2005, and 2004, $309.5$358.2 million and $316.0$309.5 million, respectively, was maintained in various OC accounts. These accounts are not assets of the Company and are not reflected in the accompanying consolidated financial statements, other than to the extent potential OC cash flows are included as part of residual interest valuations.
Option One provides a guarantee up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts before ultimate disposition of the loans by the Trusts. This guarantee would be called upon in the event adequate proceeds were not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. No losses have been sustained on this commitment since its inception. The total principal amount of Trust obligations outstanding as of April 30, 2006 and 2005 and 2004 was $6.7$7.8 billion and $3.2$6.7 billion, respectively. The fair value of mortgage loans held by the Trusts as of April 30, 2006 and 2005 was $7.9 billion and 2004 was $6.8 billion, respectively. At April 30, 2006 and $3.3 billion, respectively.2005, we recorded liabilities of $1.7 million and $0.9 million, respectively, which were included in accounts payable, accrued expenses and other current liabilities in the consolidated balance sheets.
We have various contingent purchase price obligations in connection with prior acquisitions. In many cases, contingent payments to be made in connection with these acquisitions are not subject to a stated limit. We estimate the potential payments (undiscounted) total approximately $24.5 million as of April 30, 2006. Our estimate is based on current financial conditions. Should actual results differ materially from the assumptions, the potential payments will differ from the above estimate. Such payments, if and when paid, would typically be recorded as additional purchase price, generally goodwill.
Commitments exist to loan M&P the lower of the value of their accounts receivable, work-in-process and fixed assets or $75.0 million, on a revolving basis through January 31, 2011, subject to certain termination clauses. This revolving facility bears interest at prime rate plus two percent on the outstanding amount and a commitment fee of one-half percent per annum on the unused portion of the commitment. The loan is fully secured by the accounts receivable, work-in-process and fixed assets of M&P.
We are required, in the event of non-delivery of customers’ securities owed to us by other broker-dealers or by our
customers, to purchase identical securities in the open market. Such purchases could result in losses not reflected in the accompanying consolidated financial statements.
As of April 30, 2005,2006, we had pledged securities totaling $44.6$53.0 million, which satisfied margin deposit requirements of $52.5$43.2 million.
We monitor the credit standing of brokers and dealers and customers with whom we do business. In addition, we monitor the market value of collateral held and the market value of securities receivable from others, and seek to obtain additional collateral if insufficient protection against loss exists.
We have contractual commitments to fund certain franchises requesting Franchise Equity Lines of Credit (“FELCs”)(FELCs). The commitment to fund FELCs as of April 30, 20052006 totaled $68.9$75.9 million, with a related receivable balance of $39.0$45.1 million included in the consolidated balance sheets. The receivable represents the amount drawn on the FELCs as of April 30, 2005.2006.
We are self-insured for certain risks, including certain employee health and benefit, workers’ compensation, property and general liability claims, and claims related to our POM program. We issued twothree standby letters of credit to servicers paying claims related to our POM, errors and omissions and worker’s compensation insurance policies. These letters of credit are for amounts not to exceed $10.7$16.5 million, $3.0$3.5 million and $0.9 million, respectively. At April 30, 20052006 there were no balances outstanding on these letters of credit.
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During fiscal year 2004, we announced plans to construct a new world headquarters facility in downtown Kansas City, Missouri. We are in negotiations to enter into contractual commitments with the City of Kansas City and a general contractor for the construction of the building. As of April 30, 2005, no commitment for the total cost of the building had been negotiated. We expect the remaining expenditure associated with this building to be approximately $143.1$63.9 million, which will be paid overout during fiscal year 2007.
During fiscal year 2006, we entered into a transaction with the next twoCity of Kansas City, Missouri, to provide us with sales and property tax savings on the furniture, fixtures and equipment for our new corporate headquarters facility. Under the transaction, the City purchased equipment by issuing $5.3 million in industrial revenue bonds due in December 2015, and leased the furniture, fixtures and equipment to us for an identical term under a capital lease. The City’s bonds were purchased by us. Because the City has assigned the lease to the bond trustee for our benefit as the sole bondholder, we, in effect, control enforcement of the lease against ourselves. As a result of the capital lease treatment, the furniture, fixtures and equipment will remain a component of property, plant and equipment in our consolidated balance sheet. As a result of the legal right of offset, the capital lease obligation and the corresponding bond investments have been eliminated in consolidation. The transaction provides us with property tax exemptions for the leased furniture, fixtures and equipment. Additional revenue bonds may be issued to cover the costs of certain improvements to this facility. The total amount of revenue bonds authorized for issuance is $31.0 million.
Substantially all of the operations of our subsidiaries are conducted in leased premises. Most of the operating leases are for periods ranging from 3 years to 5 years, with renewal options and provide for fixed monthly rentals. Future minimum lease commitments at April 30, 2006 are as follows:
| (in 000s) | ||||
| 2007 | $ | 269,890 | ||
| 2008 | 210,596 | |||
| 2009 | 161,388 | |||
| 2010 | 105,163 | |||
| 2011 | 51,960 | |||
| 2012 and beyond | 57,819 | |||
| $ | 856,816 | |||
Our rent expense for fiscal years.years 2006, 2005 and 2004 totaled $339.6 million, $275.3 million and $241.2 million, respectively.
In the regular course of business, we are subject to routine examinations by federal, state and local taxing authorities. In management’s opinion, the disposition of matters raised by such taxing authorities, if any, in such tax examinations would not have a material adverse impact on our consolidated financial statements.
We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Other guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counter parties from losses arising from the following: (1) tax, legal and other risks related to the purchase or disposition of businesses; (2) penalties and interest assessed by federal and state taxing authorities in connection with tax returns prepared for clients; (3) indemnification of our directors and officers; and (4) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance we will ultimately prevail in the event any such claims are asserted, we believe the fair value of these guarantees and indemnifications is not material as of April 30, 2005.2006.
| (in 000s) | ||||||
| 2006 | $ | 229,768 | ||||
| 2007 | 186,111 | |||||
| 2008 | 127,153 | |||||
| 2009 | 81,608 | |||||
| 2010 | 43,337 | |||||
| 2011 and beyond | 40,634 | |||||
| $ | 708,611 | |||||
| (in 000s) | ||||||||||||
| Charges | Cash | Accrual | ||||||||||
| to Date | Payments | balance | ||||||||||
| Employee severance costs | $ | 6,742 | $ | 5,005 | $ | 1,737 | ||||||
| Contract termination costs | 5,882 | 61 | 5,821 | |||||||||
| $ | 12,624 | $ | 5,066 | $ | 7,558 | |||||||
The liability related to this restructuring charge is included in accounts payable, accrued expenses and other on our consolidated balance sheet. Payments of employee severance costs were substantially completed by May 2006. The remaining contract termination obligations primarily relate to lease
71
obligations for fiscal years 2005, 2004 and 2003 totaled $275.3 million, $241.2 million and $215.5 million, respectively.vacant space resulting from branch office closings, as certain lease terms extend through October 2011.
RISKS–RISKS ...Loans to borrowers who do not meet traditional underwriting criteria, or non-prime borrowers, present a higher level of risk of default than prime loans, because of previous credit problems, higher debt-to-income levels, lack of income documentation or limited credit history. Loans to non-prime borrowers also involve additional liquidity risks, as these loans generally have a more limited secondary market than prime loans. During fiscal year 2006 approximately 80.0% of our non-prime loan originations were adjustable rate mortgages, 21.1% of non-prime loan originations, including both adjustable rate mortgages and fixed rate mortgages, were interest-only mortgage loans, and 13.4% of both adjustable rate mortgages and fixed rate mortgages were loans with a 40-year amortization schedule. The actual rates of delinquencies, foreclosures and losses on loans to non-prime borrowers could be higher under adverse economic conditions than those currently experienced in the mortgage lending industry in general. While we believe the underwriting procedures and appraisal processes we employ enable us to mitigate certain risks inherent in loans made to these borrowers, no assurance can be given that such procedures or processes will afford adequate protection against such risks. Because we sell or securitize almost all of the mortgage loans we originate, any potential credit problems will be reflected in our consolidated financial statements in the fair value of the residual interests we hold in securitizations, or our recourse reserves established on loans sold to third parties.
Commitments to fund loans involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the financial statements. Credit risk is mitigated by our evaluation of the creditworthiness of potential borrowers on a case-by-case basis.
Risks to the stability of Mortgage Services include external events impacting the asset-backed securities market, such as the level of and fluctuations in interest rates, real estate and other asset values, changes in the securitization market and competition.
NOTE 18:17: LITIGATION COMMITMENTS AND RELATED CONTINGENCIES
We have been involvednamed as a defendant in a number of class actions and putative class action cases since 1990numerous lawsuits throughout the country regarding our RAL programs. These cases are based onprograms (the “RAL Cases”). The RAL Cases have involved a variety of legal theories and allegations.asserted by plaintiffs. These theories andinclude allegations include,that, among others, that (i) disclosures in the RAL applications were inadequate, misleading and untimely; (ii) the RAL interest rates were usurious and unconscionable; (iii) we improperly did not disclose license feesthat we received from RAL lending bankswould receive part of the finance charges paid by the customer for RALs they makesuch loans; (iv) untrue, misleading or deceptive statements in marketing RALs; (v) breach of state laws on credit service organizations; (vi) breach of contract, unjust enrichment, unfair and deceptive acts or practices; (vii) violations of the federal Racketeer Influenced and Corrupt Organizations Act; (viii) violations of the federal Fair Debt Collection Practices Act and unfair competition with respect to our clients, (ii)debt collection activities; and (ix) we owe, and breached, a fiduciary duty to our clients and (iii)customers in connection with the RAL program violates laws such as state credit service organization laws andprogram.
The amounts claimed in the federal Racketeer Influenced and Corrupt Organizations (“RICO”) Act. Although weRAL Cases have been very substantial in some instances. We have successfully defended manyagainst numerous RAL cases, some of which were dismissed on our motions for dismissal or summary judgment, and others were dismissed voluntarily by the plaintiffs after denial of class certification. Other cases have been settled, resulting in a combined pretax expense in fiscal year 2006 of $70.2 million (the “2006 Settlements”). The 2006 Settlements are described below.
On December 21, 2005, we incurredentered into a settlement agreement regarding four RAL Cases. Pursuant to the terms of this settlement agreement, we will contribute a total of up to $62.5 million in cash for purposes of making payments to the settlement class, paying all attorneys’ fees and costs to class counsel and covering service awards to the representative plaintiffs. In addition, we paid costs for providing notice of the settlement to settlement class members. We increased existing reserves related to this matter, resulting in a pretax expensecharge of $43.5$50.7 million in fiscal year 20032006.
On April 19, 2006, we entered into a settlement agreement, subject to final court approval, regarding one other RAL Case, pursuant to which we will contribute a total of $19.5 million in connection with settling onecash for purposes of making payments to the settlement class, paying all attorneys’ fees and costs to class counsel, incentive payment awards to plaintiff and all notice and administration costs. We recorded a reserve of $19.5 million related to this settlement in fiscal year 2006.
One RAL case. Several of the RAL casesclass action case and a state attorney general lawsuit are still pending, andwith the amounts claimed in some of them areon a collective basis being very substantial. The ultimate cost of this litigation could be substantial. We believe we have meritorious
72
defenses to the remaining RAL Cases and we intend to continue defendingdefend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Likewise, there can be no assurances regarding the impact of the RAL cases vigorously, although there are no assurances as to their outcome.
We are also partiesa party to claims and lawsuits pertaining to our electronic tax return filing services, and our POM guarantee program, associated with incomeour Express IRA product and tax preparationplanning services. These claims and lawsuits include actions by individual plaintiffs, as well as cases in which plaintiffs seek to represent a class of similarly situated customers. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. We intend to continue defending these cases vigorously, although there are notno assurances as to their outcome.
In addition we and certain of our current and former directors and officers are party to several putative class actions alleging violations of certain securities laws, and certain of our current and former officers and directors are defendants in several putative shareholder derivative actions, which have purportedly been brought on behalf of the Company and in which the Company is named as a nominal defendant. The putative securities class actions allege, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of our operations. The shareholder derivative cases pertain primarily to our recent financial restatement and certain of our products and business activities and generally allege breach of fiduciary duty, abuse of control, gross mismanagement, waste and unjust enrichment. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. We intend to continue defending these cases vigorously, although there are no assurances as to their outcome.
In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine disputes incidental to our business (“Other(Other Claims and Lawsuits”)Lawsuits), including claims and lawsuits concerning the preparation of customers’ income tax returns, tax planning services, the fees charged customers for various services, investment products, relationships with franchisees, contract disputes, employment matters and civil actions, arbitrations, regulatory inquiries and class actions arising out of our business as a broker-dealer and provider of investment products and as a servicer of mortgage loans. We believe we have meritorious defenses to each of the Other Claims and Lawsuits and are defending or intend to defend, them vigorously. Although we cannot provide assurance we will ultimately prevail in each instance, we believe that amounts, if any, required to be paid in the discharge of liabilities or settlements pertaining to Other Claims and Lawsuits will not
have a material adverse effect on our consolidated financial statements. Regardless of outcome, claims and litigation can adversely affect us due to defense costs, diversion of management attention and time, and publicity related to such matters.
NOTE 19:18: SUBSEQUENT EVENTEVENTS
2006.
| NOTE 19: |
The principal business activity of our operating subsidiaries is providing tax and financial services and products to the general public. Management has determined the reportable segments identified below according to types of services offered and the manner in which operational decisions are made. We operate in the following four reportable segments:
TAX SERVICES– ...This segment is primarily engaged in providing tax return preparation and related services and products in the U.S., Canada, Australia and the United Kingdom. Segment revenues include fees earned for tax-related services performed at company-owned tax offices, royalties from franchise offices, sales of tax preparation and other software, fees from online tax preparation, and payments related to RALs. This segment includes the Company’s tax preparation software – TaxCut®- TaxCut® from H&R Block, and other personal productivity software offered to the general public, and offers online do-it-yourself-tax preparation, online tax advice to the general public through thewww.hrblock.comwebsite. Revenues of this segment are seasonal in nature.
Our international operations contributed $129.1 million, $110.0 million $97.6 million and $85.1$97.6 million in revenues for fiscal years 2006, 2005 2004 and 2003,2004, respectively, and $19.8 million, $11.3 million $11.1 million and $10.5$11.1 million of pretax income, respectively. The previously reported International Tax Operations segment has been aggregated with U.S. Tax Operations in the Tax Services segment, and prior year results have been reclassified to reflect this change.
73
MORTGAGE SERVICES– ...This segment is primarily engaged in the origination of non-prime mortgage loans, sales and securitizations of mortgage assets and servicing of non-prime loans in the U.S. This segment mainly offers, through a network of independent mortgage brokers, a flexible product line to borrowers who are creditworthy but do not meet traditional underwriting criteria. Prime mortgage loan products, as well as the same flexible product line available through brokers, are offered through H&R Block Mortgage Corporation retail offices and some other retail offices.
BUSINESS SERVICES– ...This segment offers middle-market companies accounting, tax and business consulting services, wealth management, retirement resources, payroll services, corporate finance, and financial process outsourcing. This segment offers services through offices located throughout the U.S. Revenues of this segment are seasonal in nature.
INVESTMENT SERVICES– ...This segment is primarily engaged in offering investment services and securities products through H&R Block Financial Advisors, Inc., a full-service securities broker-dealer, to the general public. Investment advice and services are primarily offered through H&R Block Financial Advisors branch offices.
CORPORATE–CORPORATE ... This segment consists primarily of corporateCorporate support departments that provide services to our operating segments. These support departments consistsegments, consisting of marketing, information technology, facilities, human resources, executive, legal, finance, government relations and corporate communications. These support department costs are largely allocated to our operating segments. Our captive insurance and franchise financing subsidiaries are also included below within this segment,Corporate, as was our small business initiatives subsidiary in fiscal years 2004 and 2003.year 2004. The pretax loss from our Corporate segment for fiscal year 2005 includes a non-operating gain of $17.3 million, or $0.06$0.03 per diluted share, resulting from legal recoveries.
IDENTIFIABLE ASSETS– ...Identifiable assets are those assets, including goodwill and intangible assets, associated with each reportable segment. The remaining assets are classified as corporate assets and consist primarily of cash, marketable securities and equipment.
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Information concerning the Company’s operations by reportable segment as of and for the years ended April 30, 2005, 2004 and 2003 is as follows. See note 2 for details of the restatement of our previously issued financial statements.
| (in 000s) | |||||||||||||||||||||||||||||||||
| 2004 | 2003 | ||||||||||||||||||||||||||||||||
| Year Ended April 30, | 2005 | As Reported | Adjustments | Restated | As Reported | Adjustments | Restated | ||||||||||||||||||||||||||
REVENUES ... | |||||||||||||||||||||||||||||||||
| Tax Services | $ | 2,358,293 | $ | 2,191,177 | $ | – | $ | 2,191,177 | $ | 1,946,763 | $ | – | $ | 1,946,763 | |||||||||||||||||||
| Mortgage Services | 1,246,018 | 1,300,675 | 23,034 | 1,323,709 | 1,186,476 | (36,396 | ) | 1,150,080 | |||||||||||||||||||||||||
| Business Services | 573,316 | 499,210 | – | 499,210 | 434,140 | – | 434,140 | ||||||||||||||||||||||||||
| Investment Services | 239,244 | 229,470 | – | 229,470 | 200,794 | – | 200,794 | ||||||||||||||||||||||||||
| Corporate | 3,148 | 4,314 | – | 4,314 | (651 | ) | – | (651 | ) | ||||||||||||||||||||||||
| $ | 4,420,019 | $ | 4,205,570 | $ | 42,310 | $ | 4,247,880 | $ | 3,746,457 | $ | (15,331 | ) | $ | 3,731,126 | |||||||||||||||||||
INCOME (LOSS) BEFORE TAXES ... | |||||||||||||||||||||||||||||||||
| Tax Services | $ | 663,518 | $ | 638,689 | $ | (196 | ) | $ | 638,493 | $ | 557,542 | $ | (839 | ) | $ | 556,703 | |||||||||||||||||
| Mortgage Services | 496,093 | 678,261 | 10,262 | 688,523 | 693,950 | (37,626 | ) | 656,324 | |||||||||||||||||||||||||
| Business Services | 29,871 | 19,321 | (9 | ) | 19,312 | (14,118 | ) | (1,915 | ) | (16,033 | ) | ||||||||||||||||||||||
| Investment Services | (75,370 | ) | (64,446 | ) | (11,168 | ) | (75,614 | ) | (128,292 | ) | (91,129 | ) | (219,421 | ) | |||||||||||||||||||
| Corporate | (96,397 | ) | (107,668 | ) | (71 | ) | (107,739 | ) | (122,005 | ) | (4 | ) | (122,009 | ) | |||||||||||||||||||
| $ | 1,017,715 | $ | 1,164,157 | $ | (1,182 | ) | $ | 1,162,975 | $ | 987,077 | $ | (131,513 | ) | $ | 855,564 | ||||||||||||||||||
| (in 000s) | ||||||||||||||||
| Restated | Restated | |||||||||||||||
| Year Ended April 30, | 2005 | 2004 | 2003 | |||||||||||||
DEPRECIATION AND AMORTIZATION ... | ||||||||||||||||
| Tax Services | $ | 79,079 | $ | 76,279 | $ | 61,487 | ||||||||||
| Mortgage Services | 31,043 | 24,428 | 21,703 | |||||||||||||
| Business Services | 23,591 | 23,104 | 23,135 | |||||||||||||
| Investment Services | 48,662 | 54,378 | 61,254 | |||||||||||||
| Corporate | 1,492 | 942 | 1,513 | |||||||||||||
| $ | 183,867 | $ | 179,131 | $ | 169,092 | |||||||||||
| Goodwill impairments: | ||||||||||||||||
| Business Services | – | – | 13,459 | |||||||||||||
| Investment Services | – | – | 108,792 | |||||||||||||
| – | – | 122,251 | ||||||||||||||
| $ | 183,867 | $ | 179,131 | $ | 291,343 | |||||||||||
CAPITAL EXPENDITURES ... | ||||||||||||||||
| Tax Services | $ | 74,297 | $ | 50,204 | $ | 65,469 | ||||||||||
| Mortgage Services | 56,613 | 28,176 | 38,204 | |||||||||||||
| Business Services | 22,582 | 18,003 | 15,248 | |||||||||||||
| Investment Services | 9,503 | 10,531 | 13,371 | |||||||||||||
| Corporate | 46,463 | 16,912 | 16,414 | |||||||||||||
| $ | 209,458 | $ | 123,826 | $ | 148,706 | |||||||||||
IDENTIFIABLE ASSETS ... | ||||||||||||||||
| Tax Services | $ | 716,981 | $ | 666,548 | $ | 354,617 | ||||||||||
| Mortgage Services | 1,336,920 | 1,108,022 | 1,241,772 | |||||||||||||
| Business Services | 701,763 | 637,542 | 677,334 | |||||||||||||
| Investment Services | 1,481,127 | 1,624,383 | 1,423,716 | |||||||||||||
| Corporate | 1,302,492 | 1,196,237 | 969,063 | |||||||||||||
| $ | 5,539,283 | $ | 5,232,732 | $ | 4,666,502 | |||||||||||
| (in 000s) | ||||||||||||
| Year Ended April 30, | 2006 | 2005 | 2004 | |||||||||
REVENUES– | ||||||||||||
| Tax Services | $ | 2,451,806 | $ | 2,358,293 | $ | 2,191,177 | ||||||
| Mortgage Services | 1,247,138 | 1,246,018 | 1,323,709 | |||||||||
| Business Services | 877,259 | 573,316 | 499,210 | |||||||||
| Investment Services | 287,955 | 239,244 | 229,470 | |||||||||
| Corporate | 8,643 | 3,148 | 4,314 | |||||||||
| $ | 4,872,801 | $ | 4,420,019 | $ | 4,247,880 | |||||||
INCOME (LOSS) BEFORE TAXES– | ||||||||||||
| Tax Services | $ | 589,766 | $ | 663,518 | $ | 638,493 | ||||||
| Mortgage Services | 321,616 | 496,093 | 688,523 | |||||||||
| Business Services | 53,378 | 29,871 | 19,312 | |||||||||
| Investment Services | (32,835 | ) | (75,370 | ) | (75,614 | ) | ||||||
| Corporate | (104,532 | ) | (96,397 | ) | (107,739 | ) | ||||||
| $ | 827,393 | $ | 1,017,715 | $ | 1,162,975 | |||||||
DEPRECIATION AND AMORTIZATION– | ||||||||||||
| Tax Services | $ | 69,095 | $ | 79,079 | $ | 76,279 | ||||||
| Mortgage Services | 37,988 | 31,043 | 24,428 | |||||||||
| Business Services | 38,037 | 23,591 | 23,104 | |||||||||
| Investment Services | 46,081 | 48,662 | 54,378 | |||||||||
| Corporate | 502 | 1,492 | 942 | |||||||||
| $ | 191,703 | $ | 183,867 | $ | 179,131 | |||||||
CAPITAL EXPENDITURES– | ||||||||||||
| Tax Services | $ | 43,607 | $ | 74,297 | $ | 50,204 | ||||||
| Mortgage Services | 48,694 | 56,613 | 28,176 | |||||||||
| Business Services | 32,270 | 22,582 | 18,003 | |||||||||
| Investment Services | 11,088 | 9,503 | 10,531 | |||||||||
| Corporate | 114,851 | 46,463 | 16,912 | |||||||||
| $ | 250,510 | $ | 209,458 | $ | 123,826 | |||||||
IDENTIFIABLE ASSETS– | ||||||||||||
| Tax Services | $ | 843,717 | $ | 716,981 | $ | 666,548 | ||||||
| Mortgage Services | 1,903,729 | 1,336,920 | 1,108,022 | |||||||||
| Business Services | 988,323 | 701,763 | 637,542 | |||||||||
| Investment Services | 1,306,822 | 1,481,127 | 1,624,383 | |||||||||
| Corporate | 946,544 | 1,301,265 | 1,197,332 | |||||||||
| $ | 5,989,135 | $ | 5,538,056 | $ | 5,233,827 | |||||||
75
| NOTE 20: |
| (in 000s, except per share amounts) | ||||||||||||||||||||
| Fiscal Year 2006 Quarter Ended | Fiscal Year 2006 | April 30, 2006 | January 31, 2006 | October 31, 2005 | July 31, 2005 | |||||||||||||||
| Revenues | $ | 4,872,801 | $ | 2,496,018 | $ | 1,156,747 | $ | 605,043 | $ | 614,993 | ||||||||||
| Income (loss) before taxes | 827,393 | 980,983 | 25,408 | (133,129 | ) | (45,869 | ) | |||||||||||||
| Income tax (benefit) | 336,985 | 393,445 | 13,295 | (51,880 | ) | (17,875 | ) | |||||||||||||
| Net income (loss) | $ | 490,408 | $ | 587,538 | $ | 12,113 | $ | (81,249 | ) | $ | (27,994 | ) | ||||||||
| Basic earnings (loss) per share | $ | 1.49 | $ | 1.79 | $ | 0.04 | $ | (0.25 | ) | $ | (0.08 | ) | ||||||||
| Diluted earnings (loss) per share | $ | 1.47 | $ | 1.77 | $ | 0.04 | $ | (0.25 | ) | $ | (0.08 | ) | ||||||||
| (in 000s, except per share amounts) | ||||||||||||||||||||||
| As Reported | As Restated | |||||||||||||||||||||
| Fiscal Year 2005 Quarter Ended | Fiscal Year 2005 | April 30, 2005 | January 31, 2005 | January 31, 2005 | ||||||||||||||||||
| Revenues | $ | 4,420,019 | $ | 2,355,279 | $ | 1,032,007 | $ | 1,036,236 | ||||||||||||||
| Income before taxes | 1,017,715 | 1,003,055 | 151,683 | 153,278 | ||||||||||||||||||
| Income taxes | 381,858 | 376,349 | 59,991 | 57,513 | ||||||||||||||||||
| Net income | $ | 635,857 | $ | 626,706 | $ | 91,692 | $ | 95,765 | ||||||||||||||
| Basic earnings per share | $ | 3.83 | $ | 3.79 | $ | .56 | $ | .58 | ||||||||||||||
| Diluted earnings per share | $ | 3.77 | $ | 3.72 | $ | .55 | $ | .57 | ||||||||||||||
| As Reported | As Restated | As Reported | As Restated | |||||||||||||||||||
| Fiscal Year 2005 Quarter Ended | October 31, 2004 | October 31, 2004 | July 31, 2004 | July 31, 2004 | ||||||||||||||||||
| Revenues | $ | 539,255 | $ | 541,953 | $ | 482,711 | $ | 486,551 | ||||||||||||||
| Income before taxes | (85,924 | ) | (79,818 | ) | (72,564 | ) | (58,800 | ) | ||||||||||||||
| Income taxes | (33,725 | ) | (29,946 | ) | (28,481 | ) | (22,058 | ) | ||||||||||||||
| Net income | $ | (52,199 | ) | $ | (49,872 | ) | $ | (44,083 | ) | $ | (36,742 | ) | ||||||||||
| Basic earnings per share | $ | (.32 | ) | $ | (.30 | ) | $ | (.26 | ) | $ | (.22 | ) | ||||||||||
| Diluted earnings per share | $ | (.32 | ) | $ | (.30 | ) | $ | (.26 | ) | $ | (.22 | ) | ||||||||||
| As Reported | As Restated | As Reported | As Restated | As Reported | |||||||||||||||||||
| Fiscal Year 2004 Quarter Ended | Fiscal Year 2004 | Fiscal Year 2004 | April 30, 2004 | April 30, 2004 | January 31, 2004 | ||||||||||||||||||
| Revenues | $ | 4,224,846 | $ | 4,247,880 | $ | 2,197,760 | $ | 2,200,935 | $ | 962,830 | |||||||||||||
| Income before taxes | 1,164,157 | 1,162,975 | 952,074 | 949,469 | 176,120 | ||||||||||||||||||
| Income taxes | 459,901 | 447,367 | 376,439 | 365,237 | 69,394 | ||||||||||||||||||
| Net income before change in accounting principle | 704,256 | 715,608 | 575,635 | 584,232 | 106,723 | ||||||||||||||||||
| Cumulative effect of change in accounting principle | (6,359 | ) | (6,359 | ) | – | – | – | ||||||||||||||||
| Net income | $ | 697,897 | $ | 709,249 | $ | 575,635 | $ | 584,232 | $ | 106,726 | |||||||||||||
| Basic earnings per share: | |||||||||||||||||||||||
| Before change in accounting principle | $ | 3.98 | $ | 4.04 | $ | 3.30 | $ | 3.35 | $ | .60 | |||||||||||||
| Net income | 3.94 | 4.01 | 3.30 | 3.35 | .60 | ||||||||||||||||||
| Diluted earnings per share: | |||||||||||||||||||||||
| Before change in accounting principle | $ | 3.90 | $ | 3.96 | $ | 3.23 | $ | 3.28 | $ | .59 | |||||||||||||
| Net income | 3.86 | 3.92 | 3.23 | 3.28 | .59 | ||||||||||||||||||
| Fiscal Year 2005 Quarter Ended | Fiscal Year 2005 | April 30, 2005 | January 31, 2005 | October 31, 2004 | July 31, 2004 | |||||||||||||||
| Revenues | $ | 4,420,019 | $ | 2,355,279 | $ | 1,036,236 | $ | 541,953 | $ | 486,551 | ||||||||||
| Income (loss) before taxes | 1,017,715 | 1,003,055 | 153,278 | (79,818 | ) | (58,800 | ) | |||||||||||||
| Income tax (benefit) | 393,805 | 388,125 | 59,542 | (31,016 | ) | (22,846 | ) | |||||||||||||
| Net income (loss) | $ | 623,910 | $ | 614,930 | $ | 93,736 | $ | (48,802 | ) | $ | (35,954 | ) | ||||||||
| Basic earnings (loss) per share | $ | 1.88 | $ | 1.86 | $ | 0.28 | $ | (0.15 | ) | $ | (0.11 | ) | ||||||||
| Diluted earnings (loss) per share | $ | 1.85 | $ | 1.83 | $ | 0.28 | $ | (0.15 | ) | $ | (0.11 | ) | ||||||||
| Fiscal Year 2004 Quarter | As Restated | As Reported | As Restated | As Reported | As Restated | ||||||||||||||||||
| Ended | January 31, 2004 | October 31, 2003 | October 31, 2003 | July 31, 2003 | July 31, 2003 | ||||||||||||||||||
| Revenues | $ | 974,520 | $ | 568,872 | $ | 573,267 | $ | 495,384 | $ | 499,158 | |||||||||||||
| Income before taxes | 181,406 | 17,134 | 15,390 | 18,829 | 16,710 | ||||||||||||||||||
| Income taxes | 69,782 | 6,758 | 5,920 | 7,310 | 6,428 | ||||||||||||||||||
| Net income before change in accounting principle | 111,624 | 10,376 | 9,470 | 11,519 | 10,282 | ||||||||||||||||||
| Cumulative effect of change in accounting principle | – | – | – | (6,359 | ) | (6,359 | ) | ||||||||||||||||
| Net income | $ | 111,624 | $ | 10,376 | $ | 9,470 | $ | 5,160 | $ | 3,923 | |||||||||||||
| Basic earnings per share: | |||||||||||||||||||||||
| Before change in accounting principle | $ | .63 | $ | .06 | $ | .05 | $ | .06 | $ | .06 | |||||||||||||
| Net income | .63 | .06 | .05 | .03 | .02 | ||||||||||||||||||
| Diluted earnings per share: | |||||||||||||||||||||||
| Before change in accounting principle | $ | .62 | $ | .06 | $ | .05 | $ | .06 | $ | .06 | |||||||||||||
| Net income | .62 | .06 | .05 | .03 | .02 | ||||||||||||||||||
| (in 000s) | ||||||||||||||||||||||||||
| Fiscal Year 2005 Quarter Ended | January 31, 2005 | October 31, 2004 | July 31, 2004 | |||||||||||||||||||||||
| Impact on | Revenues | Pretax Income | Revenues | Pretax Income | Revenues | Pretax Income | ||||||||||||||||||||
| Purchase accounting | $ | – | $ | (1,831 | ) | $ | – | $ | (1,831 | ) | $ | – | $ | (1,831 | ) | |||||||||||
| Sales of previously securitized residual interests | 4,229 | 4,229 | 2,698 | 2,698 | 3,840 | 3,840 | ||||||||||||||||||||
| Lease accounting | – | (1,207 | ) | – | (414 | ) | – | (175 | ) | |||||||||||||||||
| Incentive compensation accrual | – | – | – | – | – | 12,070 | ||||||||||||||||||||
| Improper capitalization | – | 404 | – | 5,653 | – | (140 | ) | |||||||||||||||||||
| $ | 4,229 | $ | 1,595 | $ | 2,698 | $ | 6,106 | $ | 3,840 | $ | 13,764 | |||||||||||||||
| Income tax (benefit) | (2,478 | ) | 3,779 | 6,423 | ||||||||||||||||||||||
| Net income | $ | 4,073 | $ | 2,327 | $ | 7,341 | ||||||||||||||||||||
| Fiscal Year 2004 Quarter Ended | April 30, 2004 | January 31, 2004 | ||||||||||||||||
| Impact on | Revenues | Pretax Income | Revenues | Pretax Income | ||||||||||||||
| Purchase accounting | $ | – | $ | (1,831 | ) | $ | – | $ | (1,831 | ) | ||||||||
| Sales of previously securitized residual interests | 3,175 | 3,175 | 11,690 | 11,690 | ||||||||||||||
| Lease accounting | – | (608 | ) | – | (510 | ) | ||||||||||||
| Incentive compensation accrual | – | (3,018 | ) | – | (3,018 | ) | ||||||||||||
| Improper capitalization | – | (323 | ) | – | (1,045 | ) | ||||||||||||
| $ | 3,175 | $ | (2,605 | ) | $ | 11,690 | $ | 5,286 | ||||||||||
| Income tax (benefit) | (11,202 | ) | 388 | |||||||||||||||
| Net income | $ | 8,597 | $ | 4,898 | ||||||||||||||
| Fiscal Year 2004 Quarter Ended | October 31, 2003 | July 31, 2003 | ||||||||||||||||
| Impact on | Revenues | Pretax Income | Revenues | Pretax Income | ||||||||||||||
| Purchase accounting | $ | – | $ | (1,831 | ) | $ | – | $ | (1,831 | ) | ||||||||
| Sales of previously securitized residual interests | 4,395 | 4,395 | 3,774 | 3,775 | ||||||||||||||
| Lease accounting | – | (216 | ) | – | 28 | |||||||||||||
| Incentive compensation accrual | – | (3,018 | ) | – | (3,018 | ) | ||||||||||||
| Improper capitalization | – | (1,074 | ) | – | (1,073 | ) | ||||||||||||
| $ | 4,395 | $ | (1,744 | ) | $ | 3,774 | $ | (2,119 | ) | |||||||||
| Income tax (benefit) | (838 | ) | (882 | ) | ||||||||||||||
| Net income | $ | (906 | ) | $ | (1,237 | ) | ||||||||||||
The accumulation of four quarters in fiscal years 20052006 and 20042005 for earnings per share may not equal the related per share amounts for the years ended April 30, 20052006 and 20042005 due to the repurchase of treasury shares, the timing of the exercise of stock options and release of restricted shares, and the antidilutive effect of stock options and unvested restricted shares in the first two quarters.
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Fiscal Year | ||||||||||||||||||||
Fiscal year 2005 ... | ||||||||||||||||||||||||
| Dividends per share | $ | .22 | $ | .22 | $ | .22 | $ | .20 | $ | .86 | ||||||||||||||
| Stock price range: | ||||||||||||||||||||||||
| High | $ | 55.86 | $ | 50.49 | $ | 51.50 | $ | 50.00 | $ | 55.86 | ||||||||||||||
| Low | 46.85 | 45.98 | 45.13 | 44.16 | 44.16 | |||||||||||||||||||
Fiscal year 2004 ... | ||||||||||||||||||||||||
| Dividends per share | $ | .20 | $ | .20 | $ | .20 | $ | .18 | $ | .78 | ||||||||||||||
| Stock price range: | ||||||||||||||||||||||||
| High | $ | 61.00 | $ | 60.18 | $ | 48.36 | $ | 46.00 | $ | 61.00 | ||||||||||||||
| Low | 44.50 | 47.14 | 40.55 | 36.30 | 36.30 | |||||||||||||||||||
| Fourth Quarter | Third Quarter | Second Quarter | First Quarter | Fiscal Year | ||||||||||||||||
FISCAL YEAR 2006– | ||||||||||||||||||||
| Dividends per share | $ | 0.13 | $ | 0.13 | $ | 0.13 | $ | 0.11 | $ | 0.49 | ||||||||||
| Stock price range: | ||||||||||||||||||||
| High | $ | 25.67 | $ | 26.96 | $ | 29.02 | $ | 30.00 | $ | 30.00 | ||||||||||
| Low | 19.80 | 23.06 | 23.01 | 24.47 | 19.80 | |||||||||||||||
FISCAL YEAR 2005– | ||||||||||||||||||||
| Dividends per share | $ | 0.11 | $ | 0.11 | $ | 0.11 | $ | 0.10 | $ | 0.43 | ||||||||||
| Stock price range: | ||||||||||||||||||||
| High | $ | 27.93 | $ | 25.25 | $ | 25.75 | $ | 25.00 | $ | 27.93 | ||||||||||
| Low | 23.43 | 22.99 | 22.57 | 22.08 | 22.08 | |||||||||||||||
| NOTE 21: | CONDENSED CONSOLIDATING FINANCIAL STATEMENTS |
Block Financial Corporation (“BFC”)(BFC) is an indirect, wholly-owned subsidiary of the Company. BFC is the Issuer and H&R Block, Inc. is the Guarantor of the $250.0 million 63/4% Senior Notes issued on October 21, 1997, the $500.0 million 81/2% Senior Notes issued on April 13, 2000 and the $400.0 million 5.125% Senior Notes issued on October 26, 2004. Our guarantee is full and unconditional. The following condensed consolidating financial statements present separate information for BFC, the Company and for our other subsidiaries, and should be read in conjunction with our consolidated financial statements.
These condensed consolidating financial statements have been prepared using the equity method of accounting. Income of subsidiaries is, therefore, reflected in our investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholder’s equity and other intercompany balances and transactions. The income statements and statements of cash flows for the twelve months ended April 30, 2004 and 2003 and balance sheet as of April 30, 2004 have been adjusted to reflect intercompany royalties between BFC and other subsidiaries. These adjustments have no effect on H&R Block, Inc. (Guarantor) or Consolidated H&R Block.
76
| CONDENSED CONSOLIDATING INCOME STATEMENTS | (in 000s) | |||||||||||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2006 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Revenues | $ | - | $ | 2,018,045 | $ | 2,871,364 | $ | (16,608 | ) | $ | 4,872,801 | |||||||||
| Expenses: | ||||||||||||||||||||
| Cost of service revenues | - | 500,545 | 1,883,374 | (620 | ) | 2,383,299 | ||||||||||||||
| Cost of other revenues | - | 486,971 | 36,021 | - | 522,992 | |||||||||||||||
| Selling, general and administrative | - | 481,544 | 646,535 | (15,494 | ) | 1,112,585 | ||||||||||||||
| - | 1,469,060 | 2,565,930 | (16,114 | ) | 4,018,876 | |||||||||||||||
| Operating income | - | 548,985 | 305,434 | (494 | ) | 853,925 | ||||||||||||||
| Interest expense | - | 47,242 | 1,817 | - | 49,059 | |||||||||||||||
| Other income, net | 827,393 | - | 22,527 | (827,393 | ) | 22,527 | ||||||||||||||
| Income before taxes | 827,393 | 501,743 | 326,144 | (827,887 | ) | 827,393 | ||||||||||||||
| Income taxes | 336,985 | 198,454 | 138,744 | (337,198 | ) | 336,985 | ||||||||||||||
| Net income | $ | 490,408 | $ | 303,289 | $ | 187,400 | $ | (490,689 | ) | $ | 490,408 | |||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Revenues | $ | - | $ | 1,871,703 | $ | 2,565,496 | $ | (17,180 | ) | $ | 4,420,019 | |||||||||
| Expenses: | ||||||||||||||||||||
| Cost of service revenues | - | 404,053 | 1,595,199 | (184 | ) | 1,999,068 | ||||||||||||||
| Cost of other revenues | - | 417,508 | 30,513 | - | 448,021 | |||||||||||||||
| Selling, general and administrative | - | 447,688 | 487,419 | (14,430 | ) | 920,677 | ||||||||||||||
| - | 1,269,249 | 2,113,131 | (14,614 | ) | 3,367,766 | |||||||||||||||
| Operating income | - | 602,454 | 452,365 | (2,566 | ) | 1,052,253 | ||||||||||||||
| Interest expense | - | 59,247 | 3,293 | (173 | ) | 62,367 | ||||||||||||||
| Other income, net | 1,017,715 | 17,277 | 10,552 | (1,017,715 | ) | 27,829 | ||||||||||||||
| Income before taxes | 1,017,715 | 560,484 | 459,624 | (1,020,108 | ) | 1,017,715 | ||||||||||||||
| Income taxes | 393,805 | 218,869 | 175,862 | (394,731 | ) | 393,805 | ||||||||||||||
| Net income | $ | 623,910 | $ | 341,615 | $ | 283,762 | $ | (625,377 | ) | $ | 623,910 | |||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2004 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Revenues | $ | - | $ | 1,844,772 | $ | 2,419,446 | $ | (16,338 | ) | $ | 4,247,880 | |||||||||
| Expenses: | ||||||||||||||||||||
| Cost of service revenues | - | 372,582 | 1,422,567 | (283 | ) | 1,794,866 | ||||||||||||||
| Cost of other revenues | - | 357,350 | 25,168 | - | 382,518 | |||||||||||||||
| Selling, general and administrative | - | 368,725 | 493,114 | (15,682 | ) | 846,157 | ||||||||||||||
| - | 1,098,657 | 1,940,849 | (15,965 | ) | 3,023,541 | |||||||||||||||
| Operating income | - | 746,115 | 478,597 | (373 | ) | 1,224,339 | ||||||||||||||
| Interest expense | - | 66,931 | 4,287 | - | 71,218 | |||||||||||||||
| Other income, net | 1,162,975 | - | 9,854 | (1,162,975 | ) | 9,854 | ||||||||||||||
| Income before taxes | 1,162,975 | 679,184 | 484,164 | (1,163,348 | ) | 1,162,975 | ||||||||||||||
| Income taxes | 462,523 | 263,456 | 199,216 | (462,672 | ) | 462,523 | ||||||||||||||
| Income before change in accounting | 700,452 | 415,728 | 284,948 | (700,676 | ) | 700,452 | ||||||||||||||
| Cumulative effect of change in accounting | (6,359 | ) | - | (6,359 | ) | 6,359 | (6,359 | ) | ||||||||||||
| Net income | $ | 694,093 | $ | 415,728 | $ | 278,589 | $ | (694,317 | ) | $ | 694,093 | |||||||||
77
| CONDENSED CONSOLIDATING BALANCE SHEETS | (in 000s) | |||||||||||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| April 30, 2006 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Cash & cash equivalents | $ | - | $ | 151,561 | $ | 542,797 | $ | - | $ | 694,358 | ||||||||||
| Cash & cash equivalents - restricted | - | 377,445 | 16,624 | - | 394,069 | |||||||||||||||
| Receivables from customers, brokers and dealers, net | - | 496,577 | - | - | 496,577 | |||||||||||||||
| Receivables, net | 161 | 128,123 | 374,904 | - | 503,188 | |||||||||||||||
| Intangible assets and goodwill, net | - | 387,194 | 932,752 | - | 1,319,946 | |||||||||||||||
| Investments in subsidiaries | 5,237,611 | 215 | 456 | (5,237,611 | ) | 671 | ||||||||||||||
| Other assets | - | 2,116,900 | 463,966 | (540 | ) | 2,580,326 | ||||||||||||||
| Total assets | $ | 5,237,772 | $ | 3,658,015 | $ | 2,331,499 | $ | (5,238,151 | ) | $ | 5,989,135 | |||||||||
| Accounts payable to customers, brokers and dealers | $ | - | $ | 781,303 | $ | - | $ | - | $ | 781,303 | ||||||||||
| Long-term debt | - | 398,001 | 19,538 | - | 417,539 | |||||||||||||||
| Other liabilities | 2 | 1,042,611 | 1,599,881 | - | 2,642,494 | |||||||||||||||
| Net intercompany advances | 3,089,971 | (355,358 | ) | (2,734,567 | ) | (46 | ) | - | ||||||||||||
| Stockholders’ equity | 2,147,799 | 1,791,458 | 3,446,647 | (5,238,105 | ) | 2,147,799 | ||||||||||||||
| Total liabilities and stockholders’ equity | $ | 5,237,772 | $ | 3,658,015 | $ | 2,331,499 | $ | (5,238,151 | ) | $ | 5,989,135 | |||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| April 30, 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Cash & cash equivalents | $ | - | $ | 162,983 | $ | 937,230 | $ | - | $ | 1,100,213 | ||||||||||
| Cash & cash equivalents - restricted | - | 488,761 | 28,148 | - | 516,909 | |||||||||||||||
| Receivables from customers, brokers and dealers, net | - | 590,226 | - | - | 590,226 | |||||||||||||||
| Receivables, net | 101 | 122,908 | 218,697 | - | 341,706 | |||||||||||||||
| Intangible assets and goodwill, net | - | 421,036 | 842,003 | - | 1,263,039 | |||||||||||||||
| Investments in subsidiaries | 4,851,680 | 210 | 449 | (4,851,680 | ) | 659 | ||||||||||||||
| Other assets | - | 1,484,164 | 241,532 | (392 | ) | 1,725,304 | ||||||||||||||
| Total assets | $ | 4,851,781 | $ | 3,270,288 | $ | 2,268,059 | $ | (4,852,072 | ) | $ | 5,538,056 | |||||||||
| Accounts payable to customers, brokers and dealers | $ | - | $ | 950,684 | $ | - | $ | - | $ | 950,684 | ||||||||||
| Long-term debt | - | 896,591 | 26,482 | - | 923,073 | |||||||||||||||
| Other liabilities | 2 | 532,562 | 1,182,459 | 8 | 1,715,031 | |||||||||||||||
| Net intercompany advances | 2,902,511 | (641,611 | ) | (2,262,818 | ) | 1,918 | - | |||||||||||||
| Stockholders’ equity | 1,949,268 | 1,532,062 | 3,321,936 | (4,853,998 | ) | 1,949,268 | ||||||||||||||
| Total liabilities and stockholders’ equity | $ | 4,851,781 | $ | 3,270,288 | $ | 2,268,059 | $ | (4,852,072 | ) | $ | 5,538,056 | |||||||||
78
| CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS | (in 000s) | |||||||||||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2006 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Net cash provided by (used in) operating activities: | $ | 66,667 | $ | (2,937 | ) | $ | 521,956 | $ | - | $ | 585,686 | |||||||||
| Cash flows from investing activities: | ||||||||||||||||||||
| Cash received on residual interests | - | 80,539 | - | - | 80,539 | |||||||||||||||
| Mortgage loans originated and held for investment | - | (407,538 | ) | - | - | (407,538 | ) | |||||||||||||
| Purchases of property & equipment | - | (59,824 | ) | (190,686 | ) | - | (250,510 | ) | ||||||||||||
| Payments made for business acquisitions | - | (2,939 | ) | (209,604 | ) | - | (212,543 | ) | ||||||||||||
| Net intercompany advances | 245,169 | - | - | (245,169 | ) | - | ||||||||||||||
| Other, net | - | 80,486 | 21,061 | - | 101,547 | |||||||||||||||
| Net cash provided by (used in) investing activities | 245,169 | (309,276 | ) | (379,229 | ) | (245,169 | ) | (688,505 | ) | |||||||||||
| Cash flows from financing activities: | ||||||||||||||||||||
| Repayments of short-term debt | - | (6,790,463 | ) | (258,418 | ) | - | (7,048,881 | ) | ||||||||||||
| Proceeds from issuance of short-term debt | - | 6,790,463 | 258,418 | - | 7,048,881 | |||||||||||||||
| Payments on acquisition debt | - | - | (26,819 | ) | - | (26,819 | ) | |||||||||||||
| Dividends paid | (160,031 | ) | - | - | - | (160,031 | ) | |||||||||||||
| Acquisition of treasury shares | (260,312 | ) | - | - | - | (260,312 | ) | |||||||||||||
| Proceeds from issuance of common stock | 108,507 | - | - | - | 108,507 | |||||||||||||||
| Net intercompany advances | - | 286,253 | (531,422 | ) | 245,169 | - | ||||||||||||||
| Other, net | - | 14,538 | 21,081 | - | 35,619 | |||||||||||||||
| Net cash provided by (used in) financing activities | (311,836 | ) | 300,791 | (537,160 | ) | 245,169 | (303,036 | ) | ||||||||||||
| Net decrease in cash and cash equivalents | - | (11,422 | ) | (394,433 | ) | - | (405,855 | ) | ||||||||||||
| Cash and cash equivalents at beginning of the year | - | 162,983 | 937,230 | - | 1,100,213 | |||||||||||||||
| Cash and cash equivalents at end of the year | $ | - | $ | 151,561 | $ | 542,797 | $ | - | $ | 694,358 | ||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Net cash provided by operating activities: | $ | 39,134 | $ | 122,311 | $ | 352,348 | $ | - | $ | 513,793 | ||||||||||
| Cash flows from investing activities: | ||||||||||||||||||||
| Cash received on residual interests | - | 136,045 | - | - | 136,045 | |||||||||||||||
| Purchases of property & equipment | - | (66,255 | ) | (143,203 | ) | - | (209,458 | ) | ||||||||||||
| Payments made for business acquisitions | - | - | (37,621 | ) | - | (37,621 | ) | |||||||||||||
| Net intercompany advances | 497,774 | - | - | (497,774 | ) | - | ||||||||||||||
| Other, net | - | 33,710 | 18,914 | - | 52,624 | |||||||||||||||
| Net cash provided by (used in) investing activities | 497,774 | 103,500 | (161,910 | ) | (497,774 | ) | (58,410 | ) | ||||||||||||
| Cash flows from financing activities: | ||||||||||||||||||||
| Repayments of short-term debt | - | (5,941,623 | ) | - | - | (5,941,623 | ) | |||||||||||||
| Proceeds from issuance of short-term debt | - | 5,941,623 | - | - | 5,941,623 | |||||||||||||||
| Repayments of long-term debt | - | (250,000 | ) | - | - | (250,000 | ) | |||||||||||||
| Proceeds from issuance of long-term debt | - | 395,221 | - | - | 395,221 | |||||||||||||||
| Payments on acquisition debt | - | - | (25,664 | ) | - | (25,664 | ) | |||||||||||||
| Dividends paid | (142,988 | ) | - | - | - | (142,988 | ) | |||||||||||||
| Acquisition of treasury shares | (530,022 | ) | - | - | - | (530,022 | ) | |||||||||||||
| Proceeds from issuance of common stock | 136,102 | - | - | - | 136,102 | |||||||||||||||
| Net intercompany advances | - | (324,424 | ) | (173,350 | ) | 497,774 | - | |||||||||||||
| Other, net | - | (16,813 | ) | 6,249 | - | (10,564 | ) | |||||||||||||
| Net cash provided by (used in) financing activities | (536,908 | ) | (196,016 | ) | (192,765 | ) | 497,774 | (427,915 | ) | |||||||||||
| Net increase (decrease) in cash and cash equivalents | - | 29,795 | (2,327 | ) | - | 27,468 | ||||||||||||||
| Cash and cash equivalents at beginning of the year | - | 133,188 | 939,557 | - | 1,072,745 | |||||||||||||||
| Cash and cash equivalents at end of the year | $ | - | $ | 162,983 | $ | 937,230 | $ | - | $ | 1,100,213 | ||||||||||
79
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
| Year Ended April 30, 2004 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||
| Net cash provided by operating activities: | $ | 64,782 | $ | 163,464 | $ | 624,217 | $ | - | $ | 852,463 | ||||||||||
| Cash flows from investing activities: | ||||||||||||||||||||
| Cash received on residual interests | - | 193,606 | - | - | 193,606 | |||||||||||||||
| Purchases of property & equipment | - | (35,482 | ) | (88,344 | ) | - | (123,826 | ) | ||||||||||||
| Payments made for business acquisitions | - | - | (280,865 | ) | - | (280,865 | ) | |||||||||||||
| Net intercompany advances | 473,521 | - | - | (473,521 | ) | - | ||||||||||||||
| Other, net | - | 66,046 | 17,653 | - | 83,699 | |||||||||||||||
| Net cash provided by (used in) investing activities | 473,521 | 224,170 | (351,556 | ) | (473,521 | ) | (127,386 | ) | ||||||||||||
| Cash flows from financing activities: | ||||||||||||||||||||
| Repayments of commercial paper | - | (4,618,853 | ) | - | - | (4,618,853 | ) | |||||||||||||
| Proceeds from issuance of commercial paper | - | 4,618,853 | - | - | 4,618,853 | |||||||||||||||
| Payments on acquisition debt | - | - | (59,003 | ) | - | (59,003 | ) | |||||||||||||
| Dividends paid | (138,397 | ) | - | - | - | (138,397 | ) | |||||||||||||
| Acquisition of treasury shares | (519,862 | ) | - | - | - | (519,862 | ) | |||||||||||||
| Proceeds from issuance of common stock | 119,956 | - | - | - | 119,956 | |||||||||||||||
| Net intercompany advances | - | (453,477 | ) | (20,044 | ) | 473,521 | - | |||||||||||||
| Other, net | - | 18,850 | 12,831 | - | 31,681 | |||||||||||||||
| Net cash provided by (used in) financing activities | (538,303 | ) | (434,627 | ) | (66,216 | ) | 473,521 | (565,625 | ) | |||||||||||
| Net increase (decrease) in cash and cash equivalents | - | (46,993 | ) | 206,445 | - | 159,452 | ||||||||||||||
| Cash and cash equivalents at beginning of the year | - | 180,181 | 733,112 | - | 913,293 | |||||||||||||||
| Cash and cash equivalents at end of the year | $ | - | $ | 133,188 | $ | 939,557 | $ | - | $ | 1,072,745 | ||||||||||
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| (in 000s) | ||||||||||||||||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||||
| Year Ended April 30, 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | |||||||||||||||||||
| Revenues | $ | – | $ | 1,871,703 | $ | 2,565,496 | $ | (17,180 | ) | $ | 4,420,019 | |||||||||||||
| Expenses: | ||||||||||||||||||||||||
| Cost of service revenues | – | 404,205 | 1,595,199 | (184 | ) | 1,999,220 | ||||||||||||||||||
| Cost of other revenues | – | 385,908 | 30,513 | – | 416,421 | |||||||||||||||||||
| Selling, general and administrative | – | 479,136 | 487,419 | (14,430 | ) | 952,125 | ||||||||||||||||||
| – | 1,269,249 | 2,113,131 | (14,614 | ) | 3,367,766 | |||||||||||||||||||
| Operating income | – | 602,454 | 452,365 | (2,566 | ) | 1,052,253 | ||||||||||||||||||
| Interest expense | – | 59,247 | 3,293 | (173 | ) | 62,367 | ||||||||||||||||||
| Other income, net | 1,017,715 | 17,277 | 10,552 | (1,017,715 | ) | 27,829 | ||||||||||||||||||
| Income before taxes | 1,017,715 | 560,484 | 459,624 | (1,020,108 | ) | 1,017,715 | ||||||||||||||||||
| Income taxes | 381,858 | 206,572 | 175,969 | (382,541 | ) | 381,858 | ||||||||||||||||||
| Net income | $ | 635,857 | $ | 353,912 | $ | 283,655 | $ | (637,567 | ) | $ | 635,857 | |||||||||||||
| Year Ended April 30, 2004 | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| (as restated) | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Revenues | $ | – | $ | 1,844,772 | $ | 2,419,446 | $ | (16,338 | ) | $ | 4,247,880 | ||||||||||||
| Expenses: | |||||||||||||||||||||||
| Cost of service revenues | – | 372,217 | 1,422,567 | (283 | ) | 1,794,501 | |||||||||||||||||
| Cost of other revenues | – | 355,197 | 25,168 | – | 380,365 | ||||||||||||||||||
| Selling, general and administrative | – | 399,956 | 464,401 | (15,682 | ) | 848,675 | |||||||||||||||||
| – | 1,127,370 | 1,912,136 | (15,965 | ) | 3,023,541 | ||||||||||||||||||
| Operating income | – | 717,402 | 507,310 | (373 | ) | 1,224,339 | |||||||||||||||||
| Interest expense | – | 38,218 | 33,000 | – | 71,218 | ||||||||||||||||||
| Other income, net | 1,162,975 | – | 9,854 | (1,162,975 | ) | 9,854 | |||||||||||||||||
| Income before taxes | 1,162,975 | 679,184 | 484,164 | (1,163,348 | ) | 1,162,975 | |||||||||||||||||
| Income taxes | 447,367 | 263,456 | 184,055 | (447,511 | ) | 447,367 | |||||||||||||||||
| Income before change in accounting | 715,608 | 415,728 | 300,109 | (715,837 | ) | 715,608 | |||||||||||||||||
| Cumulative effect of change in accounting | (6,359 | ) | – | (6,359 | ) | 6,359 | (6,359 | ) | |||||||||||||||
| Net income | $ | 709,249 | $ | 415,728 | $ | 293,750 | $ | (709,478 | ) | $ | 709,249 | ||||||||||||
| (in 000s) | |||||||||||||||||||||||
| Year Ended April 30, 2003 | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| (as restated) | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Revenues | $ | – | $ | 1,551,572 | $ | 2,192,510 | $ | (12,956 | ) | $ | 3,731,126 | ||||||||||||
| Expenses: | |||||||||||||||||||||||
| Cost of service revenues | – | 304,947 | 1,320,729 | 261 | 1,625,937 | ||||||||||||||||||
| Cost of other revenues | – | 285,228 | 15,521 | – | 300,749 | ||||||||||||||||||
| Selling, general and administrative | – | 429,255 | 467,057 | (13,197 | ) | 883,115 | |||||||||||||||||
| – | 1,019,430 | 1,803,307 | (12,936 | ) | 2,809,801 | ||||||||||||||||||
| Operating income | – | 532,142 | 389,203 | (20 | ) | 921,325 | |||||||||||||||||
| Interest expense | – | 50,276 | 26,447 | – | 76,723 | ||||||||||||||||||
| Other income, net | 855,564 | 4,127 | 6,835 | (855,564 | ) | 10,962 | |||||||||||||||||
| Income before taxes | 855,564 | 485,993 | 369,591 | (855,584 | ) | 855,564 | |||||||||||||||||
| Income taxes | 377,949 | 232,577 | 145,381 | (377,958 | ) | 377,949 | |||||||||||||||||
| Net income | $ | 477,615 | $ | 253,416 | $ | 224,210 | $ | (477,626 | ) | $ | 477,615 | ||||||||||||
| (in 000s) | |||||||||||||||||||||||
| H&R Block, Inc. | BFC | Other | Consolidated | ||||||||||||||||||||
| April 30, 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Cash & cash equivalents | $ | – | $ | 162,983 | $ | 937,230 | $ | – | $ | 1,100,213 | |||||||||||||
| Cash & cash equivalents — restricted | – | 488,761 | 28,148 | – | 516,909 | ||||||||||||||||||
| Receivables from customers, brokers and dealers, net | – | 590,226 | – | – | 590,226 | ||||||||||||||||||
| Receivables, net | 101 | 199,990 | 218,697 | – | 418,788 | ||||||||||||||||||
| Intangible assets and goodwill, net | – | 421,036 | 842,003 | – | 1,263,039 | ||||||||||||||||||
| Investments in subsidiaries | 4,878,783 | 210 | 449 | (4,878,783 | ) | 659 | |||||||||||||||||
| Other assets | – | 1,407,082 | 243,007 | (640 | ) | 1,649,449 | |||||||||||||||||
| Total assets | $ | 4,878,884 | $ | 3,270,288 | $ | 2,269,534 | $ | (4,879,423 | ) | $ | 5,539,283 | ||||||||||||
| Accounts payable to customers, brokers and dealers | $ | – | $ | 950,684 | $ | – | $ | – | $ | 950,684 | |||||||||||||
| Long-term debt | – | 896,591 | 26,482 | – | 923,073 | ||||||||||||||||||
| Other liabilities | 2 | 532,562 | 1,156,583 | 8 | 1,689,155 | ||||||||||||||||||
| Net intercompany advances | 2,902,511 | (653,908 | ) | (2,250,521 | ) | 1,918 | – | ||||||||||||||||
| Stockholders’ equity | 1,976,371 | 1,544,359 | 3,336,990 | (4,881,349 | ) | 1,976,371 | |||||||||||||||||
| Total liabilities and stockholders’ equity | $ | 4,878,884 | $ | 3,270,288 | $ | 2,269,534 | $ | (4,879,423 | ) | $ | 5,539,283 | ||||||||||||
| April 30, 2004 (as | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| restated) | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Cash & cash equivalents | $ | – | $ | 133,188 | $ | 939,557 | $ | – | $ | 1,072,745 | |||||||||||||
| Cash & cash equivalents — restricted | – | 532,201 | 13,227 | – | 545,428 | ||||||||||||||||||
| Receivables from customers, brokers and dealers, net | – | 625,076 | – | – | 625,076 | ||||||||||||||||||
| Receivables, net | 180 | 150,188 | 178,851 | – | 329,219 | ||||||||||||||||||
| Intangible assets and goodwill, net | – | 457,661 | 829,283 | – | 1,286,944 | ||||||||||||||||||
| Investments in subsidiaries | 4,214,499 | 205 | 297 | (4,214,499 | ) | 502 | |||||||||||||||||
| Other assets | (145 | ) | 1,125,578 | 247,758 | (373 | ) | 1,372,818 | ||||||||||||||||
| Total assets | $ | 4,214,534 | $ | 3,024,097 | $ | 2,208,973 | $ | (4,214,872 | ) | $ | 5,232,732 | ||||||||||||
| Accounts payable to customers, brokers and dealers | $ | – | $ | 1,065,793 | $ | – | $ | – | $ | 1,065,793 | |||||||||||||
| Long-term debt | – | 498,225 | 47,586 | – | 545,811 | ||||||||||||||||||
| Other liabilities | 15,879 | 580,331 | 1,204,542 | 561 | 1,801,313 | ||||||||||||||||||
| Net intercompany advances | 2,378,840 | (317,187 | ) | (2,061,092 | ) | (561 | ) | – | |||||||||||||||
| Stockholders’ equity | 1,819,815 | 1,196,935 | 3,017,937 | (4,214,872 | ) | 1,819,815 | |||||||||||||||||
| Total liabilities and stockholders’ equity | $ | 4,214,534 | $ | 3,024,097 | $ | 2,208,973 | $ | (4,214,872 | ) | $ | 5,232,732 | ||||||||||||
CONTROLS AND PROCEDURES
| (in 000s) | |||||||||||||||||||||||
| Year Ended April 30, | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| 2005 | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Net cash provided by operating activities: | $ | 39,134 | $ | 91,081 | $ | 383,578 | $ | – | $ | 513,793 | |||||||||||||
| Cash flows from investing activities: | |||||||||||||||||||||||
| Cash received on residual interests | – | 136,045 | – | – | 136,045 | ||||||||||||||||||
| Purchases of property & equipment, net | – | (66,255 | ) | (143,203 | ) | – | (209,458 | ) | |||||||||||||||
| Payments made for business acquisitions | – | – | (37,621 | ) | – | (37,621 | ) | ||||||||||||||||
| Net intercompany advances | 497,774 | – | – | (497,774 | ) | – | |||||||||||||||||
| Other, net | – | 60,424 | (7,800 | ) | – | 52,624 | |||||||||||||||||
| Net cash provided by (used in) investing activities | 497,774 | 130,214 | (188,624 | ) | (497,774 | ) | (58,410 | ) | |||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||||||||
| Repayments of commercial paper | – | (5,191,623 | ) | – | – | (5,191,623 | ) | ||||||||||||||||
| Proceeds from issuance of commercial paper | – | 5,191,623 | – | – | 5,191,623 | ||||||||||||||||||
| Repayments of long- term debt | – | (250,000 | ) | – | – | (250,000 | ) | ||||||||||||||||
| Proceeds from issuance of long-term debt | – | 395,221 | – | – | 395,221 | ||||||||||||||||||
| Payments on acquisition debt | – | – | (25,664 | ) | – | (25,664 | ) | ||||||||||||||||
| Dividends paid | (142,988 | ) | – | – | – | (142,988 | ) | ||||||||||||||||
| Acquisition of treasury shares | (530,022 | ) | – | – | – | (530,022 | ) | ||||||||||||||||
| Proceeds from issuance of common stock | 136,102 | – | – | – | 136,102 | ||||||||||||||||||
| Net intercompany advances | – | (336,721 | ) | (161,053 | ) | 497,774 | – | ||||||||||||||||
| Other, net | – | – | (10,564 | ) | – | (10,564 | ) | ||||||||||||||||
| Net cash provided by (used in) financing activities | (536,908 | ) | (191,500 | ) | (197,281 | ) | 497,774 | (427,915 | ) | ||||||||||||||
| Net increase (decrease) in cash and cash equivalents | – | 29,795 | (2,327 | ) | – | 27,468 | |||||||||||||||||
| Cash and cash equivalents at beginning of the year | – | 133,188 | 939,557 | – | 1,072,745 | ||||||||||||||||||
| Cash and cash equivalents at end of the year | $ | – | $ | 162,983 | $ | 937,230 | $ | – | $ | 1,100,213 | |||||||||||||
| (in 000s) | |||||||||||||||||||||||
| Year Ended April 30, | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| 2004 (as restated) | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Net cash provided by operating activities: | $ | 64,782 | $ | 184,949 | $ | 677,076 | $ | – | $ | 926,807 | |||||||||||||
| Cash flows from investing activities: | |||||||||||||||||||||||
| Cash received on residual interests | – | 193,606 | – | – | 193,606 | ||||||||||||||||||
| Purchases of property & equipment, net | – | (39,229 | ) | (88,344 | ) | – | (127,573 | ) | |||||||||||||||
| Payments made for business acquisitions | – | – | (280,865 | ) | – | (280,865 | ) | ||||||||||||||||
| Net intercompany advances | 473,521 | – | – | (473,521 | ) | – | |||||||||||||||||
| Other, net | – | 66,046 | 17,653 | – | 83,699 | ||||||||||||||||||
| Net cash provided by (used in) investing activities | 473,521 | 220,423 | (351,556 | ) | (473,521 | ) | (131,133 | ) | |||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||||||||
| Repayments of commercial paper | – | (4,618,853 | ) | – | – | (4,618,853 | ) | ||||||||||||||||
| Proceeds from issuance of commercial paper | – | 4,618,853 | – | – | 4,618,853 | ||||||||||||||||||
| Payments on acquisition debt | – | – | (59,003 | ) | – | (59,003 | ) | ||||||||||||||||
| Dividends paid | (138,397 | ) | – | – | – | (138,397 | ) | ||||||||||||||||
| Acquisition of treasury shares | (519,862 | ) | – | – | – | (519,862 | ) | ||||||||||||||||
| Proceeds from issuance of common stock | 119,956 | – | – | – | 119,956 | ||||||||||||||||||
| Net intercompany advances | – | (453,477 | ) | (20,044 | ) | 473,521 | – | ||||||||||||||||
| Other, net | – | – | (2,045 | ) | – | (2,045 | ) | ||||||||||||||||
| Net cash provided by (used in) financing activities | (538,303 | ) | (453,477 | ) | (81,092 | ) | 473,521 | (599,351 | ) | ||||||||||||||
| Net increase (decrease) in cash and cash equivalents | – | (48,105 | ) | 244,428 | – | 196,323 | |||||||||||||||||
| Cash and cash equivalents at beginning of the year | – | 180,181 | 695,172 | – | 875,353 | ||||||||||||||||||
| Cash and cash equivalents at end of the year | $ | – | $ | 132,076 | $ | 939,600 | $ | – | $ | 1,071,676 | |||||||||||||
| Year Ended April 30, | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||
| 2003 (as restated) | (Guarantor) | (Issuer) | Subsidiaries | Eliminations | H&R Block | ||||||||||||||||||
| Net cash provided by operating activities | $ | 36,560 | $ | 140,617 | $ | 513,648 | $ | – | $ | 690,825 | |||||||||||||
| Cash flows from investing activities: | |||||||||||||||||||||||
| Cash received on residual interests | – | 140,795 | – | – | 140,795 | ||||||||||||||||||
| Sales of residual interests in securitizations | – | 142,486 | – | – | 142,486 | ||||||||||||||||||
| Purchases of property & equipment, net | – | (37,999 | ) | (112,898 | ) | – | (150,897 | ) | |||||||||||||||
| Payments made for business acquisitions | – | – | (26,408 | ) | – | (26,408 | ) | ||||||||||||||||
| Net intercompany advances | 280,583 | – | – | (280,583 | ) | – | |||||||||||||||||
| Other, net | – | (1,480 | ) | 20,843 | – | 19,363 | |||||||||||||||||
| Net cash provided by (used in) investing activities | 280,583 | 243,802 | (118,463 | ) | (280,583 | ) | 125,339 | ||||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||||||||
| Repayments of commercial paper | – | (9,925,516 | ) | – | – | (9,925,516 | ) | ||||||||||||||||
| Proceeds from issuance of commercial paper | – | 9,925,516 | – | – | 9,925,516 | ||||||||||||||||||
| Payments on acquisition debt | – | – | (57,469 | ) | – | (57,469 | ) | ||||||||||||||||
| Dividends paid | (125,898 | ) | – | – | – | (125,898 | ) | ||||||||||||||||
| Acquisition of treasury shares | (317,570 | ) | – | – | – | (317,570 | ) | ||||||||||||||||
| Proceeds from issuance of common stock | 126,325 | – | – | – | 126,325 | ||||||||||||||||||
| Net intercompany advances | – | (402,197 | ) | 121,614 | 280,583 | – | |||||||||||||||||
| Other, net | – | – | (2,344 | ) | – | (2,344 | ) | ||||||||||||||||
| Net cash provided by (used in) financing activities | (317,143 | ) | (402,197 | ) | 61,801 | 280,583 | (376,956 | ) | |||||||||||||||
| Net increase (decrease) in cash and cash equivalents | – | (17,778 | ) | 456,986 | – | 439,208 | |||||||||||||||||
| Cash and cash equivalents at beginning of the year | – | 197,959 | 238,186 | – | 436,145 | ||||||||||||||||||
| Cash and cash equivalents at end of the year | $ | – | $ | 180,181 | $ | 695,172 | $ | – | $ | 875,353 | |||||||||||||
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES– ...
We have established disclosure controls and procedures (“Disclosure Controls”)(Disclosure Controls) to ensure that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls were designed to provide reasonable assurance that the controls and procedures would meet their objectives. Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable assurance of achieving the designed control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusions of two or more people, or by management override of the control. Because of the inherent limitations in a cost-effective, maturing control system, misstatements due to error or fraud may occur and not be detected.
As of the end of the period covered by this Form 10-K, we evaluated the effectiveness of the design and operation of our Disclosure Controls. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our Disclosure Controls and procedures were not effective as of the end of the period covered by this Annual Report on Form 10-K because of the material weakness in internal control over financial reporting discussed below.10-K.
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(b) MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING– ...
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in “Internal Control –- Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)(COSO) as of April 30, 2005.2006.
Based on our assessment, management determined that a material weakness existed in the Company’s internal controls over accounting for income taxes as of April 30, 2005. Specifically, the Company did not maintain sufficient resources in the corporate tax function to accurately identify, evaluate and report, in a timely manner, non-routine and complex transactions. In addition, the Company had not completed the requisite historical analysis and related reconciliations to ensure tax balances were appropriately stated prior to the completion of the Company’s internal control activities. These deficiencies resulted in errors in the Company’s accounting for income taxes. These errors were corrected prior to issuance of the consolidated financial statements as of and for the year ended April 30, 2005. In the aggregate, these deficiencies represent a material weakness in internal control over financial reporting on the basis that there is a more than remote likelihood that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected by its internal control over financial reporting. Because of this material weakness in internal control over financial reporting, management concluded that, as of April 30, 2005,2006, the Company’s internal control over financial reporting was not effective based on the criteria set forth by COSO.
The Company’s external auditors, KPMG LLP, an independent registered public accounting firm, have issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears on page 44.
in Item 8.
(c) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING– ... As disclosed most recently in our Quarterly Report on Form 10-Q for the quarter ended January 31, 2005, management had identified an internal control deficiency in our accounting for income taxes. We have dedicated substantial resources to the review of our control processes and procedures specifically related to accounting for income taxes. Based on the results of this review, during
During the fourth quarter managementof fiscal year 2006, we completed numerous enhancementsremediation efforts relating to improvea material weakness in our internal controls over financial reporting, specifically those related to accounting for income taxes includingthat was reported as of April 30, 2005. In addition to control enhancements identified in our previously filed reports on Form 10-Q, management implemented additional improvements to controls in the following actions:state income tax rate calculation process to incorporate the use of current period pro forma federal and state taxable income calculations and the use of current and projected state apportionment factors, among other data inputs.
Other than the changes outlined above, there were no changes that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| ITEM 9B. | OTHER INFORMATION |
None.
PART III
| ITEM 10. |
The following information appearing in our definitive proxy statement, to be filed no later than 120 days after April 30, 2005,2006, is incorporated herein by reference:
| Information appearing under the heading “Election of Directors” | |||
| Information appearing under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” | |||
| Information appearing under the heading “Board of Directors’ Meetings and Committees” regarding identification of the Audit Committee and Audit Committee financial experts. |
We have adopted a code of business ethics and conduct that applies to our directors, officers and employees, including our chief executive officer, chief financial officer, principal accounting officer and persons performing similar functions. A copy of the code of business ethics and conduct is available on our website atwww.hrblock.com.www.hrblock.com. We intend to provide information on our website regarding amendments to, or waivers from, the code of business ethics and conduct.
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Information about our executive officers as of May 15, 20052006 is as follows:
| Name, age | Current position | Business experience since May 1, | 2001 | |||
Mark A. Ernst , age 47 | Chairman of the Board, President and Chief Executive Officer | Chairman of the Board of Directors since September 2002; Chief Executive Officer since January 2001; President of the Company since September | ||||
William L. Trubeck , age | Executive Vice President and Chief Financial Officer | Executive Vice President and Chief Financial Officer since October 2004; Executive Vice President | ||||
Jeffrey E. Nachbor, age | ||||||
| Senior Vice President and Corporate Controller | Senior Vice President and Corporate Controller since October | April 2003. | ||||
Robert E. Dubrish , age | President and Chief Executive Officer, Option One Mortgage Corporation | President and Chief Executive Officer, Option One Mortgage Corporation, since March 1996. | ||||
Timothy C. Gokey , age | President, Retail Tax Services | President, Retail Tax Services since June 2004; McKinsey & Company from 1986 until June 2004. | ||||
Brad C. Iversen , age | Senior Vice President and Chief Marketing Officer | Senior Vice President and Chief Marketing Officer since September 2003; Founded Catamount Marketing in 2002; Executive Vice President and Director of Marketing at Bank One Corporation from 1997 to 2002. | ||||
Linda M. McDougall , age | Vice President, Communications | Vice President, Communications since July 1999. | ||||
Steve L. Nadon, age 49 | President, Consumer Financial Services Group | President, Consumer Financial Services Group since March 2006; Executive Vice President and Chief Operating Officer of Option One Mortgage Corporation from January 1998 to March 2006. | ||||
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Name, age | May 1, 2001 | |||||
Tammy S. Serati , age | Senior Vice President, Human Resources | Senior Vice President, Human Resources since December 2002; Vice President, Human Resources Corporate Staffs, for Monsanto Agricultural Company, from May 2000 through November 2002. | ||||
Becky S. Shulman , age | Vice President and Treasurer | Vice President and Treasurer since September 2001; Chief Investment Officer of U.S. Central Credit Union, from September 1998 until August 2001. | ||||
Nicholas J. Spaeth , age | Senior Vice President and Chief Legal Officer | Senior Vice President and Chief Legal Officer since February 2004; Senior Vice President, General Counsel and Secretary of Intuit, Inc. from August 2003 to February 2004; Senior Vice President, General Counsel and Secretary, GE Employers Reinsurance Corporation from September 2000 until August | 2003. | |||
Steven Tait , age | President, RSM McGladrey Business Services, Inc. | President, RSM McGladrey Business Services, Inc. since April 2003; Executive Vice President, Sales & Client Operations, Gartner, Inc., from June 2001 through March 2003; Senior Vice President, Sales and Operations at Gartner, Inc. from July 2000 until May | ||||
| 2001. | ||||||
Robert A. Weinberger , age 61 | Vice President, Government Relations | Vice President, Government Relations, since March 1996. | ||||
Marc West , age | Senior Vice President and Chief Information Officer | Senior Vice President and Chief Information Officer since September 2004; Senior Vice President and Chief Information Officer of Electronic Arts Inc. from 2000 until September 2004. | ||||
Bret G. Wilson , age | Vice President and Secretary | Vice President and Secretary since October 2002; Vice President, Corporate Development and Risk Management from October 2000 until October | 2002. | |||
| ITEM 11. |
The information called for by this item is contained in our definitive proxy statement filed pursuant to Regulation 14A not later than 120 days after April 30, 2005,2006, in the sections entitled “Director Compensation” and “Compensation of Executive Officers,” and is incorporated herein by reference.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information called for by this item is contained in our definitive proxy statement filed pursuant to Regulation 14A not later than 120 days after April 30, 2005,2006, in the section titled “Equity Compensation Plans” and in the section titled “Information Regarding Security Holders,” and is incorporated herein by reference.
| ITEM 13. |
The information called for by this item is contained in our definitive proxy statement filed pursuant to Regulation 14A no later than 120 days after April 30, 2005,2006, in the section titled “Employee Agreements, Change in Control and Other Arrangements,” and is incorporated herein by reference.
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by this item is contained in our definitive proxy statement filed pursuant to Regulation 14A no later than 120 days after April 30, 2005,2006, in the section titled “Audit Fees,” and is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| (a) | |
| 1. | The following financial statements appearing in Item 8: “Consolidated Statements of Income and Comprehensive Income;” “Consolidated Balance Sheets;” “Consolidated Statements of Cash Flows;” and “Consolidated Statements of Stockholders’ Equity.” | ||
| 2. | Financial Statement Schedule II | ||
| 3. | Exhibits: The list of exhibits in the Exhibit Index to this Report is incorporated herein by reference. The following exhibits are required to be filed as exhibits to this Form 10-K: |
| 10.6 | The H&R Block Executive Performance Plan. | ||
| 10.38 | Agreement of Settlement dated April 19, 2006 among HSBC Finance Corporation, HSBC Taxpayer Financial Services Inc., Beneficial Franchise Company, Inc., H&R Block, Inc., H&R Block Services, Inc., H&R Block Tax Services, Inc., Block Financial Corporation, HRB Royalty, Inc., H&R Block Eastern Enterprises, Inc., and Lynne A. Carnegie. | ||
| 10.70 | Amendment Number Seven, dated April 28, 2006, to Indenture between Option One Owner Trust 2001-1A and Wells Fargo Bank, N.A. | ||
| 10.77 | Amendment Number Eight, dated April 28, 2006, to Indenture between Option One Owner Trust 2001-1B and Wells Fargo Bank, N.A. | ||
| 12 | Computation of Ratio of Earnings to Fixed Charges for the five years ended April 30, 2006. | ||
| 21 | Subsidiaries of the Company. | ||
| 23.1 | Consent of KPMG LLP, Independent Registered Public Accounting Firm. | ||
| 31.1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
| 31.2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
| 32.1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | ||
| 32.2 | Certification by Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. |
The exhibits will be filed with the SEC but will not be included in the printed version of the Annual Report to Shareholders.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Mark A. Ernst
Chairman of the Board, President and
Chief Executive Officer
June 30, 2006
Chairman of the Board, President and
Chief Executive Officer
June 30, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated on June 30, 2006.
Mark A. Ernst
Chairman of the Board, President, Chief Executive
Officer and Director (principal executive officer)
Thomas M. Bloch
Director
Jerry D. Choate
Director
Donna R. Ecton
Director
Henry F. Frigon
Director
Roger W. Hale
Director
Len J. Lauer
Director
David B. Lewis
Director
Tom D. Seip
Director
Louis W. Smith
Director
Rayford Wilkins, Jr.
Director
William L. Trubeck
Executive Vice President and Chief Financial
Officer (principal financial officer)
Jeffrey E. Nachbor
Senior Vice President and Corporate
Controller
(principal accounting officer)
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EXHIBIT INDEX
The following exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K:
| 3.1 | Restated Articles of Incorporation of H&R Block, Inc., as amended, filed as Exhibit 3.2 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, are incorporated herein by reference. | |
| 3.2 | Certificate of Amendment of Articles of Incorporation effective September 30, 2004, filed as Exhibit 3.1 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. | |
| 3.3 | Amended and Restated Bylaws of H&R Block, Inc., as amended and restated as of June 9, 2004, filed as Exhibit 3.3 to the Company’s annual report on Form 10-K for the year ended April 30, 2004, file number 1-6089, is incorporated herein by reference. | |
| 4.1 | Indenture dated as of October 20, 1997, among H&R Block, Inc., Block Financial Corporation and Bankers Trust Company, as Trustee, filed as Exhibit 4(a) to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 1997, file number 1-6089, is incorporated herein by reference. | |
| 4.2 | First Supplemental Indenture, dated as of April 18, 2000, among H&R Block, Inc., Block Financial Corporation, Bankers Trust Company and the Bank of New York, filed as Exhibit 4(a) to the Company’s current report on Form 8-K dated April 13, 2000, file number 1-6089, is incorporated herein by reference. | |
| 4.3 | Officer’s Certificate, dated October 26, 2004, in respect of 5.125% Notes due 2014 of Block Financial Corporation, filed as Exhibit 4.1 to the Company’s current report on Form 8-K dated October 21, 2004, file number 1-6089, is incorporated herein by reference. | |
| 4.4 | Form of 81/2% Senior Note due 2007 of Block Financial Corporation, filed as Exhibit 4(b) to the Company’s current report on Form 8-K dated April 13, 2000, file number 1-6089, is incorporated herein by reference. | |
| 4.5 | Form of 5.125% Note due 2014 of Block Financial Corporation, filed as Exhibit 4.2 to the Company’s current report on Form 8-K dated October 21, 2004, file number 1-6089, is incorporated herein by reference. | |
| 4.6 | Copy of Rights Agreement dated March 25, 1998, between H&R Block, Inc. and ChaseMellon Shareholder Services, L.L.C., filed on July 22, 1998 as Exhibit 1 to the Company’s Registration Statement on Form 8-A, file number 1-6089, is incorporated herein by reference. | |
| 4.7 | Form of Certificate of Designation, Preferences and Rights of Participating Preferred Stock of H&R Block, Inc., filed as Exhibit 4(e) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1995, file number 1-6089, is incorporated by reference. | |
| 4.8 | Form of Certificate of Amendment of Certificate of Designation, Preferences and Rights of Participating Preferred Stock of H&R Block, Inc., filed as Exhibit 4(j) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1998, file number 1-6089, is incorporated by reference. | |
| 4.9 | Form of Certificate of Designation, Preferences and Rights of Delayed Convertible Preferred Stock of H&R Block, Inc., filed as Exhibit 4(f) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1995, file number 1-6089, is incorporated by reference. | |
| 10.1 | * | The Company’s 2003 Long-Term Executive Compensation Plan, as amended and restated as of September 10, 2003, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended |
| October 31, 2003, file number 1-6089, is incorporated by reference. | ||
| 10.2 | * | Form of 2003 Long-Term Executive Compensation Plan Award |
| 10.3 | * | The H&R Block Deferred Compensation Plan for Directors, as Amended and Restated effective July 1, 2002, filed as Exhibit 10.2 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. |
| 10.4 | * | The H&R Block Deferred Compensation Plan for Executives, as Amended and Restated July 1, 2002, filed as Exhibit 10.3 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. |
| 10.5 | * | Amendment No. 1 to the H&R Block Deferred Compensation Plan for Executives, as Amended and Restated, effective as of March 12, 2003, filed as Exhibit 10.5 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. |
| 10.6 | * | The H&R Block Executive Performance Plan. |
| 10.7 | * | Summary of Non-Employee Director Compensation and Benefits, filed as Exhibit 10.1 to the Company’s current report on Form 8-K dated March 1, 2006, file number 1-6089, is incorporated herein by reference. |
| 10.8 | * | Description of Executive Officer Cash Compensation, filed as Exhibit 10.8 to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. |
| 10.9 | * | The Company’s 1989 Stock Option Plan for Outside Directors, as amended and restated as of September 8, 2004, filed as Exhibit 10.5 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. |
| 10.10 | * | Form of 1989 Stock Option Plan for Outside Directors Stock Option |
| 10.11 | * | The H&R Block Stock Plan for Non-Employee Directors, as amended |
| August 1, 2001, filed as Exhibit 10.3 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2001, file number 1-6089, is incorporated herein by reference. | ||
| 10.12 | * | The H&R Block, Inc. 2000 Employee Stock Purchase Plan, as amended August 1, 2001, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2001, file number 1-6089, is incorporated herein by reference. |
| 10.13 | * | The H&R Block, Inc. Executive Survivor Plan (as Amended and Restated) filed as Exhibit 10.4 to the Company’s quarterly report on |
86
| Form 10-Q for the quarter ended October 31, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 10.14 | * | First Amendment to the H&R Block, Inc. Executive Survivor Plan (as Amended and Restated), filed as Exhibit 10.9 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. |
| 10.15 | * | Second Amendment to the H&R Block, Inc. Executive Survivor Plan (as Amended and Restated), effective as of March 12, 2003, filed as Exhibit 10.12 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. |
| 10.16 | * | Employment Agreement dated July 16, 1998, between the Company and Mark A. Ernst, filed as Exhibit 10(a) to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 1998, file number 1-6089, is incorporated herein by reference. |
| 10.17 | * | Amendment to Employment Agreement dated June 30, 2000, between HRB Management, Inc. and Mark A. Ernst, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 2000, file number 1-6089, is incorporated herein by reference. |
| 10.18 | * | Employment Agreement dated as of October 4, 2004 between HRB Management, Inc. and William L. Trubeck, filed as Exhibit 10.2 to the Company’s current report on Form 8-K/A Amendment No. 1 dated September 9, 2004, file number 1-6089, is incorporated herein by reference. |
| 10.19 | Employment Agreement dated as of February 2, 2004, between HRB Management, Inc. and Nicholas J. Spaeth, filed as Exhibit 10.16 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2004, file number 1-6089, is incorporated herein by reference. | |
| 10.20 | * | Employment Agreement dated September 2, 2003, between HRB Management, Inc. and Brad C. Iversen, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2004, file number 1-6089, is incorporated herein by reference. |
| 10.21 | * | Employment Agreement between Option One Mortgage Corporation and Robert E. Dubrish, executed on February 9, 2002, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2002, file number 1-6089, is incorporated herein by reference. |
| 10.22 | * | Employment Agreement dated December 2, 2002 between HRB Management, Inc. and Tammy S. Serati, filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended January 31, 2003, file number 1-6089, is incorporated herein by reference. |
| 10.23 | * | Employment Agreement dated as of April 1, 2003 between HRB Business Services, Inc. and Steven Tait, filed as Exhibit 10.23 to the annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. |
| 10.24 | * | Employment Agreement dated as of September 15, 2004 between HRB Management, Inc. and Marc West, filed as Exhibit 10.1 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. |
| 10.25 | * | Employment Agreement dated as of June 28, 2004 between H&R Block Services, Inc. and Timothy C. Gokey, filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. |
| 10.26 | * | Employment Agreement dated September 27, 2005 between HRB Management, Inc. and Jeff Nachbor, filed as Exhibit 10.10 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. |
| 10.27 | * | Form of Indemnification Agreement for directors, filed as Exhibit 10.1 to the Company’s current report on Form 8-K dated December 14, 2005, file number 1-6089, is incorporated herein by reference. |
| 10.28 | Second Amended and Restated Refund Anticipation Loan Operations Agreement dated as of June 9, 2003, between H&R Block Services, Inc., Household Tax Masters, Inc. and Beneficial Franchise Company, filed as Exhibit 10.27 to the annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. | |
| 10.29 | Fourth Amended and Restated Refund Anticipation Loan Participation Agreement dated as of December 31, 2004, between Block Financial Corporation, HSBC Taxpayer Financial Services, Inc. and Household Tax Masters Acquisition Corporation, filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.30 | 2004 Amendment to Second Amended and Restated Refund Anticipation Loan Operations Agreement dated as of August 20, 2004, by and among H&R Block Services, Inc., Household Tax Masters, Inc., and Beneficial Franchise Company, filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference.** | |
| 10.31 | Second Amendment to Second Amended and Restated Refund Anticipation Loan Operations Agreement dated as of August 31, 2005 among H&R Block Services, Inc., H&R Block Tax Services, Inc. HRB Royalty, Inc. HSBC Taxpayer Financial Services, Inc., HSBC Bank USA, National Association and Beneficial Franchise Company filed as Exhibit 10.23 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference.** | |
| 10.32 | HSBC Retail Settlement Products Distribution Agreement dated as of September 23, 2005, among HSBC Bank USA, National Association, HSBC Taxpayer Financial Services Inc., Beneficial Franchise Company Inc., Household Tax Masters Acquisition Corporation, H&R Block Services, Inc., H&R Block Tax Services, Inc., H&R Block Enterprises, Inc., H&R Block Eastern Enterprises, Inc., H&R Block Digital Tax Solutions, LLC, H&R Block Associates, L.P., HRB Royalty, Inc., HSBC Finance Corporation and H&R Block, Inc., filed as Exhibit 10.14 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. ** | |
| 10.33 | ||
| 10.34 | HSBC Refund Anticipation Participation Agreement dated as of September 23, 2005, among Household Tax Masters Acquisition |
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| Corporation, Block Financial Corporation, HSBC Bank USA, National Association and HSBC Taxpayer Financial Services Inc., filed as Exhibit 10.16 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. ** | ||
| 10.35 | HSBC Settlement Products Servicing Agreement dated as of September 23, 2005, among HSBC Bank USA, National Association, HSBC Taxpayer Financial Services Inc., Household Tax Masters Acquisition Corporation and Block Financial Corporation, filed as Exhibit 10.17 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. ** | |
| 10.36 | HSBC Program Appendix of Defined Terms and Rules of Construction, filed as Exhibit 10.18 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. ** | |
| 10.37 | Agreement of Settlement dated December 23, 2005 among H&R Block, Inc., H&R Block Services, Inc., H&R Block Tax Services, Inc., Block Financial Corporation, HRB Royalty, Inc., H&R Block Eastern Enterprises, Inc., Deadra D. Cummins, Ivan and La Donna Bell, Levon Mitchell, Geral Mitchell, Joyce Green, Lynn Becker, Justin Sevey, Maryanne Hoekman and Renea Griffith, filed as Exhibit 10.5 to the quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated herein by reference.* | |
| 10.38 | Agreement of Settlement dated April 19, 2006 among HSBC Finance Corporation, HSBC Taxpayer Financial Services Inc., Beneficial Franchise Company, Inc., H&R Block, Inc., H&R Block Services, Inc., H&R Block Tax Services, Inc., Block Financial Corporation, HRB Royalty, Inc., H&R Block Eastern Enterprises, Inc., and Lynne A. Carnegie. | |
| 10.39 | Amended and Restated Five-Year Credit and Guarantee Agreement dated as of August 10, 2005 among Block Financial Corporation, H&R Block, Inc.,. the lenders party thereto, Bank of America, N.A., HSBC Bank USA, National Association, Royal Bank of Scotland PLC, JPMorgan Chase Bank, N.A., and J.P Morgan Securities Inc., filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.40 | Five-Year Credit and Guarantee Agreement dated as of August 10, 2005 among Block Financial Corporation, H&R Block, Inc., the lenders party thereto, Bank of America, N.A., HSBC Bank USA, National Association, The Royal Bank of Scotland PLC, JPMorgan Chase Bank, N.A. and J.P. Morgan Securities, Inc., filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.41 | License Agreement dated as of June 30, 2004 by and between Sears, Roebuck and Co. and H&R Block Services, Inc., filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. | |
| 10.42 | Other Income License Agreement (Products and/or Services) dated September | |
| Standard Form of Agreement Between Owner and Designer/Builder dated as of May 5, 2003 by and between H&R Block Tax Services, Inc. and J.E. Dunn Construction Company, filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10.44 | Sale and Servicing Agreement dated as of June 1, 2005 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2005-6 and Wells Fargo Bank, N.A., filed as Exhibit 10.1 to the quarterly report on Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.45 | Note Purchase Agreement dated as of June 1, 2005 among Option One Loan Warehouse Corporation, Option One Owner Trust 2005-6 and Lehman Brothers Bank., filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.46 | Indenture dated as of June 1, 2005 between Option One Owner Trust 2005-6 and Wells Fargo Bank, N.A., filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.47 | Fourth Amended and Restated Loan Purchase and Contribution Agreement dated as of September 1, 2005 between Option One Loan Warehouse Corporation and Option One Mortgage Corporation, filed as Exhibit 10.22 to the quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.48 | Amended and Restated Sales and Servicing Agreement dated November 12, 2004 among Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.49 | Amendment Number One to the Amended and Restated Sale and Servicing Agreement dated November 11, 2005 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-5 and Wells Fargo Bank, N.A., filed as Exhibit 10.1 to the quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated herein by reference. | |
| 10.50 | Note Purchase Agreement dated November 14, 2003 between Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation and Citigroup Global Markets Realty Corp., filed as Exhibit 10.5 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.51 | Amendment Number One to the Note Purchase Agreement, dated November 14, 2004, among Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation and Citigroup Global Markets Realty Corp., filed as Exhibit 10.6 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.52 | Indenture dated as of November 1, 2003 between Option One Owner Trust 2003-5 and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.7 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.53 | Second Amended and Restated Sale and Servicing Agreement dated as of March 8, 2005 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National |
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| filed as Exhibit 10.40 to the Company’s annual report on Form 10-K for the year ended April 30, 2005, file number, 1-6089, is incorporated by reference. | ||
| 10.54 | Amendment No. 1 to Second Amended and Restated Sale and Servicing Agreement dated March 8, 2005 among Option One Owner Trust 2001-2, Option One Mortgage Corporation, Option One Loan Warehouse Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.4 to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 2005, file number, 1-6089, is incorporated by reference. | |
| 10.55 | Amendment Number Two to the Second Amended and Restated Sale and Servicing Agreement dated March 8, 2005 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.12 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number, 1-6089, is incorporated by reference. | |
| 10.56 | Amendment Number Three to the Second Amended and Restated Sale and Servicing Agreement dated March 8, 2005 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.12 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number, 1-6089, is incorporated by reference. | |
| 10.57 | Amendment Number Four to the Second Amended and Restated Sale and Servicing Agreement dated March 8, 2005 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number, 1-6089, is incorporated by reference. | |
| 10.58 | Amended and Restated Note Purchase Agreement dated as of November 25, 2003, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation and Bank of America, N.A., filed as Exhibit 10.11 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.59 | Amendment Number Seven to Amended and Restated Note Purchase Agreement, dated November 25, 2005, among Option One Loan Warehouse Corporation, Option One Owner Trust 2001-2 and Bank of America, N.A., filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated herein by reference. | |
| 10.60 | Amended and Restated Indenture dated as of November 25, 2003 between Option One Owner Trust 2001-2 and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.14 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | |
| 10.61 | Amendment Number Eight to the Amended and Restated Indenture dated as of November 25, 2003 between Option One Owner Trust 2001-2 and Wells Fargo Bank Minnesota, N.A., filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated herein by reference. | |
| 10.62 | Letter Agreement dated as of April 1, 2000 among Option One Mortgage Corporation and Bank of America N.A., filed as Exhibit 10.15 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.63 | Amended and Restated Note Purchase Agreement dated as of March 18, 2005 among Option One Owner Trust 2002-3, UBS Real Estate Securities Inc. and Option One Mortgage | |
| Amended and Restated Sale and Servicing Agreement dated as of March 18, 2005, among Option One Owner Trust 2002-3, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.47 to the Company’s annual report on Form 10-K for the year ended April 30, 2005, file number, 1-6089, is incorporated by reference. | ||
| Omnibus Amendment No. 1 dated as of September 8, 2005 among Option One Mortgage Corporation, Option One Owner Trust 2002-3 and Wells Fargo Bank, N.A. , filed as Exhibit 10.8 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | ||
| 10.66 | Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1A, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.48 to the Company’s annual report on Form 10-K for the year ended April 30, 2005, file number, 1-6089, is incorporated by reference. | |
| Amendment Number One to Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1A, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.6 to the quarterly report of Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10.68 | Indenture dated as of April 1, 2001 between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National | |
| Amendment Number Four, dated April 16, 2004, to Indenture between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, | ||
| Amendment Number | ||
| Amended and Restated Note Purchase Agreement dated as of April 16, 2004, among Option One Owner Trust 2001-1A, Option One Loan Warehouse Corporation and Greenwich Capital Financial Products, Inc., filed as Exhibit 10.53 to the Company’s annual report on Form 10-K for the year ended April 30, 2005, file number, 1-6089, is incorporated by reference. | ||
| Amendment No. 1 to Amended and Restated Note Purchase Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1A, Greenwich Capital Financial Products, Inc. and |
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| Option One Loan Warehouse | ||
| Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1B, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A. filed as Exhibit 10.55 to the Company’s annual report on Form 10-K for the year ended April 30, 2005, file number, 1-6089, is incorporated by reference. | ||
| Amendment Number One to Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1B, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.7 to the quarterly report of Form 10-Q for the quarter ended July 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10.75 | Indenture dated as of April 1, 2001 between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National | |
| Amendment Number Five, dated April 16, 2004, to Indenture between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, | ||
| Amendment Number | ||
| Amended and Restated Note Purchase Agreement dated as of April 16, 2004, among Option One Owner Trust 2001-1B, Option One Loan Warehouse Corporation and Steamboat Funding | ||
| Amendment No. 1 to Amended and Restated Note Purchase Agreement dated as of April 29, 2005 among Option One Owner Trust | ||
| Amended and Restated Sale and Servicing Agreement dated as of August | ||
| Indenture dated as of August 8, 2003 between Option One Owner Trust 2003-4 and Wells Fargo Bank Minnesota, National | ||
| Amended and Restated Note Purchase Agreement dated as of August | ||
| 10.83 | Sale and Servicing Agreement dated as of September 1, 2005 among Option One | |
| 10.84 | Note Purchase Agreement dated as of September 1, 2005 between Option One Loan Warehouse Corporation, Option One Owner Trust 2005-7, HSBC Securities (USA) Inc., HSBC Bank USA, N.A., Bryant Park Funding LLC and HSBC Securities (USA) Inc., filed as Exhibit 10.6 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.85 | Indenture dated as of September 1, 2005 between Option One Owner Trust 2005-7 and Wells Fargo Bank, N.A. , filed as Exhibit 10.7 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.86 | Sale and Servicing Agreement dated as of October 1, 2005 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2005-8 and Wells Fargo Bank, N.A., filed as Exhibit 10.19 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.87 | Note Purchase Agreement dated as of October 1, 2005 among Option One Loan Warehouse Corporation, Option One Owner Trust 2005-8 and Merril Lynch Bank USA, filed as Exhibit 10.20 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.88 | Indenture dated as of October 1, 2005 between Option One Owner Trust 2005-8 and Wells Fargo Bank, N.A. , filed as Exhibit 10.21 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2005, file number 1-6089, is incorporated by reference. | |
| 10.89 | Sale and Servicing Agreement dated as of December 30, 2005 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2005-9 and Wells Fargo Bank, N.A., filed as Exhibit 10.6 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated by reference. | |
| 10.90 | Note Purchase Agreement dated as of December 30, 2005 among Option One Loan Warehouse Corporation, Option One Owner Trust 2005-9 DB Structured Products, Inc., Gemini Securitization Corp., LLC, Aspen Funding Corp. and Newport Funding Corp., filed as Exhibit 10.7 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated by reference. | |
| 10.91 | Indenture dated as of December 30, 2005 between Option One Owner Trust 2005-9 and Wells Fargo Bank, N.A. , filed as Exhibit 10.8 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2006, file number 1-6089, is incorporated by reference. | |
| 12 | Computation of Ratio of Earnings to Fixed Charges for the five years ended April 30, | |
| 21 | Subsidiaries of the Company. | |
| 23.1 | Consent of KPMG | |
| 31.1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification by Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. |
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| 3 | .1 | Restated Articles of Incorporation of H&R Block, Inc., as amended, filed as Exhibit 3.2 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, are incorporated herein by reference. | ||
| 3 | .2 | Certificate of Amendment of Articles of Incorporation effective September 30, 2004, filed as Exhibit 3.1 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 3 | .3 | Amended and Restated Bylaws of H&R Block, Inc., as amended and restated as of June 9, 2004, filed as Exhibit 3.3 to the Company’s annual report on Form 10-K for the year ended April 30, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .1 | Indenture dated as of October 20, 1997, among H&R Block, Inc., Block Financial Corporation and Bankers Trust Company, as Trustee, filed as Exhibit 4(a) to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 1997, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .2 | First Supplemental Indenture, dated as of April 18, 2000, among H&R Block, Inc., Block Financial Corporation, Bankers Trust Company and the Bank of New York, filed as Exhibit 4(a) to the Company’s current report on Form 8-K dated April 13, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .3 | Officer’s Certificate, dated October 26, 2004, in respect of 5.125% Notes due 2014 of Block Financial Corporation, filed as Exhibit 4.1 to the Company’s current report on Form 8-K dated October 21, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .4 | Form of 81/2% Senior Note due 2007 of Block Financial Corporation, filed as Exhibit 4(b) to the Company’s current report on Form 8-K dated April 13, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .5 | Form of 5.125% Note due 2014 of Block Financial Corporation, filed as Exhibit 4.2 to the Company’s current report on Form 8-K dated October 21, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .6 | Copy of Rights Agreement dated March 25, 1998, between H&R Block, Inc. and ChaseMellon Shareholder Services, L.L.C., filed on July 22, 1998 as Exhibit 1 to the Company’s Registration Statement on Form 8-A, file number 1-6089, is incorporated herein by reference. | ||
| 4 | .7 | Form of Certificate of Designation, Preferences and Rights of Participating Preferred Stock of H&R Block, Inc., filed as Exhibit 4(e) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1995, file number 1-6089, is incorporated by reference. | ||
| 4 | .8 | Form of Certificate of Amendment of Certificate of Designation, Preferences and Rights of Participating Preferred Stock of H&R Block, Inc., filed as Exhibit 4(j) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1998, file number 1-6089, is incorporated by reference. | ||
| 4 | .9 | Form of Certificate of Designation, Preferences and Rights of Delayed Convertible Preferred Stock of H&R Block, Inc., filed as Exhibit 4(f) to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 1995, file number 1-6089, is incorporated by reference. | ||
| 10 | .1 * | The Company’s 2003 Long-Term Executive Compensation Plan, as amended and restated as of September 10, 2003, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2003, file number 1-6089, is incorporated by reference. | ||
| 10 | .2 | Form of 2003 Long-Term Executive Compensation Plan Award Agreement. | ||
| 10 | .3 * | The H&R Block Deferred Compensation Plan for Directors, as Amended and Restated effective July 1, 2002, filed as Exhibit 10.2 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. | ||
| 10 | .4 * | The H&R Block Deferred Compensation Plan for Executives, as Amended and Restated July 1, 2002, filed as Exhibit 10.3 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. | ||
| 10 | .5 * | Amendment No. 1 to the H&R Block Deferred Compensation Plan for Executives, as Amended and Restated, effective as of March 12, 2003, filed as Exhibit 10.5 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .6 * | The H&R Block Short-Term Incentive Plan, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .7 * | Summary of Non-Employee Director Cash Compensation, filed as Exhibit 10.1 to the Company’s current report on Form 8-K dated March 16, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .8 * | The Company’s 1989 Stock Option Plan for Outside Directors, as amended and restated as of September 8, 2004, filed as Exhibit 10.5 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .9 | Form of 1989 Stock Option Plan for Outside Directors Stock Option Agreement. | ||
| 10 | .10 * | The H&R Block Stock Plan for Non-Employee Directors, as amended August 1, 2001, filed as Exhibit 10.3 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2001, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .11 * | The H&R Block, Inc. 2000 Employee Stock Purchase Plan, as amended August 1, 2001, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2001, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .12 * | The H&R Block, Inc. Executive Survivor Plan (as Amended and Restated) filed as Exhibit 10.4 to the Company’s quarterly report on Form 10-Q for the quarter ended October 31, 2000, file number 1-6089, is incorporated herein by reference. |
| 10 | .13 * | First Amendment to the H&R Block, Inc. Executive Survivor Plan (as Amended and Restated), filed as Exhibit 10.9 to the Company’s annual report on Form 10-K for the fiscal year ended April 30, 2002, file number 1-6089, is incorporated by reference. | ||
| 10 | .14 * | Second Amendment to the H&R Block, Inc. Executive Survivor Plan (as Amended and Restated), effective as of March 12, 2003, filed as Exhibit 10.12 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .15 * | Employment Agreement dated July 16, 1998, between the Company and Mark A. Ernst, filed as Exhibit 10(a) to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 1998, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .16 * | Amendment to Employment Agreement dated June 30, 2000, between HRB Management, Inc. and Mark A. Ernst, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended July 31, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .17 * | Employment Agreement dated September 7, 1999, between HRB Management, Inc. and Jeffery W. Yabuki, filed as Exhibit 10.4 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2000, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .18 * | Employment Agreement dated as of October 4, 2004 between HRB Management, Inc. and William L. Trubeck, filed as Exhibit 10.2 to the Company’s current report on Form 8-K/A Amendment No. 1 dated September 9, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .19 | Employment Agreement dated as of February 2, 2004, between HRB Management, Inc. and Nicholas J. Spaeth, filed as Exhibit 10.16 to the company’s annual report on Form 10-K for the fiscal year ended April 30, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .20 * | Employment Agreement dated September 2, 2003, between HRB Management, Inc. and Brad C. Iversen, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .21 * | Employment Agreement between Option One Mortgage Corporation and Robert E. Dubrish, executed on February 9, 2002, filed as Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2002, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .22 * | Employment Agreement dated December 2, 2002 between HRB Management, Inc. and Tammy S. Serati, filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended January 31, 2003, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .23 * | Employment Agreement dated as of April 1, 2003 between HRB Business Services, Inc. and Steven Tait, filed as Exhibit 10.23 to the annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .24 * | Employment Agreement dated as of September 15, 2004 between HRB Management, Inc. and Marc West, filed as Exhibit 10.1 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .25 * | Employment Agreement dated as of June 28, 2004 between H&R Block Services, Inc. and Timothy C. Gokey, filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .26 * | Termination Agreement dated January 7, 2005 between H&R Block, Inc., H&R Block Financial Advisors, Inc. and Brian L. Nygaard, filed as Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .27 | Second Amended and Restated Refund Anticipation Loan Operations Agreement dated as of June 9, 2003, between H&R Block Services, Inc., Household Tax Masters, Inc. and Beneficial Franchise Company, filed as Exhibit 10.27 to the annual report on Form 10-K for the fiscal year ended April 30, 2003, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .28 | Fourth Amended and Restated Refund Anticipation Loan Participation Agreement dated as of December 31, 2004, between Block Financial Corporation, HSBC Taxpayer Financial Services, Inc. and Household Tax Masters Acquisition Corporation, filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .29 | 2004 Amendment to Second Amended and Restated Refund Anticipation Loan Operations Agreement dated as of August 20, 2004, by and among H&R Block Services, Inc., Household Tax Masters, Inc., and Beneficial Franchise Company, filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference.** | ||
| 10 | .30 | 364-Day Credit and Guarantee Agreement dated as of August 11, 2004 among Block Financial Corporation, H&R Block, Inc., Bank of America, N.A., Barclays Bank PLC, HSBC Bank USA, National Association, The Royal Bank of Scotland PLC, JPMorgan Chase Bank, J.P. Morgan Securities, Inc. and other lending parties thereto, filed as Exhibit 10.1 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .31 | Five-Year Credit and Guarantee Agreement dated as of August 11, 2004 among Block Financial Corporation, H&R Block, Inc., Bank of America, N.A., Barclays Bank PLC, HSBC Bank USA, National Association, The Royal Bank of Scotland PLC, JPMorgan Chase Bank, J.P. Morgan Securities, Inc. and other lending parties thereto, filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .32 | License Agreement dated as of June 30, 2004 by and between Sears, Roebuck and Co. and H&R Block Services, Inc., filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended July 31, 2004, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .33 | Leasing Operations Supplier Agreement (Products and/or Services) dated as of September 11, 2003 between Wal*Mart Stores, Inc. and H&R Block Services, Inc. | ||
| 10 | .34 | Standard Form of Agreement Between Owner and Designer/Builder dated as of May 5, 2003 by and between H&R Block Tax Services, Inc. and J.E. Dunn Construction Company, filed as Exhibit 10.2 to the quarterly report on Form 10-Q for the quarter ended October 31, 2004, file number 1-6089, is incorporated herein by reference. |
| 10 | .35 | Second Amended and Restated Loan Purchase and Contribution Agreement dated as of November 14, 2003 between Option One Loan Warehouse Corporation and Option One Mortgage Corporation, filed as Exhibit 10.3 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .36 | Amended and Restated Sales and Servicing Agreement dated November 12, 2004 among Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A., filed as Exhibit 10.4 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .37 | Note Purchase Agreement dated November 14, 2003 between Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation and Citigroup Global Markets Realty Corp., filed as Exhibit 10.5 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .38 | Amendment Number One to the Note Purchase Agreement, dated November 14, 2004, among Option One Owner Trust 2003-5, Option One Loan Warehouse Corporation and Citigroup Global Markets Realty Corp., filed as Exhibit 10.6 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .39 | Indenture dated as of November 1, 2003 between Option One Owner Trust 2003-5 and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.7 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .40 | Second Amended and Restated Sale and Servicing Agreement dated as of March 8, 2005 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .41 | Amended and Restated Note Purchase Agreement dated as of November 24, 2003, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation and Bank of America, N.A., filed as Exhibit 10.11 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .42 | Amendment Number One to the Amended and Restated Note Purchase Agreement, dated as of December 17, 2004, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation and Bank of America, N.A., filed as Exhibit 10.12 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .43 | Amendment Number Two to the Amended and Restated Note Purchase Agreement, dated as of February 15, 2005, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation and Bank of America, N.A., filed as Exhibit 10.13 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .44 | Amended and Restated Indenture dated as of November 25, 2003 between Option One Owner Trust 2001-2 and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.14 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated herein by reference. | ||
| 10 | .45 | Letter Agreement dated as of April 1, 2000 among Option One Mortgage Corporation and Bank of America N.A., filed as Exhibit 10.15 to the quarterly report on Form 10-Q for the quarter ended January 31, 2005, file number 1-6089, is incorporated by reference. | ||
| 10 | .46 | Amended and Restated Note Purchase Agreement dated as of March 18, 2005 among Option One Owner Trust 2002-3, UBS Real Estate Securities Inc. and Option One Mortgage Corporation. | ||
| 10 | .47 | Amended and Restated Sale and Servicing Agreement dated as of March 18, 2005, among Option One Owner Trust 2002-3, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A. | ||
| 10 | .48 | Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1A, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A. | ||
| 10 | .49 | Indenture dated as of April 1, 2001 between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .50 | Amendment Number Four, dated April 16, 2004, to Indenture between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. | ||
| 10 | .51 | Amendment Number Five, dated April 30, 2004, to Indenture between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. | ||
| 10 | .52 | Amendment Number Six, dated April 29, 2005, to Indenture between Option One Owner Trust 2001-1A and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. | ||
| 10 | .53 | Amended and Restated Note Purchase Agreement dated as of April 16, 2004, among Option One Owner Trust 2001-1A, Option One Loan Warehouse Corporation and Greenwich Capital Financial Products, Inc. | ||
| 10 | .54 | Amendment No. 1 to Amended and Restated Note Purchase Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1A, Greenwich Capital Financial Products, Inc. and Option One Loan Warehouse Corporation. | ||
| 10 | .55 | Second Amended and Restated Sale and Servicing Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1B, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank, N.A. | ||
| 10 | .56 | Indenture dated as of April 1, 2001 between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .57 | Amendment Number Five, dated April 16, 2004, to Indenture between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. | ||
| 10 | .58 | Amendment Number Six, dated April 30, 2004, to Indenture between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. |
| 10 | .59 | Amendment Number Six, dated April 29, 2005, to Indenture between Option One Owner Trust 2001-1B and Wells Fargo Bank Minnesota, National Association, as amended and restated through and including November 25, 2003. | ||
| 10 | .60 | Amended and Restated Note Purchase Agreement dated as of April 16, 2004, among Option One Owner Trust 2001-1B, Option One Loan Warehouse Corporation and Steamboat Funding Corporation. | ||
| 10 | .61 | Amendment No. 1 to Amended and Restated Note Purchase Agreement dated as of April 29, 2005 among Option One Owner Trust 2001-1B, Steamboat Funding Corporation and Option One Loan Warehouse Corporation. | ||
| 10 | .62 | Sale and Servicing Agreement dated as of August 8, 2003 among Option One Owner Trust 2003-4, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .63 | Amendment No. 1 to Sale and Servicing Agreement dated as of August 6, 2004 among Option One Owner Trust 2003-4, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .64 | Amendment No. 2 to Sale and Servicing Agreement dated as of August 24, 2004 among Option One Owner Trust 2003-4, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .65 | Indenture dated as of August 8, 2003 between Option One Owner Trust 2003-4 and Wells Fargo Bank Minnesota, National Association. | ||
| 10 | .66 | Note Purchase Agreement dated as of August 8, 2003 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 10 | .67 | Amendment No. 1 to Note Purchase Agreement dated as of August 6, 2004 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 10 | .68 | Amendment No. 2 to Note Purchase Agreement dated as of August 24, 2004 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 10 | .69 | Amendment No. 3 to Note Purchase Agreement dated as of October 29, 2004 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 10 | .70 | Amendment No. 4 to Note Purchase Agreement dated as of November 30, 2004 among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 10 | .71 | Amendment No. 5 to Note Purchase Agreement dated January 31, 2005, among Option One Mortgage Corporation, Option One Loan Warehouse Corporation, Option One Owner Trust 2003-4, Falcon Asset Securitization Corporation, Jupiter Securitization Corporation, Preferred Receivables Funding Corporation, financial institutions thereto and Bank One, NA. | ||
| 12 | Computation of Ratio of Earnings to Fixed Charges for the five years ended April 30, 2005. | |||
| 21 | Subsidiaries of the Company. | |||
| 23 | .1 | Consent of KPMG LLP, Independent Registered Public Accounting Firm. | ||
| 23 | .2 | Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm. | ||
| 31 | .1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
| 31 | .2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
| 32 | .1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | ||
| 32 | .2 | Certification by Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. |
| Indicates management contracts, compensatory plans or arrangements. | ||
| ** | Confidential Information has been omitted from this exhibit and filed separately with the Commission pursuant to a confidential treatment request under Rule 24b-2. |
90
| Additions | |||||||||||||||||||||||
| Balance at | |||||||||||||||||||||||
| Beginning of | Charged to Costs | Charged to | Balance at End | ||||||||||||||||||||
| Description | Period | and Expenses | Other | Deductions | of Period | ||||||||||||||||||
| Allowance for Doubtful Accounts – deducted from accounts receivable in the balance sheet | |||||||||||||||||||||||
| 2005 | $ | 54,521,000 | $ | 52,221,000 | – | $ | 66,712,000 | $ | 40,030,000 | ||||||||||||||
| 2004 | $ | 23,941,000 | $ | 53,663,000 | – | $ | 23,083,000 | $ | 54,521,000 | ||||||||||||||
| 2003 | $ | 65,842,000 | $ | 49,748,000 | – | $ | 91,649,000 | $ | 23,941,000 | ||||||||||||||
Report of Independent Registered Public Accounting Firm on Schedule
To the Board of Directors and Stockholders of H&R Block, Inc.:
Under date of JulyJune 29, 2005,2006, we reported on the consolidated balance sheets of H&R Block, Inc. and its subsidiaries (the Company) as of April 30, 20052006 and 2004,2005, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the years thenin the three-year period ended April 30, 2006, which are included in the Company’s annual report filed on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule for each of the years in the three-year period ended April 30, 2005 and 20042006, included in the Form 10-K. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
The audit report on the consolidated financial statements of H&R Block, Inc. and its subsidiaries referred to above contains an explanatory paragraph stating that, as discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting to adopt Emerging Issues Task Force Issue No. 00-21,Revenue Arrangements with Multiple Deliverables;and Statement of Financial Accounting Standards No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure,Deliverables, during the year ended April 30, 2004.
/s/ KPMG LLP
Kansas City, Missouri
JulyJune 29, 20052006
Kansas City, Missouri
H&R BLOCK, 2005 Form 10K
INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
| Additions | ||||||||||||||||
| Balance at | Charged to | |||||||||||||||
| Beginning of | Costs and | Balance at | ||||||||||||||
| Description | Period | Expenses | Deductions (1) | End of Period | ||||||||||||
| Allowance for Doubtful Accounts - deducted from accounts receivable in the balance sheet | ||||||||||||||||
| 2006 | $ | 35,352,000 | $ | 39,746,000 | $ | 8,835,000 | $ | 66,263,000 | ||||||||
| 2005 | $ | 37,424,000 | $ | 52,221,000 | $ | 54,293,000 | $ | 35,352,000 | ||||||||
| 2004 | $ | 14,329,000 | $ | 53,663,000 | $ | 30,568,000 | $ | 37,424,000 | ||||||||
| Liability related to Mortgage Services restructuring charge | ||||||||||||||||
| 2006 | $ | - | $ | 12,624,000 | $ | 5,066,000 | $ | 7,558,000 | ||||||||
| (1) | Deductions from the Allowance for Doubtful Accounts reflect recoveries and charge-offs. Deductions from the restructuring charge liability represent payments made. |